RX 24 - How To Have A Successful FInancial Statement Audit - Doug McVey

Transcribed Content

All right. Welcome everyone to the session, How to Have a Successful Financial Statement Audit. Let's give a warm welcome to Doug McVeigh. Thank you. So by way of introduction, I am Doug McVeigh. I'm a partner with Kaepen Krausz. We're a public accounting firm that specializes in working with not for profit organizations, and we serve over eight 600 churches across the country. I've been auditing churches for many years. And, so today, we're gonna talk a little bit about how to have a successful financial statement audit. I'm just curious, by show of hands, how many of you go through an audit at your organization? So about half. I liken this to teaching somebody how to prepare for a colonoscopy. So it's that's a joke. It's not always the funniest thing to do to go through an audit, but it's certainly something that's important as you seek to have you know, good financial practices in place. And so let's get started. Really, the the thing that I'm gonna talk about a lot today is preparation. You know, anytime you have an audit, there's a fair amount of work that goes into preparing, for the audit, and there's, that will really be the key in terms of having a successful successful audit. And the way I would define a successful audit is one where you receive a clean audit opinion. That's the piece that belongs to the auditors where they give an opinion on your financial statements in terms of whether your statements are in accordance with generally accepted accounting principles. And so that's the objective is to get a clean opinion. The other deliverables would be the financial statements themselves as well as management letter a management comment letter, which comes from the auditors and would disclose any internal control deficiencies as well as make recommendations for improvement. And so the cleaner your management letter is, the better. So those are kind of the objectives that we're looking for. And then, of course, we wanna have it done timely. We wanna meet all the deadlines. So in order to accomplish that, there's really, you know, about seven different things that I'm gonna talk about today. We'll go over each of these in a little bit more detail. But to begin with, you know, first step would really be to analyze, review, and reconcile the significant trial balance accounts. Reconciling those accounts and making any necessary adjustments is really the the the basic starting point for for the audit. You're gonna wanna meet with your auditor to confirm the audit plan and the timeline, making sure that expectations are clear on both sides. You're gonna wanna talk to your internal accounting team about duties and responsibilities and how you divide up the workflow. You're gonna wanna inform others within your organization about what to expect. While most of the heavy lifting will be done by the accounting team, there will be other folks within your organization that may have some involvement, and so it's good for them to know, what's going on. It's also critical that you finish recording all of the activity for the year prior to the start of the audit and to have everything ready for the audit team before they arrive or if it's being done remotely before they commence work. And don't forget that you'll need to communicate throughout the process. So in terms of analyzing, reviewing, and reconciling significant trial balance accounts, you're really gonna wanna work on implementing a system where you do that with some regularity during the year. If you let all your reconciliations pile up until the end, you're gonna have a backlog from the start. And, really, it does enhance your internal financial reporting to have those reconciling or those reconciliations done on a on a periodic basis. And I'd say, you know, for cash accounts, bank accounts, investment accounts, you're gonna wanna do that monthly. But for other types of accounts, maybe accrual, accrued liabilities, or, prepaids or other such accounts, fixed assets, you may wanna do that less frequently, probably quarterly would be appropriate. And I would suggest that you develop a checklist to ensure that the appropriate individuals are performing the reconciliations and that somebody other than the one preparing them is also reviewing those and documenting that review. As an auditor, if it's not documented, it didn't happen is kind of our mantra. And so we wanna make sure we see good documentation relative to any sort of reviews that are done after the reconciliation is complete. As you begin to prepare the work papers that are necessary for the audit, make sure that they're clear and easy to follow and that you have links, whether there's notations on the work paper or actual embedded links to the supporting documents that would provide the detail necessary to to support the work on the work paper. Remember in an audit, we're not reporting to the penny. We're reporting with this concept of materiality. And so we take a look at your financial statements, and we would determine what is material to the financial statements taken as a whole. And that threshold is useful in determining our testing that we perform. So you don't have to chase every penny. Oftentimes, if you get it pretty close, that's probably close enough. And then lastly, as you go about preparing the work papers, think about what the auditors will likely ask for when you're doing the reconciliations or the work paper prep. Oftentimes, can anticipate what sort of follow-up questions we may have and can kind of head those off at the past by documenting, answers to that information ahead of time. Next step would be when you meet with your auditor to confirm the audit plan and the timeline, you really wanna lay out an agreed upon time frame and get it on the calendar so that it's documented. You wanna establish key dates to provide information to the auditor as well as key audit work dates. Again, they may be coming on-site or