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Tax and Financial News for October 2008

The Financial Statement Audit -
Is It Worth the Expense and Hassle?
As year-end approaches, many businesses are facing the prospect of an annual financial statement audit. Some businesses, like public companies and large borrowers, are required to obtain annual audits, while some just believe it to be good business practice. Let’s take a look at the advantages and disadvantages of obtaining a periodic examination of your financial statements.

Types of Accountant’s Reports
When you talk about financial statements, a certified public accountant basically has three levels of service he can offer – audit, review, or compilation. A compilation is typically nothing more than the accountant taking the numbers you give him or her and putting them into proper financial statement format. The accountant will then issue a report to that effect and specifically state that he or she has not audited or even reviewed the numbers. While that is technically true, you do obtain some value from the service because you 1) might satisfy the banker’s needs for annual financial information and 2) the CPA does get a chance to look at the numbers and discuss the economic state of your business with you.

A review is a little more in-depth than a compilation. Typically, the CPA will compare your financial results to your industry peers and your prior year’s results. Additionally, the CPA will go through a detailed list of questions designed to determine if there are any indications of errors in your financial statements. This gives a CPA the basis to at least say he didn’t find anything that caused him to believe the finances were misstated. It also gives the CPA a little more information to allow him to identify business issues you may need to address.

An audit is far more detailed than either of the preceding services. It is designed to allow a CPA to report that, in their opinion, your financial statements are free from material misstatements. The CPA is saying he or she believes the financial statements contain the information necessary for an investor to make an informed decision on the financial health of your company. In addition to the work involved in a review, CPAs must also perform detailed tests to obtain the evidence necessary to support their opinion.

Disadvantages of an Audit
The first hurdle a CPA must overcome when talking to a prospective audit client is cost. Simply put, if you want a quality audit, defined as one where all professional standards are observed, it is going to cost a fair amount of money. As previously stated, an audit by its nature is far more time-consuming than a review, which takes longer than a compilation. Depending on the complexity of your system, the audit can cost 2 to 3 times what a financial statement review can cost. By comparison, the compilation takes about one-half to one-third the time of a review.

Once you get past the cost of the audit, the second concern is time. Since audits are expensive, CPAs generally ask a lot from the company’s accounting staff. The more work your staff can do in the form of preparing schedules and providing requested documentation, the less time the auditors will be on-site - and that translates into cost savings for you. If your company carries a significant inventory, you might also expect to spend a great deal of time performing a physical count, which the CPA observes, to give you an accurate picture of your inventory value at year-end.

As part of the audit, an auditor spends a great deal of time with your staff asking about controls in place to ensure that financial statement amounts are properly recorded. This helps the CPA determine what work is needed in order to be comfortable with stated amounts and is another reason for the large amount of time spent on audits, as opposed to simpler financial statement services.

Advantages of an Audit
The disadvantages of an audit are actually what make it so valuable. It takes time to understand the industry in which a client operates and exactly how they do so. That time spent can give the CPA invaluable insights into your business operations, which can translate into major savings for you.

For example, auditors are required to evaluate the controls you employ to protect your cash. One of the simplest controls is to require an employee (typically the owner in small businesses) other than the one writing checks to receive the bank statement unopened. This allows the reviewer to look at checks written and deposits made for anything unusual. This one step has saved business owners hundreds of thousands of dollars by helping them catch employee theft early.

While the goal of the financial audit is to obtain the necessary information to report on your financial statements, CPAs are - first and foremost - business advisors. Their extensive experience with similar clients gives them a reference point from which to make suggestions on such far-reaching issues as tax planning, inventory valuation, and maximizing business value. The time spent by the CPA in auditing allows them to identify areas where you can streamline your operation and enhance profits.

As an example: many accountants also serve on the board of directors of one or more nonprofits, so their nonprofit clients can benefit from their knowledge of fundraising techniques and other operational issues that the CPA might learn from service on a nonprofit board.

Companies that begin with an eye to going public in the future may not need audits early in their lives, but it’s a good idea to start them annually anyway. When the company does begin the registration process to become a public entity, the regulators will require several years of audited financial statements. Proactively obtaining audits can look good to potential investors and reduce the cost of performing a lower-level service followed by the higher-cost audit.

When it comes down to it, the cost of an audit is not out of line with the benefit a client obtains from the process. Operating and financial advice that might result from the audit can help a floundering company prosper - or help a prosperous company become even more profitable. If you are thinking of engaging a certified public accountant to report on your financial statements, let’s talk about your alternatives, including an audit, and choose the one that’s right for you.

Have a terrific month.

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