Ricochet News

Top 10 tips for audit readiness

By Ian Ferreira-Massyn. (Assistant Manager at Mazars and on the SIPA South Africa Committee) - Aug 8, 2018
Top 10 tips for audit readiness

Audits can be intimidating, and you no longer need to have those sleepless nights before the Auditors arrive…

Keep your auditor “happy” with these TOP 10 tips and experience a smooth audit process.

1. BALANCE YOUR BANK (to the cent)!

Your bank account(s) should be seen as the “heart” of the accounting records. If your bank accounts do not properly balance (i.e. reconcile), then it immediately raises a “red flag” to the auditor as to whether regular processing takes place and if unreconciled items are cleared in a timely manner.

Often Auditors consider the reliability of the accounting records when making their risk assessments as part of the planning phase, so rather avoid having unreconciled bank accounts which could increase the risk assessment which in turn may result in more audit work performed in various sections of the audit file… and of course leading to more audit costs.

You therefore need to make sure that ALL the bank accounts of the business are reconciled regularly (at least monthly). In today’s economy, businesses seldomly deal with cheques and as such there should not be uncleared reconciling items.

Also make sure that your bank account reconciles to the cent. A R1 difference may seem to be “trivial” to a business owner, but to the Auditor all it means is a possible one million rand in the one direction and another one million and one rand in another direction.

Having your bank accounts reconciled regularly is also good practice for any business as it helps to bring any “missing money” to the surface. So, it is essential that the person involved in the payments function is separated from the person performing the reconciliations.  

2. SUSPENSE ACCOUNTS “SUCKS”!

There is nothing an Auditor “hates” more than starting an audit where a balance in the financial statements includes a “suspense account” in the trial balance. It is almost a guarantee that your Auditor will “zoom” into the transactions posted to the Suspense account and expect explanations and support for those transactions.

Suspense accounts are often used by businesses as a temporary “resting” place for an entry that is intended to end up in another account ledger where it belongs. The reason an auditor “hates” a suspense account in the books is because it relates to various possible errors, such as:

  • Trial balance error - when a balance or total is omitted or incorrectly extracted in the preparation of the trial balance;
  • Compensating error - when two equal and opposite errors leave the trial balance balancing. Even though this is a rare error, it can be because of a deliberate second error being made to force the balancing of the records or conceal to fraud;
  • Addition error – when figures are incorrectly added in a ledger account (which should seldomly happen if accounting records are maintained in proper, reliable accounting software);
  • Posting error – results when an entry made in one record is not posted at all, or if the entry is posted incorrectly to another record (e.g. a car purchased for R200,000 is posted as R20,000).

For an auditor to assess whether a balance in a suspense account might result in a material misstatement of the financial statements will require unnecessary time for the auditor to scrutinize the transaction to determine the underlying error. The same principle as for bank accounts also applies.

Even a R1 balance in a suspense account could still mean a material misstatement to the auditor when drilling into the transactions.

3. “DAZZLE” (the auditor) with your DEBTORS!

Auditors have analytical minds and know how to compare “apples with apples” and “pears with pears”. For example, an auditor might assess various other aspects of the financial statements (e.g. movement in inventory, increases or decreases in sales, movement in bad debts, etc.) when evaluating the reasonability of a debtor’s balance.

Make sure that your debtors are correct and properly reconciled and supported by following these points:

  • Have a proper debtors age analysis that reconciles to the debtors control account.
  • Make sure that there is no “suspense” or “cash” debtors in your age analysis which contain postings which still needs to be cleared against the relevant debtors.
  • Have supporting evidence ready to substantiate any debtor with a credit balance (especially the debtors with large credit balances). If a debtor overpaid, it is advisable to have an e-mail as evidence where you have notified the debtor of the over-payment and the credit on their account.
  • Carefully scrutinise old outstanding debtors (usually those above 90 days but may differ pending the industry in which the company operates) to determine which ones are recoverable. An auditor may need you to explain and provide evidence why you consider a debtor to be recoverable when there is bad repayment behaviour or lack of commitment in the form of e-mail correspondence from the debtor to pay their account.
  • Be careful of debtors with credit balances older than four months. In terms of the VAT act, when a customer overpays you and you don’t refund the overpayment within four months (e.g. because your customer knows of the overpayment and asks you to use the overpayment towards his next purchase from you), the overpayment results in a deemed output VAT which should be declared to SARS. 

4. CREDITORS MUST BE COMPLETE!

Accounting standards (such as IFRS or IFRS for SME) requires that financial statements be prepared on the accrual basis of accounting. It is therefore no longer appropriate to simply account for transaction when the payment or receipt reflects in the bank statement.

If you acquire a product or service before a financial year-end, and the supplier is only paid for the product or service after the financial year-end, then that supplier must be a creditor in your books as at the end of the financial year.

This means that you need to timely raise supplier invoices in your accounting records so that your creditors are complete at year-end. Here are some sub-tips to ensure that your creditors are complete:

  • Promptly raise the invoices that you receive from your supplier in your accounting records (i.e. raise them as a creditor), and then post the payment against the supplier (creditor) when you pay your supplier.
  • Same principle as for the debtors, you need to make sure that your creditors age analysis agree (reconciles) to creditors (supplier) control account.
  • Make sure that you have obtained statements from your suppliers reflecting the balance as at year-end. For each creditor (supplier), reconcile the balance as per the supplier’s statement to the balance in your accounting records / age analysis.
  • Investigate creditors on the creditors age analysis with debit balances, and have explanations ready in case the auditor asks.
  • A good internal test to make sure whether your creditors are complete is to look at payments (from your bank statements) that you made to suppliers during the first month- or two after the financial year-end and trace those payments to the invoice you received from the supplier. If the invoice is dated before the end of the financial year, and the payment is made to the supplier after the end of the financial year- then it means that the supplier should be a creditor (to be paid) as at the end of the financial year.          

