As a privately held company, you are not required to prepare and submit financial statement audits. Currently, U.S. government regulators require that only public companies that sell stock or bonds, or companies that are in the process of going public must file audited financial statements. Again, privately held companies do not have to file, which applies both to corporations with closely held stock and to unincorporated businesses, which could be sole proprietorships, partnerships or limited liability companies. But you may want to get an audit anyway.
Indeed, the most important thing for you to know is that there are a number of important benefits for your business and other reasons that justify at least seriously considering adding audits to your financial tool kit, if you haven’t already.
While the government may not require your private company to provide audited financial statements, others may insist on seeing these documents as a matter of best practices. For example, banks or lending parties commonly ask for annual audited financial statements from businesses that apply for loans to ensure that the business is operating on sound financial best practices. Moreover, if you seek to recruit outside investors in a partnership or LLC, those potential partners may insist on reviewing financial statements to acquire reliable information about the business’ condition before making any commitments.
But let’s start at the beginning.
What Are Financial Statement Audits?
A financial statement audit is created when you hire an independent auditor to examine your business entity’s financial statements and accompanying disclosures. The auditor’s report of the results of the examination attests to the fairness of presentation of the financial statements and related disclosures. To be considered audited financial statements, then, they must always be accompanied by the auditor’s report whenever your business issues them to any recipients.
During the audit, the independent examiner reviews both the underlying financial data of the company and the organizational elements in place to prevent fraud and ensure accurate information.
Because of the independently established credibility of the audit process and the resulting statements, your business can receive significant benefits. That’s why many privately held businesses schedule periodic audits to promote ongoing organizational health.
Using GAAP Reporting Will Improve Reliability
If you are seeking to obtain loans or expand your business, or if you are exploring the possibilities of going public, you should decide to employ Generally Accepted Accounting Principles (GAAP) financial reporting. Businesses commonly rely on these trusted principles to generate credible, concise and comprehensible financial information that is necessary for lending institutions and investors to evaluate allocating resources effectively and efficiently.
Additionally, if you ask any of your suppliers to extend a trade credit, especially when it’s for a substantial amount, they will most likely request audited financial statements before they agree to do so.
According to accountingfoundation.org, the credibility provided by GAAP reporting actually helps private companies realize greater flexibility in the types of financing available to them and in the number of investors willing to provide it. Also, because providers appreciate the fundamental qualitative characteristics of GAAP, businesses may also benefit from a lower cost of financing.
If you are seriously considering transitioning from a private to a publicly held corporation, GAAP will also facilitate that conversion. Once you become a public entity, your company will have different ownership, capital structure and investment strategies, along with more accounting resources in combination with limited investor access to management. That’s why your company would immediately need to meet the regulatory requirements in which you are now filing as a public company. For example, that would necessitate submitting GAAP financial statements to the U.S. Securities and Exchange Commission.
Two occurrences have made financial statement audits increasingly common. First, there has been a series of disclosures of fraudulent reporting by major companies. Second, the two primary accounting frameworks, GAAP and International Financial Reporting Standards, have continued to grow more complex.
You do have a couple of other options to consider in this process. Of the several types of financial statement examinations available, the full audit is the most expensive. At the opposite end of the choices, a compilation is the least expensive, followed by a review. Because of the higher cost of a full financial statement audit, you may consider downgrading to a review or compilation. However, you must ensure that either of those is acceptable to the intended recipients of the report. Note that the review includes some assurance, although not as much as an audit, and a compilation doesn’t include any assurance.
Publicly held firms pay even more for audits, because the auditors are bound to the much stricter and more rigorous audit standards of the Public Company Accounting Oversight Board (PCAOB), so auditors will then charge those increased costs to their clients.
Six Phases of an Audit
While CPAs customize every audit to address the needs of the individual organization, and there is a wide range of rules and guidance, the overall approach is always the same.
Auditors must evaluate the risks associated with each audit or engagement. So your independent CPA will inquire about special circumstances with your business, as well as the integrity of management and any pending lawsuits before they even initiate an audit. The auditor also evaluates the staffing necessary to complete the auditing engagement. Part of that evaluation requires them to confirm that those staff members are able to maintain an independent viewpoint. Once all of those elements are in place and the auditor accepts the project, they then send out an engagement letter to the client that details the timing, responsibility and cost of the audit.
To prepare correctly for a financial statement audit, the auditor must perform adequate planning. This process will vary, depending on the size and complexity of a company. The auditor must evaluate and develop an understanding of the entity’s business, market and particular industry. Among the tasks involved, they must perform trend and ratio analyses, document the business’ process of internal control, and assess the risk of a misstatement in the company’s financial statements. Once the auditor completes the planning stage, they can inform you, the client, of the timing and extent of audit testing they anticipate for the project.
When the auditor arrives to work at your offices to perform the fieldwork portion of the process, they will complete the financial data tests. As one component of that testing, for instance, the CPA will choose a random sample of disbursements to ensure that the checks are payable to the correct vendor and include the correct amount to be paid. Further, that test includes a review of the invoices for those disbursements to check whether the vendors are real and the expenses were categorized appropriately. The results of the planning process will also impact the selection of financial statement accounts tests the auditor performs.
The CPA will choose a random sample of disbursements to ensure that the checks are payable to the correct vendor and include the correct amount to be paid.
The account analysis portion of the process features the auditor checking to ensure that financial statement account balances are supported by underlying documentation and analysis. Also during this stage, the CPA will evaluate the results of all tests, review management’s responses to questions and record audit-adjusting journal entries. Last, the auditor will apply GAAP to perform additional research, along with documenting reasons for significant yearly changes in accounts.
When they issue their report, CPAs include an opinion as to whether the financial statements were completed in accordance with U.S. GAAP protocols. In this stage, the auditor usually includes a draft of the basic financial statements and notes for the organization’s management. Should they find any weaknesses in the business’s internal control process, they will issue a report about those as well.
Upon completion, the CPA will keep all of the important documentation pertaining to the audit for future account analysis, but also in the event that any lawsuits are filed regarding the reported amounts. The auditor will also obtain management’s signatures to confirm the accuracy of the information reported in the financial statements.
Although the financial statement audit process can be involved and expensive, the return on your investment will be well worth it, because they will enhance your ability to acquire loans, possible investors and additional resources that you need to grow your business.