The 2 Day Close, Phase 7 - Audit Preparation

?As a government contractor, your company may be subject to both financial statement audits and DCAA audits. In this article, I discuss preparing for an audit throughout the year to reduce audit stress, refocus staff on analysis and identify areas of improvement. If you have followed the phases outlined in my last six articles, you and your accounting staff have: documented and improved your processes, automated manual tasks, created a soft closing and refocused on analyzing financial data. With each phase you have improved the timeliness and the authenticity of your financial data. 

Financial auditors provide an opinion on the validity of your financial statements, by identifying audit risks, and following a process to minimize each risk. Audit processes vary depending on the industry, your customer base and your business model. Auditors review your policies and procedures to evaluate your internal controls; and perform tests to confirm the controls operate as designed. Auditors then review your balance sheet and income statement accounts to provide reasonable assurance of the accuracy of your financial statements.   

DCAA auditors will rely on your financial audit report; however, they will also focus in a more granule level to verify the structure of your indirect cost pools, review cost pool allocations, unallowable expenses and confirm charge classification across contracts. 

Financial Audits

Your financial auditors will review your processes to access your internal cost controls and determine the level of testing required. Working with your accounting department in phase 3, you reviewed and improved each of your processes. Contact your auditor and ask them to review the new processes to identify any issues or concerns. This will allow your staff time to address issues prior to beginning the audit. Your auditor will modify their audit plan based upon the new processes prior to beginning testing and onsite work. 

Audit Account Analysis and Schedules 

Focus on audit preparation by developing account reconciliations and audit schedules, based upon the list of schedules your auditor requested last year. 

Income Statement Account Analysis

The revenue recognition process is one of the biggest audit risks and requires significant analysis. Create a revenue schedule grouping projects by each revenue recognition method. Confirm you have access to the actual contracts and all modifications available for review. Your auditor will review each revenue recognition method and select projects for testing. 

• Provide your auditor with the project revenue set up and the revenue recognition process documentation(s) you created during phase 3. 

Your indirect cost allocations will impact revenue as well as gross profit calculations across projects. The auditor will review the allocation process and confirm it is properly followed. 

Provide your auditor:

• The indirect cost allocation process documentation you created during phase 3.
• The indirect cost allocation process server job definition you set up during phase 4. 
• Create a schedule to reconcile your indirect cost allocations to your income statement. 
• Reconcile the accounts assigned the cost pool to the income statement.

Next, your auditors will review all major expense items on your income statement. If your company is a professional service organization, labor costs and related employee benefits are the biggest audit risk. If your company is a manufacturer, material and inventory costs pose the biggest audit risk. 

Analysis of Labor Costs

• Provide the process documentation for timesheet collection, timesheet approvals and the labor corrections as developed in phase 3. 
• Create a schedule detailing all labor corrections. 
• If you followed the soft closing process recommended in phase 5, your labor corrections should be minimal
• Create a schedule to reconcile all labor accounts to your quarterly tax filings - form 941.
• If you aligned your timesheet periods with your month end as outlined in phase 4, this reconciliation will be straight forward. 

Analysis of Manufacturing and Inventory Costs

• Provide the process documentation for procuring materials, as developed in phase 3; including competitive bids, controlling inventory and related party transactions. 
• Review your process for capitalizing work in progress costs with your auditor. 

Next your auditor will review your travel, meals and entertainment expenses. They will review your processes and test to determine proper charging of unallowable expenses and over per diem amounts. 

• Provide your auditors with the process documentation you developed as part of phase 3.  

Finally, prepare a schedule to document any significant changes in current year expenses as compared to last year. 

Balance Sheet Account Analysis

Each account on your balance sheet will represent an audit risk and will be reviewed by your auditor. Accounts such as cash, accounts receivable and account payable represent the highest risk and will require in-depth reviews. 

Reconcile Cash Accounts

I am always surprised to find companies that do not reconcile their cash accounts throughout the year. Bank transactions and statements are ready available throughout the month. Prepare bank reconciliations for each of your cash accounts as soon as data is available. 

• Establish a separate payroll bank account to simplify the cash reconciliations. 
• Establish separate general ledger accounts for each bank account, including line of credit or high yield accounts. 

Reconcile Accounts Payable

Auditors will review your accounts payable process to understand the level of internal controls and risk of fraudulent payments. Your auditors will test various accounts payable transactions to confirm processing and authenticity. 

• Provide auditors the payment approval process, including purchase orders as developed in phase 3. 
• Reconcile accounts payable ledger to the general ledger. 
• Create a schedule to document each over due accounts payable item. 
• Create a system query to identify variations between vendor master file name and the vendor name on each payment. 

Reconcile Accounts Receivable 

Your auditor will review accounts receivable to support revenue and deferred revenue calculations. 

• Provide auditors the customer invoicing process documentation as developed in phase 3. 
• Reconcile the account receivable aging to the general ledger. 
• Create a schedule to outline and document all late accounts receivable transactions
• Create a schedule to document all invoice corrections. 
• An automated query is the easiest way to identify multiple billing corrections. 

Fixed Assets and Leasehold Improvements

Many companies utilize an automated system to track asset and leasehold transactions through out the year. If you are not using a system, develop schedules to track fixed assets and leasehold improvements as the transactions take place.  

• Provide auditors the fixed asset and leasehold improvement capitalization process as developed in phase 3. 
• Reconcile fixed assets and leasehold improvements schedules to the general ledger.

Other Liabilities

Other liabilities include short term and long term debt, loans from owners and government agencies. These accounts will be reviewed to confirm outstanding balances and calculation of interest expense. Third party lenders can provide interest amortization schedules to confirm accurate interest calculation. 

• Provide auditors the liability and interest expense process documentation developed in phase 3. 
• Create a schedule to reconcile loans and other liability balances and reconcile to the general ledger. 

DCAA Audits

DCAA auditors will utilize many of the same schedules and detailed procedures you provided the financial auditors. DCAA auditors will focus on:

• Travel, meals, entertainment and unallowable expenses.
• Indirect cost pool structure and proper cost pool allocations.
• Project costing and invoicing.

DCAA auditors will also review your project costing policies and confirm periodic progress reviews with project managers and customers. 

Organization and Efficiency for Audits

Develop an audit document repository and invite your financial auditors to review periodically. 

• As account analysis are completed, post them to the audit document repository. 
• Create a table of contents as a guide for your auditors. The list of schedules your auditor provided last year is a good outline to use.
• Provide secured remote access for your auditors, and ask them to review the process documentation and schedules prior to starting onsite work.
• Ask your auditor if testing can be performed throughout the year. 

Summary

Supporting an audit is a lot of work, especially when all the tasks are performed at year end. By spreading audit tasks throughout the year, you will reduce audit stress and your staff will identify additional areas for improvement. The transformation in your accounting department continues, creating efficiencies, reducing stress and engaging in more analytical tasks. Moving closer to doing it right the first time. 

Developing an environment of continued improvement, embracing technology and anticipating change is one component of the services offered by Jezior Advisors. Please email me directly to discuss how we can help your firm. joejezior@jezadvisors.com

Next post “Continually Strive to Improve” Realize all that has changed and how to continue improving.