5. “TRUST” YOUR TRIAL BALANCE

Do you trust the accuracy of your trial balance? If you don’t have that “warm and fuzzy” feeling that your trial balance is correct, then chances are neither will your Auditor.

  • The first (and obvious) is that your trial balance must balance (i.e. your total debits must be equal to your total credits)
  • Look at the ledger accounts that make up your trial balance to see if there are any “unusual” ledgers or balances that does not appear to be correct.
  • Scrutinize your expense accounts which should contain monthly postings. For example, expenses such as rent and telephone which is paid monthly will need to contain 12 monthly entries (postings).
  • Check that expense accounts are on the debit side. If an expense account is on the credit side (i.e. credit total) it does not necessarily mean that it is incorrect, but it could be regarded as “unusual”. Similarly, your income accounts are generally on the credit side.
  • Scrutinize your repairs and maintenance expense ledgers to make sure that it does not contain any posting which should have been raised as an asset. Similarly, scrutinize your fixed asset ledgers to make sure that it does not contain asset additions which should have been expensed as repairs.
  • Make sure there are no suspense accounts (refer to rule 2).

6. BACK UP YOUR BALANCES

An Auditor absolutely LOVES to get a neat and tidy file that contains supporting schedules or statements to support (i.e. “back up”) the balances which are in your statement of financial position (i.e. “balance sheet”);

  • Support all bank account balances in your trial balance with a bank statement reflecting the balance at year-end. Obviously, this also ties in with rule 1 relating to bank reconciliations.
  • Support your property, plant and equipment (i.e. “fixed assets”) with a fixed asset register. The book value as per the fixed asset register needs to reconcile to the book value of your assets in your “balance sheet”.
  • Support your debtors balance with a debtors age analysis that reconciles (links in with rule 3).
  • Support your creditors balance with a creditors age analysis that reconcile (links in with rule 4).

Except for the retained earnings balance, it is advisable to have an external statement- or schedule ready to also support any other balance in your “balance sheet” not listed above. “External” statement or schedule is generated or prepared outside of the accounting system in which processing takes place.

Also make sure that all your other documents are properly filed and easy to retrieve. If an Auditor spends unnecessary time to scratch through untidy files to try and find supporting evidence, then this could drive up audit fees.

7. CHECK YOUR OPENING BALANCES

The opening balances in your “balance sheet” accounts must agree to the prior year financial statements. If your opening balances do not agree then it probably means that there is a prior period error that you will need to explain or have disclosed in the current year; or in most cases, that errors identified during the previous year audit were corrected for the financial statements, but not posted through the accounting records.

8. VERIFY YOUR VAT (if you are a vat vendor)

VAT is probably one of the balances that an Auditor will always look at because it effects a regulatory authority (being SARS).

  • Make sure that your VAT submissions agree to your accounting records.
  • Make sure that your balance in your VAT account agrees to the balance as per the VAT statement of account (request a statement from SARS if you do not have one), and correct differences.
  • Consider whether your total output VAT declared for the year makes sense when looking at your total sales / income for the year.
  • Consider whether your total input VAT claimed for the year makes sense when comparing it to total expenditure and purchases during the year on which input VAT could have been claimed.
  • Make sure that your VAT submissions and payments are done timeously (within 25 days after the end of the VAT return period) throughout the year to avoid possible interest and penalties.
  • If there are any interest and penalties on VAT accounts, make sure that it is posted to an expense account properly named to clearly identify that the account relates to interest or penalties.

9. THE GREATNESS IN “GROSS PROFIT”

Compare your gross profit margin in the current financial year to the gross profit margin in the previous financial year.

The gross profit margin is a financial metric used to assess the financial health of a business but is also a key financial indicator used by many auditors to identify whether there are unusual fluctuations. It is therefore a key to pick apart reasons why the margin changes from period to period.

To calculate your gross profit margin, subtract your cost of sales from your sales, and divide the answer by your sales.

A change in gross profit margin can be caused by various events, such as:

  • Changes in sales prices,
  • Change in the unit volume of inventory sold,
  • Changes in the mix of products sold, and
  • Changes in purchase prices.

Therefore, if there has been no significant changes in sales prices, purchase prices, inventory production or the market- then it is unlikely that there should be any significant fluctuation in the gross profit margin.  

10. A CASUAL COFFEE…

Probably a “silly” rule, but many people often believe that Auditors are merely there to fulfil a “compliance” step in their company.

However, beyond ticking boxes a good Auditor should also try to add value to your business as far as possible whilst still adhering to the International Standards on Auditing and Codes of Professional Conduct.

Have a casual chat with your auditor over a cup of coffee or tea at the start of the Audit and tell them about your business, introduce them to the key people in your organisation and tell them about the vision of your company.

Whilst your Auditor may point out internal weaknesses in systems or errors- this should be seen as a learning curve with one big (and mutual) goal in mind- protecting your business and ensuring that you have a clear financial “picture” of your business’ solvency and liquidity.

For more information, visit Mazars Port Elizabeth at 30 Bird Street, Central, Port Elizabeth, or call 041 501 9700. Also visit them at www.mazars.co.za