Your response to control deficiencies – gaps or weaknesses in your internal processes flagged during an audit – can help you get more value from the audit experience and strengthen your business:
You’re in a tough situation. During a thorough audit of your company’s financial statements, auditors found deficiencies that need remediation. What do these deficiencies mean, and how should you respond? Don’t panic or ignore the auditors’ findings. You can learn how to use this information to strengthen your organization while maintaining good relations with your auditors, shareholders and your board of directors.
It’s common for auditors to find deficiencies, whether the business is a small, privately held company or a vast enterprise. And it’s okay if you’re unclear about exactly what those deficiencies mean and what to do about them. The solution is simple but critical: Talk to your auditors! They’ll always be willing to discuss deficiencies to help you understand the problem and offer practical suggestions for how to remedy the issues they’ve observed.
An audit is a two-way street, with auditors working to understand your company and you working to help them get a clear view of its operations and finances. And sometimes an apparent deficiency boils down to a communications problem that can be resolved with better documentation or a simple conversation to eliminate misunderstandings.
If there truly is a deficiency, then your auditors can help you come up with a game plan to resolve it. While auditors may not have full insight into the cause at your company, they can offer suggestions based on their experience with similar businesses and can help you figure it out.
You and your auditors are (or should be) on the same team, taking a collaborative approach to the entire audit process. An “us against them” mentality from either party is counterproductive for your audit. Working together to come up with solutions is a win-win situation, because it makes future audits smoother for auditors and helps protect your business. If your auditors aren’t prepared to maintain an ongoing conversation about any deficiencies and offer suggestions for remediation, then you’ll find better value with a different audit team.
Audit deficiencies come in three flavors of varying severity:
Deficiencies can appear in different audit areas, but most arise out of a lack of expertise or staffing bandwidth, or both. And the way you resolve each one depends on the magnitude of the problem and the experience and abilities of your team. Some deficiencies are easy for your internal staff to address appropriately by putting in place process improvements and new procedures to make sure the issue can’t recur. Others stem from technical accounting challenges that may be most cost-effectively resolved by bringing in expert help.
Figuring out the optimal approach to remediate each deficiency is your first priority. Here again, your auditors are the best source of information. Some auditors will include suggestions for remediation in the audit report, while others prefer to share their ideas in conversations with leaders.
Their objective analysis of the root causes behind audit deficiencies gives you valuable information, but those conversations may not be easy ones. For example, the most effective solution is sometimes to replace staff with someone who has more expertise. Awkward or not, once you know what needs to happen, it’s time to formulate your action plan.
A strong remediation plan includes specific information that lays out:
Small and mid-sized businesses (SMBs) and younger companies in general are especially likely to receive audit deficiencies related to inadequate controls, poor closing processes and technical accounting problems.
But instead of correcting these issues, leaders of smaller companies sometimes ignore audit findings in the mistaken belief that they lack the necessary time or talent needed to resolve them. Here’s some good news: It can be very easy to add processes that create adequate oversight and control while taking only a few minutes to complete each month or quarter.
Before your next audit, explore these three simple but effective strategies to avoid common audit deficiencies and mitigate the risks they represent for your company.
Control-based audit deficiencies often arise when the same person wears many hats at the company, leading to less segregation of duties around financial functions than auditors want to see. What auditors know (and now you do too) is that even the smallest companies can implement effective controls despite limited staff, budgets and time. It’s just a matter of wanting to do so and understanding how.
Implementing simple internal controls goes a long way toward mitigating risk. You can resolve many deficiencies by establishing and documenting a second layer of review, whether that’s from your CEO, the board of directors or another party. In practice, it could mean:
Surprisingly few companies have a detailed close process with a checklist to provide guidance. Putting that documentation in place and requiring staff to complete it helps make sure you’re covering everything that needs to happen during month-end close.
Do the same thing for quarterly and year-end closing processes. Then have the CEO or another senior leader sign off on the completed checklist each month, quarter and year, which documents the oversight auditors are looking for. A formal close process also makes it easier to revisit those processes and procedures as the company grows.
Technical accounting challenges are also very common at smaller or younger companies, where you’re devoting most resources to growing the business. Leaders may not recognize how to properly record and report many types of complex accounting issues. These challenging accounting scenarios can lead to noncompliance that demands excessive time, money and hassle to correct down the road.
Rather than making a large investment in a bulletproof internal technical accounting team, it’s often far more cost-effective to bring in external help. Having extra resources in your corner, whether it’s a fractional CFO, an outsourced accounting solution or a specialized provider, can provide extra reassurance and additional expertise that prevents headaches later on.
Your remediation plan, executed properly, will not only solve the immediate deficiency but also prevent it from recurring and document improvements around audit findings.
When the CEO (or someone else) signs off on reviews of payroll, vendor lists, bank reconciliations and budget-to-actual reports, you’re able to show auditors that you have appropriate controls in place. Your completed and signed monthly, quarterly and year-end closing checklists serve as proof that you have better close processes in place.
For technical accounting deficiencies, be ready to show how you resolved the issue. Let’s say your auditors noted a deficiency because your company didn’t properly account for valuation work that needed to be done on some convertible notes. In response, you hired a third-party valuation expert to properly value these notes and booked material changes.
The following year you’re in a position to show your auditors that you got expert assistance, corrected the accounting and now have an ongoing relationship with qualified valuators. That means the next time any of these notes come up, you’ll know who to turn to for help and can get the accounting done correctly the first time around. Your previous deficiency isn’t likely to happen again.
Auditors are required to communicate in writing to the board of directors any significant deficiency or material weakness. The audit team may also present to the board directly, or to the audit committee. As a leader, you’ll want to have a solid remediation plan in place before the board learns about any audit deficiencies.
You may be able to have auditors include your planned or completed response to deficiencies in their presentation, so board members understand how you have resolved (or will resolve) each issue. Knowing that you’ve already rectified a problematic condition helps the board feel confidence in the current management team as well as the company’s continued strength.
Just like taxes, your audit should be an ongoing conversation rather than a time-limited, seasonal event. Meeting with your auditors periodically throughout the year is an opportunity to discuss new developments at your business. For instance, auditors may be able to advise you on necessary adjustments or technical accounting that’s required due to new contracts or revenue processes at your company. They’ll also be able to let you know when the situation calls for additional expertise or outside consultants.
Staying in regular contact will help you avoid unpleasant surprises that could cause delays and added expense at audit time.
Most audit deficiencies don’t merit major stress, but they do deserve your attention and a thoughtful resolution. The audit experts at Armanino help you identify solutions that strengthen your business as you prevent deficiencies in future audits. Reach out today and discover the hidden opportunities in your next financial statement audit.
Want to smooth potential audit bumps? Get our financial statement audit checklist to learn document tips, what transactions to flag and more.