they may be working remotely, but make sure that those dates are established. We typically refer to those as the field work dates. And also make sure that you have the key reporting deadlines established. Oftentimes, I'll start with the reporting deadlines and work backwards from there to try and achieve to try and arrive at the other deadlines. And you'll really you'll wanna solidify any board or committee meeting dates as early as possible so that you can make sure that you're all wrapped up and done in time for those meetings where the auditors will typically come and report the findings to the board or the finance committee. You wanna make sure that your time frame is reasonable and achievable. You don't wanna rush. An audit is is not something that's done well when it's rushed. And so make sure that you're you're realistic in how you set your your targets. And hold your team to the deadline and also hold the auditors to the deadline. That's important. You'll also wanna talk to your internal accounting team and delegate responsibilities based on various roles, trying to move some of the work down. You it's really too much for any one person to accomplish on their own. And so depending on the size of your staff, you know, you may have involvement of the controller or various staff accountants or accounting clerks. You might even have interns that can assist in some of the prep. But just make sure that you assign responsibilities appropriately to various folks on the team and that you share the load. And you wanna develop a timeline internally that aligns with the auditor's timeline. Give yourself a little bit of cushion just so that you can deal with the unexpected, which seems to always happen. You do wanna have a little bit of margin in your schedule. You also may wanna discuss how you can better organize the work year round so that you can plan, in advance for the audit. One of the things that's important is looking at your filing system. How do you, maintain your your, documents, you know, finding a way that helps, kinda put them in folders or files that can be easily accessed, when the audit comes around is important. You wanna also make sure that you have access to large agreements or contracts that your organization may be party to because inevitably, the auditors are gonna ask for copies of those, as part of the audit. So you wanna have be able to put your hands on those rather easily. The reconciliation process is you'll wanna have, you know, those documented well so that when the auditor asks you how do you go about doing those those tasks, you typically will have a memo or a write up that will explain it. That's important. As well as internal control. One of the things we spend a fair amount of time on is looking at how cash, comes into the organization, you know, cash receding that transaction cycle as well as cash disbursements and payroll. Those are three areas that will receive a lot of scrutiny by the auditors. And so having your workflows documented in those areas can really be helpful to expedite things. And then the last item here is electronic documents. Almost all audits are now done electronically. It would be very unusual to have one done on paper these days. And so having your key work papers and the supporting documents already scanned and saved electronically will really save you a lot of time so you don't have to scramble to do that at the end. Next, in terms of finishing recording all the activity for the year, you're gonna wanna focus on the significant account reconciliations. And again, as I mentioned earlier, you're gonna wanna document the independent review of those reconciliations. And you're gonna wanna gather supporting documents that would support those reconciling items, and you're gonna wanna make all your adjustments to record the reconciling items within your general ledger, upon completion of those reconciliations. One of the things auditors do throughout the audit is we will look at variances from one year to the next. And so certain account balances will have an expectation in terms of what those balances may be. But if there's a significant change, we'll wanna talk about that and understand what's driving those variances. And so as you're going about prepping for the audit, if you can start documenting the variance explanations ahead of time while it's fresh in your mind, that'll save you time at the end and probably easier as well. And then lastly, you'll wanna do a little bit of research on new audit standards and how they might impact your your audit. There's there's oftentimes new accounting pronouncements that come out periodically. And I would check with your auditor early in the process just to understand what's new this year that might require some additional effort on your part. And the auditors should be well equipped to educate you on what those changes may be and to help you walk through that process together. This next one is really key in my view. That is to have everything ready for ready for the audit team before they arrive. You're gonna wanna work through the entire audit prep list and have it to the auditors before they come out or before the the established dates of remote field work. Typically, if we're gonna start on a Monday, I wanna have everything by the Friday before so that we can get it uploaded into our system and be ready to hit the ground running come Monday. If you know that the auditors are gonna ask for something, even if it's not on the list, I would go ahead and prepare it. You know your the the transactions and the the activities of your organization better than we do, and so you may know that there's things that are gonna trigger questions. And so going ahead and having that ready in advance would certainly be helpful and appreciated by your audit team. Next, you're gonna wanna upload all of the information requested to one secure site. You're gonna wanna avoid email if possible because things can get lost in the shuffle. There can be confusion as to