Author: Kristiine Villemi
An annual audit is an indispensable resource for obtaining assurance that a company’s financial statements and accounting is free from material misstatements. One of the most important preconditions for productive cooperation between auditor and the company is adherence to deadlines and being ready for the audit at the agreed time.
The auditor verifies the accuracy of the financial information and the functioning of the company’s processes. At the end of the audit, the auditor gives the client feedback on audit findings and deficiencies in internal control and recommendations for eliminating them to protect the company against fraud and misstatements.
Good preparation is half the battle
Before the audit begins, the auditor sends the client a list of documents that the client can start getting ready or sending to the auditor in advance. If all of the documents requested are submitted to the auditor by the agreed time, there is high confidence that the audit will be completed much faster than if the client starts sending documents only once the auditor is present. It’s even worse if it’s something that is thought about only after the auditor arrives.
In the last case, the auditor will expend much time on the spot waiting for documents and it is very likely the auditor will not get all of the documents. That means that the auditor must come back again or two or three times, which in turn prolongs the audit.
Documents must be accurate
It is worth knowing that it isn’t enough to just assemble a stack of documents if they are not accurate and in line with accounting records. In such a case, the auditor will spend much more time checking the documents. In accordance with subsection 15 (3) of the Accounting Act, for the purposes of preparing annual accounts, inventory shall be taken of all balances of the assets and liabilities of the accounting entity, meaning that the conformity of the balances to the main accounting principles set forth in Section 16 of the Accounting Act should be assessed. All balances in the balance sheet and income statement must be inventoried. The accountant must know exactly which amounts they consist of and be capable of providing source documents to the auditor.
Physical inventory means counting or checking something
The actual results revealed by the stock-taking or physical inventory must be compared to accounting information, and if there are discrepancies the reasons must be determined and corrections made. For example, the physical inventory of cash in hand, stocks and non-current assets balances must be performed by counting and the results documented in the inventory report.
In case of inventories, it is also important to indicate the inventory balances whose book value has decreased below the net realizable value. This impairment should be recognized in accounts. If the auditor believes that the inventory balance is significant from the standpoint of the annual financial statements, the auditor shall participate in the stock-taking as an observer and perform spot checks.
In the case of non-current assets, non-current assets unfit for use must be written off. The adequacy of depreciation rates must also be reviewed.
With regard to bank balances, the auditor requests the client to ask the bank for a letter of confirmation where besides the cash and investment balances, the bank also brings out all of the company’s obligations, including collaterals and guarantees. As to the balance of receivables recognized in the balance sheet, the accountant must know what receivables it consists of. The collectability of receivables must also be estimated, and if necessary, an allowance for doubtful accounts formed. Confirmation of balances must be obtained from the counterparties as well. If the company has issued loans, the borrower’s solvency and collectability of the loans must be evaluated. It is not enough for the other party to just confirm the balance, as this does not give the auditor assurance regarding the value of the receivable.
Taking inventory of prepaid expenses should not be neglected, because it should be checked that all expenses for the audited period are recognized in the income statement. On the liabilities side, payables to suppliers and loans received must be inventoried. Balance confirmations are sent out to make sure that there are no obligations that are not recognized (such as accrual-basis interest). In the case of tax balances, the tax balances in the accounting software should be compared with the balances reported to the tax authority. Among others, late fees and interest must also be taken into consideration.
Nor should the inventorying of payables to employees, including holiday obligations, be neglected. If the company has liabilities where the date and amount of realisation are not certain, the provision must be recognized in the balance sheet (e.g. warranty reserve) and the auditor must receive a documented evaluation from the management on how this representation was arrived at.
In the case of the income statement, the auditor must obtain evidence that all transactions are recognized correctly and pursuant to the source documents and that no transactions have failed to be recognized. In accounting, the matching principle of revenues and expenses must be followed. If accounts have been kept correctly, there will be no need to prepare anything, because as subsection 6 (4) of the Accounting Act states, all accounting entries shall be supported by source documents certifying the corresponding business transactions or by summary documents prepared on the basis of source documents. If all source documents exist, all that is left to do is get ready the documents the auditor has requested.
We certainly advise devoting more attention to the transactions that preceded and followed the year’s end, so that all items are recognized in the right period. With regard to unrecognized transactions, keeping the lines open between the management and accounting department is important as often there are situations where a transaction has not been recognized precisely because the documents did not reach the accountant in a timely manner. Thus, good cooperation and exchange of information between the company’s executives and the accountant should not be underestimated as a requirement for a smooth audit process.
Constant communication with auditor
Yet another important factor that some audits go more efficiently than others is an open communication style. The most ideal client for an auditor is an accountant who constantly consults the auditor if there is a question about some transaction. Resolving problems straight away is much more effective than correcting mistakes discovered during an audit. The latter is one of the main reasons that the final deadlines tend to be overrun.
An interim audit can be a help
Conducting an interim audit is something that should definitely be supported. An interim audit means that, e.g. if your financial year ends at 31 December, the auditor may carry out some procedures based on 9-month reports in October so that the final audit at year’s end goes smoother and faster. In the course of the interim report, both past events and future plans affecting reporting during the period are discussed. In addition, key areas and the audit plan are agreed. Transactions that have taken place to that point can also be reviewed. If the interim audit has been performed effectively, the only thing left to check in the final audit is the transactions and balances for the last three months.
Auditing the annual report is time-consuming
The time expended on auditing the annual report cannot be underestimated, as this may often mean more time outlay for the auditor than originally expected. This can happen if hastily and carelessly prepared financial statements are presented to the auditor, followed by the auditor preparing a long list of audit findings of which the accountant decides to correct only half. Once the auditor has checked the statements, the auditor must indicate the same findings again and sometimes new errors have cropped up in addition to the errors that were left uncorrected.
Nor is it unusual for the report to be bounced back and forth four or five times. It is obvious that such an audit will not be successful. Thus, we advise taking time to prepare the financial statements, reviewing the findings made the last year and taking them into consideration in preparing the report for the year at hand.
The principal errors are lack of notes explaining key balances, the lack or incorrectness of references and cross-references (in all of the main financial statements), leaving key circumstances unaccounted for (such as events following the balance sheet date), conflict between accounting policies and the company’s accounting itself, incorrect cash flow statement, and failure to recognize related-party transactions and balances.
A separate document folder simplifies work
To find documents faster during the audit, some accountants prepare a separate audit folder, which is a good idea and simplifies all of the parties’ work. Many times, we have heard opinions that the accountant does not wish to present the draft annual report to the auditor by the start of the audit, as “it will have to be changed anyway.” Actually it is good practice for the preliminary annual report to be included in the documents presented to the auditor. The accountant should not be preparing the annual report knowing that something is definitely incorrect, because pursuant to the Accounting Act, they have to be sure that all balances are correct before the annual report is prepared. The presentation of the draft annual report by the start of the audit is a signal that the accountant is ready for the audit.
Ten recommendations for a successful audit
- Timely selection of auditor and realistic schedule.
- Sticking to deadlines and honouring agreements, including timely submission of documents to auditor pursuant to the list received in advance.
- Performing a preliminary audit to spread out workload and detect possible errors early.
- Accounts are inventoried timely and source documents for all transactions exist and can easily be retrieved.
- Conformity of accounting policies and procedures to actual situation, annual review and updating, if necessary.
- Regular communication with auditors and, in the case of complicated transactions, consulting them in advance.
- Efficient exchange of information between financial department and management. Management must be included in making estimates.
- A working internal control system laid down based on the company’s profile and needs.
- Positive attitude toward auditors.
- Correctly and timely prepared annual report.