Is Your Organization Ready for Its Year-End Audit?
By Christian Spencer, CPA, Partner
As the end of the year approaches, many organizations are in the process of preparing for their year-end audits. By now, your auditor has contacted you to discuss the nature, timing, and extent of the work to be performed, which includes an upfront planning meeting to address any significant events and transactions that occurred during the year.
Preparing for your annual audit can be a bit of a juggling act as you work to close out the year, report preliminary financial results to your board and other constituents, and prepare for the audit. All of these tasks are happening while you are simultaneously addressing events and transactions currently affecting your organization. This can be a daunting time of year for chief financial officers, controllers, and their staff.
As you continue to prepare for your upcoming audit, here are several common areas to consider that hopefully will help facilitate a smooth audit, reduce any internal control findings, and minimize significant audit adjustments.
Incomplete Documentation
Many organizations have good internal controls in place over their monthly close process, which include preparation and review of significant account reconciliations, review and approval of manual journal entries, and investigation of significant budget-to-actual variances. However, those controls are often performed without any verifiable evidence documenting their execution. This is becoming more important as financial transactions and reviews are increasingly automated and less paper is involved in the process.
For example, the controller may review all reconciliations and manual journal entries posted by the senior accountant each month, but without documenting this review, the auditor has no way of verifying that the review actually took place. Proper documentation is essential to confirming that a control exists and is timely and properly executed.
This documentation can be noted by signing and dating reconciliations as they are prepared and reviewed. If your organization is less paper intensive, the use of a monthly close checklist may be helpful. The checklist would detail the monthly closing procedures and provide the preparer and reviewer the ability to sign and date the form as items are completed. This checklist creates a trail of the procedures performed and enables the auditor to verify that the control objectives over the monthly close have been properly executed.
New Accounting Standards in Effect for 2019
By now you should be familiar with Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers and ASU 2018-08, Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made. These accounting standards are in effect for organizations with a December 31, 2019 year end and later. Reviewing the standards and determining the impact, if any, on the revenue recognition for your key revenue streams is an essential audit preparation tool. Auditors will be asking for how you addressed the applicability of these two new standards to your revenue recognition policies.
Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, affects entities that either enter into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g. insurance contracts or lease contracts). The ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, the ASU provides a five-step process. Not-for-profit organizations should be examining the core principles of this standard in connection with key revenue streams, which typically include membership, meetings, publications, royalty, and contracts.
For not-for-profit organizations receiving grants and contributions income, ASU 2018-08, Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made, applies commencing with the year ended December 31, 2019. This ASU provides not-for-profit entities with guidance on how to classify revenue as either contributions or exchange (earned income) transactions. This distinction is important because the accounting for the two types of transactions is very different. In addition, this ASU provides clarification on when a promise to give is considered to be conditional or unconditional.
Contract Reviews
An organization typically has differing levels of authority to enter into binding contracts on its behalf. For example, the director of fundraising for a museum enters into an agreement with a beverage company to exclusively offer only that company’s products in its restaurant. During the preparation of the organization’s Form 990, the agreement is reviewed by the tax preparer and the exclusive provider provision is discovered—which, unbeknownst to the director of fundraising, has now triggered taxable unrelated business income. In addition, because there were little costs incurred with the contract, nearly the entire amount of the fee is now taxable.
This is just one example of why it is essential for all contracts to be reviewed by qualified individuals for potential financial and tax ramifications. Because the financial impact of a contract may not have been appropriately considered, individuals may unknowingly enter into agreements that are not beneficial to the organization. As a result, all contracts should be reviewed at a minimum by the chief financial officer, who may consult legal counsel or tax advisors for additional guidance.
Evaluating Significant Estimates
Most financial statements include at least one significant amount based upon management’s estimate. These typically include the allowance for uncollectible receivables and reserve for nonsalable inventory. The organization needs to have a documented procedure for evaluating and adjusting significant estimates. Throughout the year, management should be reviewing and adjusting these estimates based upon historical and prospective data.
For example, the allowance for doubtful accounts may include 50 percent of amounts past 90 days due based upon historical collection history, plus an amount for any additional items potentially uncollectable. An organization’s inventory-obsolescence reserve may include items for which sales were minimal during the year as well as items for which new updated editions are now available.
Because accounting estimates are subjective and based upon management’s evaluation of the account and transaction cycle, it is essential that the estimate process be well-documented, reasonable, and consistently applied.
Audit Requirement of 401(k) or 403(b) Plans
Organizations should be cognizant of the eligible number of plan participants as this drives the requirement to have an audit of the plan performed. The Employee Retirement Income Security Act of 1974 (ERISA) requires annual audits of plan financial statements by an independent qualified public accountant of plans subject to the provisions of ERISA if the plan has 100 or more eligible participants at the beginning of the plan year. Plans meeting this criteria would be considered a “large plan.” The 80-120 Rule allows a plan with between 80 and 120 participants, as of the first day of the plan year, to file Form 5500 in the same category (“large plan” or “small plan”) as indicated on the prior year Form 5500 filing.
Accordingly, once a plan first reaches over 120 participants as of the beginning of a plan year, the plan is officially a “large plan” and requires an audit.
For 2019 calendar year end plans, the audit and the related Form 5500 must be completed and submitted with the Form 5500 by July 31, 2020 (or October 15, 2020 with an appropriately filed request for extension of time to file).
Conclusion
Establishing the appropriate internal control structure at your organization to ensure that all transactions are identified and evaluated for financial ramifications is essential to eliminating surprises during the audit. Auditors should be proactively meeting with their clients throughout the year to update them on standards, events, and best practices in the industry.
Conversely, when questions arise during the year, organizations should consult their auditor early on in the process and not wait until year end to discuss significant matters. Consistent and timely communication between all parties, both internal and external, is a key element to successfully navigating your organization through its year-end audit.
Christian Spencer is a partner in Tate & Tryon’s audit and assurance services department and can be reached at cspencer@tatetryon.com.
The post Is Your Organization Ready for Its Year-End Audit? appeared first on Tate & Tryon.