Typically, nonpublic companies obtain an audit of their financial statements only if it is required by a third party, such as their financial institution, other lender or investor. However, there are a number of reasons why obtaining audits can be beneficial even if there is no third-party requirement.
One example, says Don Carobine, CPA and vice president of Gumbiner Savett Inc., is when a growing company requires outside funding in order to finance future plans and goals. “Having audited financial statements at least one year prior to this need will ease the process when negotiating with financial institutions, other lenders or investors,” he explains.
Smart Business spoke with Carobine about the advantages of regularly conducting audits, how often they should be obtained and the new audit standards.
What advantages can a nonpublic company gain by regularly having audits?
A company may have future plans to go public or be acquired by or merge with a public company, which will require the audit of three years’ balance sheets and two years’ income statements. Having regular audits beginning at least two years prior to the year a company plans to go public will ease the process and ensure the company is ready. The decision to obtain audits may also go hand in hand with the owner’s individual life plans. That is, after working hard to build a valuable business throughout his or her career, an owner may want to slow down and enjoy a certain quality of life. Having several years of audits in place will ease the sale process when the time comes and help ensure a top-dollar sale price.
Another reason owners may want to obtain audits is to provide them with a level of comfort that the internal accounting records are accurate. Finally, a good auditor will learn about the business and operations of the company and provide valuable advice to the owners that may include more efficient and cost-effective ways to operate, ways to improve upon internal controls to ensure accurate reporting, and ways to minimize taxes through keeping up with ever-changing tax laws.
How often should audits be conducted?
Audits are typically conducted on an annual basis at the end of a company’s fiscal year. There are situations where an audit may be helpful at an interim period, such as when a company is sold, but such a scenario would be dictated by circumstances. A company may want to consider having a review performed during interim periods, such as quarterly or semiannually, if it would be beneficial. A review is smaller in scope than an audit and includes inquiries and analytical procedures.
Does a company’s size or rate of growth affect how audits should be conducted?
Yes. Auditors consider many factors when determining how they will conduct an audit, including the company’s size and rate of growth. The first phase of an audit is planning. The auditor learns as much as possible about the business, operations, internal controls, current year developments, risk areas and possible areas of fraud concern, among many other things. Obtaining this knowledge helps in the determination of how the audit will be conducted.
How important a role do audits play in identifying and reducing risk?
Audits are performed on historical information. That is, they are performed after the fact. Although auditors may identify areas of risk during the course of an audit and provide recommendations for reducing such, a company should not rely on the audit process for identifying and reducing risk. Instead, company management should develop a customized system of internal controls over financial reporting that is appropriately designed and that takes into consideration risks that have been identified by management. These internal controls should be monitored periodically through compliance testing to ensure their design is effective and that they are operating as intended. In addition, the internal control structure should be revised when changes occur at the company, such as the addition or deletion of personnel, a change in accounting software or the addition of a new line of business.
Are there any new audit standards of which companies should be aware?
There are eight new statements on auditing standards that were issued by the American Institute of Certified Public Accountants last year that are effective for the upcoming audit season. They are referred to as the risk assessment auditing standards and require that, among other things, the auditor obtain a more in-depth understanding of a company’s internal controls and that the controls be tested by the auditor before arriving at conclusions as to the design and effectiveness of a company’s internal controls during the audit. This will require that companies provide their auditors with more in-depth documentation of their internal control system than they may have in the past. Management should begin discussions with the company’s auditors now to learn what will be expected of them in relation to these new standards for their next audit.
DON CAROBINE is a CPA and vice president of Gumbiner Savett Inc. Reach him at email@example.com or (310) 828-9798.