what's been provided, what's not been provided, what's still outstanding. So your auditor should be able to provide you with a secure client portal where you could upload all the documentation and it's collected in that repository. And you then have a record of what's been submitted and what may still be outstanding, and it's it's more secure than an email. Again, don't forget communication is key throughout the process. As I said before, you wanna hold their your auditors to their agreed timeline. There really should be no reason for delay on their end. Usually, when delays occur, it's because information has not been provided to them, when requested. And so, but but they should be, you know, honoring their end of the bargain. After fieldwork, you know, check-in with them at least weekly. You know, the fieldwork is typically a week, but then there'll be a two to three week wrap up period, subsequent to that. And you should be in communication with the auditor during that period so you understand what's where things are at and what kind of issues may still pop up. Please understand that there will be last minute questions or certain requests that will occur. You may have completed the prep list in its entirety, but there are certain things that may be triggered by information that we received during the audit that would result in additional questions or additional requests. And so those will come. It's part of the nature of an audit. Just be aware that that'll happen. And and it's okay to ask the auditors to give you a heads up, you know, in terms of, you know, what additional questions do you think may be coming our way just so that you're not caught off guard. And then at the end of fieldwork, it would be appropriate to ask your auditor for a preliminary list of audit adjustments. These would be adjusting entries that are gonna be suggested by the auditor to true up your records to agree with the work that they've done. And then you'll wanna make sure that you have agreement on the nature of those adjustments and what they're designed to accomplish. The second area that you'd wanna talk to your auditor about would be the management letter comments that they have, identified at the end of field work. And they're probably still gonna be in draft form. They may still be working through what the recommendations will exactly entail, but getting an idea of what issues they may have identified from an internal control perspective is something that you would wanna know early on, and as soon as field work is complete. A couple tips I would give you relative to virtual audits. Going back a few years pre COVID, there were still a lot of audits that were done in person where the auditors would come out to your organization and work, in person, conducting the audit, and there may be a fair amount of paper documents that they would work through while while doing their work. Post COVID, really, a lot of the audits that we're doing are now remote, where where we do not necessarily come on-site for field work. We may come out in advance just to meet and develop some baseline relationship, which I still think is very important. But But when it comes time to doing the audit field work, more and more often, we're doing that remotely. So that takes a little bit of a of discipline and organization to make that go smoothly. Just be aware that the week the auditors are working, even if they're not in your conference room, there's still there's still a handful of folks that are dedicated to working on your engagement and will inevitably need a lot of your attention that week even if it's even if it's remote. I would set daily check ins with the audit in charge just to stay abreast of where things are at on a day to day basis during field work. And, again, that centralized repository site for document submission will come in very handy. And I would take a moment to brainstorm with your auditors if there's any information that they've asked of you that might be overly burdensome to provide electronically. Maybe there's maybe they're doing some testing and there's a a a stack of invoices that they need to review to support certain transactions within your system. There may be a lot of effort involved in scanning those. And so you have a conversation and see maybe they can send somebody out to review those in person if they're local, or maybe there's another way to skin that cat. So don't be afraid to ask if if there's certain requests that are that are overly burdensome to you. Also, remember that the communication style that fits best for you is what you should request. If you're a person who prefers phone calls, let your auditor know that. Or maybe you wanna do video conferencing or you utilize email. Your auditor should be able to adapt to whatever best meets your needs. So just let them know your style upfront, and I think things will go more smoothly. It's also worthwhile to lay out a road map for the week, identifying what areas your auditors are gonna tackle first so that you kinda know the cadence of what's gonna be done during the the week in question. And just remember there's a certain level of flexibility that's important as we go through that because things can can evolve or change a little bit as as we get into it. So those are some tips on how to how to have a successful audit. I thought we'd also spend a little bit of time just talking about the basic structure of an audit, particularly for those of you who maybe who haven't been through it before. We'll just kind of outline what's in what's involved in in in the audit engagement. The first phase is really the planning phase. And this is where once you've decided to engage an auditor, you'll wanna have some conversations with them upfront to really understand, for them to really understand your organization and understand, you know, what's new this year, what sort of transactions significant transactions might have occurred that perhaps didn't occur last year, or if it's a first time engagement, just