Many small companies have bookkeepers on staff rather than accountants. Bookkeepers are generally great at processing daily transactions. However, an accountant is more versed in analyzing what is left in the financial statements at the end of the day. Let’s take a look at some common items on your balance sheet (a.k.a. statement of financial position) and procedures that you can do to ensure you can pass the scrutiny of the independent auditor/reviewer. My assumption here is that you are on the accrual basis of accounting.
Cash - All bank accounts should be reconciled as of the balance sheet date. Start with the bank statement balance, add any deposits in transit, deduct outstanding checks and arrive at your book balance. Look at your outstanding checklist and other reconciling items and make sure that any old items (over 90 days) have been researched. Stale-dated items can raise questions in an audit or review. As most items clear quickly, older items are more likely to contain errors.
Investments - Generally accepted accounting principles (GAAP) require most investments to be stated at their fair values as of the balance sheet date. For investments held by a broker, generally the broker’s statement is adequate for marking investments to market. If you hold investments in real estate or other harder-to-value investments, an independent appraisal may be required, or statements of comparable sales for comparable properties in recent months may be adequate. Talk with your CPA about what is required in advance of your period end.
Accounts Receivable - Accounts receivable (AR) are required to be stated at net realizable value. Look over the aging of your receivables portfolio at year-end and determine if any slow-paying accounts need to be researched or reserved as potentially uncollectible. CPAs look at your analysis both for accounts that you have specifically reserved as well as any general reserve. They will analyze your reserve against specific accounts you have written off in prior periods. They will look at your credit policies and trends in your business and in your industry. If you are being audited, most likely the auditors will select a sample of accounts to confirm independently with your customer. If the customer does not reply, the auditor will look at collections you have made on the account subsequent to year-end. Speak with your customers and document their responses and plans to get their accounts current. CPAs like to see that you are on top of your accounts receivable portfolio.
Prepaid Insurance and Other Items - Analyze your prepaid asset accounts to ensure they represent items that have future value as of the balance sheet date. For example, if you paid your annual property insurance premium in full on the beginning date of the policy December 1, and you have a December 31 year-end, then 11 months of that premium would be a valid prepaid asset as of the balance sheet date as you will be covered for 11 months in the coming year without paying anything more. In most cases, a quick look at the policy and a quick calculation can “prove” what your balance should be. Is it reasonable?
Inventories - If you are being audited and inventories are material to your financial statements, the auditor will most likely want to be on site to observe a physical inventory count near year-end. If you plan the physical inventory on the last day of the year, you will have less work in rolling quantities forward (or back) to year-end. Auditors will want you to reconcile items you counted for purchases and sales between the physical inventory count date and your year-end. Analyze your inventories for slow-moving or obsolete items that should be reserved. Make sure your facilities are well organized and items are clearly labeled.
Fixed Assets - Companies tend to hold assets long-term, so the most common approach used by CPAs to analyze them is to roll forward balances from the prior year and focus their attention on additions and retirements during the year they are auditing/reviewing. Have your fixed asset additions been recorded at their full installed cost? How did you estimate their useful life for depreciation purposes? Is that consistent with your capitalization policy? What were your disposals for the year, and did you properly record any gain or loss on disposal? The net book value (cost less accumulated depreciation) on the date of disposal is compared against any proceeds from the disposal (sales price) to determine the gain or loss.
Accounts Payable - Accounts payable should include all items for which goods or services were received prior to year-end (assuming title has passed). This typically requires either: 1) you hold your books open for a few days after year-end to ensure all vendor invoices have been received; or 2) your accounting system tracks items received for which no vendor invoice has yet been received. If you are being audited, the CPAs will most likely look at your disbursement registers after year-end and request to look at supporting invoices to determine if items have been properly included in accounts payable as of the balance sheet date.
Accrued Liabilities - Some common accrued liabilities are payroll expenses. Any salaries and wages earned as of the balance sheet but not paid until after the balance sheet date should be accrued. This might be a complete or partial pay period. It can be estimated if a partial period. Also, consider items such as accrued vacation, sick leave, and other benefits including employer contributions to benefit plans and employee bonuses earned as of the balance sheet date.
Long-term Debt - Reconcile your records of debt balances to those of your financial institution. Include borrowings on lines of credit. Consider the need to accrue interest for any time that has elapsed since your last payment.
Equity - The CPAs will probably require you to roll forward the balances in your equity accounts from the prior year audited/reviewed balances. Make sure you understand any journal entries that have been made to your equity balances, and be prepared to provide support for current year activity including dividends, stock options, etc.
Continue on to Part 3: Kicking the Tires on your Income statement” for more suggestions for helping you get on top of your game before meeting with your auditors/reviewers.