With inflation seemingly reaching its peak and access to capital starting to improve, there may be a number of different reasons why your business requires an audit of its financial statements for the first time.
Whether you are raising private equity, commencing an initial public offering (IPO), obtaining debt financing, getting sale ready or simply improving your internal governance procedures, your business may require, or otherwise still benefit from, an independent financial audit. The prospect of an audit may be daunting at first, however, there are a number of steps that can be taken in advance to ensure the business is prepared, and to reduce the risk of any unpleasant surprises. Having an audit ready business involves ensuring that your bookkeeping is accurate and up to date, your accounting policies are compliant with Australian Accounting Standards and that sufficient documentation has been prepared and retained to support your financial information.
There are a number of common audit observations, particularly for businesses being audited for the first time, which directors and management may wish to focus on in advance. Being aware of these areas and considering them appropriately may improve efficiency, save time and costs, and limit significant changes to financial information resulting from the audit process.
- Impairment considerations: one of the consequences of a high inflationary environment and volatile capital markets is an increased risk of impairment of non-financial assets such as property, plant and equipment, goodwill, and other intangible assets. Accounting standard AASB 136 Impairment of Assets requires businesses to assess indicators of impairment annually and may require you to calculate the recoverable amount of your assets. This process can be complex and involve a high degree of judgment, particularly when forward-looking valuation models such as discounted cash flow are used. A common audit finding, particularly for businesses forecasting high growth, is a lack of sufficient appropriate evidence available to support growth assumptions.
- Accounting for employee benefits: another common audit finding is not appropriately accounting for employee entitlement liabilities, such as annual leave and long service leave. AASB 119 Employee Benefits requires that employee on-costs, such as superannuation, workcover and payroll tax are added to the nominal value of annual leave and long service leave balances. Similarly, long service leave should be accrued, on a probability basis, from employee commencement and not just when employees become entitled to take long service leave.
- Accounting for leases: the introduction of AASB 16 Leases changed the way that lessees are required to account for lease arrangements. Unless otherwise exempt due to the short-term nature or low value of the contract, lease arrangements from the lessee perspective are now required to be accounted for on the balance sheet as a right of use asset and corresponding lease liability. In these instances, rent or lease expenses are replaced with depreciation and interest expenses. This can have important ramifications when considering any financial covenants included in borrowing agreements, particularly when EBIT or EBITDA measures are applicable. Calculating an appropriate value for the right of use asset and corresponding lease liability can be judgmental and may involve making assumptions regarding lease extension options and applying an appropriate incremental borrowing rate which is used to discount future lease payments to present value.
- Accounting for share-based payments: from time-to-time businesses may issue shares or options to settle liabilities or to provide an incentive to employees. It is important to consider the value of any equity instruments issued and to account for them appropriately. Valuation methodologies can be complex and involve a high degree of judgement, particularly when performance hurdles are involved. In certain instances, it may be appropriate to involve a valuation specialist to assist in this exercise.
Regardless of whether you have an imminent requirement for an independent audit or if this is something your business is aspiring towards, being audit ready is a sign of financial reporting maturity. An audit can improve internal and external confidence by reducing the risk of fraud or error in your financial statements and enhance the information being used for decision making. If you are thinking about commencing an audit process, whether for the first time or as part of your annual cycle, it is essential to plan early, consider the common findings and prepare your supporting documentation accordingly.