gauging getting that baseline understanding of what you do and how you do it. And then once that's done, then the auditor will prepare an engagement letter. An engagement letter is simply the written agreement that outlines the scope of the work that'll be performed and provides, you know, the billing schedule and timing related information. And that document will typically need to be signed by a member of management as well as a member of the board, recognizing that auditors really work for the board, not for management. And so we wanna include both a representative of both bodies, in acknowledging the terms of the agreement. Then it's important for the auditors to review the board minutes from the year leading up to the end of your fiscal year. And we do that to understand what sort of significant board actions have occurred, what sort of decisions have been made. Typically, things of significance are noted in the minutes, and so we we really use that as a opportunity to zero in on areas that might require more work from us to drill down as part of the audit. We'll also review professional service expenditures. So, and focusing specifically on legal expenses that may have been incurred during the year, we're required to consider whether there might be any liabilities, that you're, subject to as a result of any any claims against the organization or any litigation that might, exist. And we'll we'll try to identify if there's any consultations with attorneys relative to that, and then we'll typically need to send a letter to the attorney asking for clarification on the status of the case. Hopefully, of that applies to you, but if it does, that would be the the the protocols. And then we also send out confirmation letters. Anytime an auditor can confirm a balance with a third party, that's the best audit evidence we can get. And so, for example, your bank accounts, we're gonna send a letter to the bank asking them to confirm for us what your ending balances were, and we'll use that to reconcile back to your financial statements. We'll do the same thing for investment accounts. Occasionally, auditors might confirm other types of, transactions, whether it would be pledges or, sometimes, like, contribute significant contributions that come in might need to be confirmed, particularly if there's restrictions attached to them that are maybe unclear. Those are just some examples. But those confirmations, we'll ask you to prepare those, and we'll send those out usually a week or two before the audit so that we get those back in time for field work. The next phase of the audit is what we call the risk assessment phase, and this is where we're really looking at the organization in-depth just to gain a deeper understanding of how you do what you do from a financial reporting perspective. And the goal is to identify any risk areas within the organization where there might be financial statement errors or misstatements that we would need to identify as part of the audit. So we're gonna look at the financial reporting system documentation. Again, I mentioned earlier, you know, having a write up of how you receive funds, how you disperse funds, payroll, other significant areas. Having those sort of memos prepared in advance will really help. And then we'll do walk throughs where we'll ask you, we'll show us we'll pick a transaction, maybe a a gift that came in, and we'll wanna see how that flows through your system so that we have clarity on how your systems are operating and what sort of controls you have in place. We'll also spend some time looking at in information systems and technology To the extent that that would have impact on your financial reporting, we'd wanna understand that and and look for any risk areas there as well. We'll consider tax compliance. You know, as a church, you're not gonna file income taxes or nine nineties typically, but you will have tax areas of taxation that you're required to be in compliance with relative to payroll. Or in the last couple years, a lot of organizations have filed for various tax credits as part of the COVID relief. And so we'll look at those areas and make sure that you're in compliance. We'll also do preliminary analytical review where we'll take your interim financial statements and review those to drill down on anything that looks unusual or, different than what we might expect so that we can include that in our audit plan. And then lastly, we're gonna test journal entries. That is the way that you make manual adjustments to your general ledger. And by the nature of the fact that it's a manual adjustment, it's an area that has higher risk. And so we'll wanna pull a sample of journal entries and test those to make sure that they're appropriate and make sure you have the proper review of the entry by someone other than the one who's posting it. We then pull all that information together and have what's called the a brainstorm session. This is done by the audit team from the partner on down to the the newest associate. And, really, it's a it's a opportunity for us to think about, you know, where could there be errors or misstatements within your financial statements. You know, what what could go wrong or what could be wrong within the statements? And we do have to consider the possibility that there could be certain fraud risks that could exist. And so, typically, your auditor will ask questions of various folks within your organization trying to understand if there are any fraud risks that exist that we would need to be aware of or any allegations of fraud that may have been been made that we would certainly wanna know about so that we can test appropriately. We'll look at how you recognize revenue. That is a significant area of any audit. We're gonna look at the consideration of risk of material misstatement to your financials. And then we're gonna document our audit plan and our response to all the risks that we identified during BrainStorm, and that's where we really developed the customized, audit testing that will need to be performed in order for us to give an opinion on your financial statements. And then we we pulled together a document that we're required to share with a represent representative of governance, typically, would be an audit committee member, audit committee chair, or a finance committee chair, somebody at that level, just so they have some visibility into what we think are the riskier areas and what are the steps that we're gonna perform relative to those risks. Then we conduct the execution phase of the audit where we basically execute the plan that we've developed. This would typically be referred to as fieldwork, and we really start at the top of your balance sheet, you know, cash being the first line item. We audit all the way through the balance sheet, all the account balances, all the way down to the income statement, looking at income, and then all the way down to even the smallest expense lines, maybe a miscellaneous expense, for example. And so we really that's where we really do the heavy lifting of the audit in terms of testing transaction balances and activities. Once we're done with that, we move into the wrap phase. And this is where we would work with you to identify any related parties. This could be, family members of those that have significant influence at the church, board members that you might do business with, those sort of relationships. And then the purpose of that is to identify whether there's any disclosure requirements as a result of that. We also have to look at the organization's ability to continue as a going concern. What this means is we financial statements are prepared under the assumption that you're gonna be viable in in business one year post, the financial statement, report date. And so we have to look at that. And if if there's questions about your viability financially, then we would have some conversations about that. Hopefully, that's not a concern of yours, and it'll be pretty pretty clear cut that you're in a a strong financial position. But we do have to consider that. We also have to consider whether there's any commitments you've entered into. For example, if you're gonna do a significant building project, you may have a construction contract that you signed but has not yet work has not yet commenced, and so there's no no balance on your on your balance sheet relative to that liability, but you have committed significant future dollars to that project, we would need to potentially disclose that. We would also look at potential loss contingencies, and that's where getting back to the legal inquiries that we make. If there was a potential settlement that was going to occur, we would need to know about that and potentially disclose that loss contingency in your footnotes. Lastly, we perform subsequent event review. We're required to consider, has anything happened since the end of your fiscal year? So let's say you're a December year end, well, the audit's not wrapped up until April or May. What's happened during that interim period that might be relevant to the reader of the financial statements. And so if you entered into some sort of significant transaction or a commitment that's not reflected in the financials but will have significant impact in the future, we may have to disclose that in your footnotes. So that's what the subsequent event review is designed to accomplish. And then lastly, we have the reporting phase of the audit. This is where the auditors will produce the deliverables that come to you as part of the audit work, what we do. And the first one would be the independent auditor's report. This is the opinion letter where we give an opinion on your financial statements and whether they are materially accurate in accordance with generally accepted accounting principles. Then we draft the financial statements. Sometimes our clients will draft their own statements and then we'll review them. But, typically, your auditor will be happy to draft them for you if if that's easier. And then there's the notes to the financial statements, have to be prepared as well. The notes can be fairly extensive. There's a lot of disclosures that are required nowadays, and so that takes a fair amount of time as well. And then, again, the last deliverable would be that management letter where we, would report any deficiencies in internal controls and make recommendations on how you can remediate those those risks. And our firm really uses the management letter as a as a way to be helpful to add value. We'll include control deficiencies, but we'll also include best practice recommendations as well in that letter just to add add some value to the process. And a lot of times, that's where you get a lot of the value out of the audit is the recommendations that come in that letter. There's a number of additional audit committee matters that are disclosed in that letter as well. I won't go through those, but they just you know, if if there for example, if there were disagreements with management or if there were significant challenges in conducting the audit, we would talk about those things. We also disclose any audit adjustments that were necessary, those sort of things. And all that gets reported to the finance committee. Once we're done with all of that and the audit is is buttoned up and finalized, then we typically have an opportunity to present the audit in person to or via video to the finance team, the finance committee. And I think that's a valuable process, just allowing us the opportunity to speak into the process and help them understand the findings. So that's a a best practice that I always recommend. That concludes my summary of what you can do to have a successful audit. And I think to sum it up in one word, it's just advanced it's preparation. That said, I'm happy to take any questions that anyone has relative to audits in general, whether it's, you know, preparation or just, you know, any any question relative to that. I'm happy to chat with you about that.