Audit preparation - Be prepared

No finance director likes nasty surprises at their audit. Good organisation and working closely with your auditor throughout the year can prevent problems arising.

Sally Percy.

Few finance directors actually look forward to their year-end audit. More often than not they secretly dread it. And although they may leave most day-to-day dealings with auditors to their finance team, the audit is the time when an FD's leadership, and the decisions he or she makes over key accounting treatments, inevitably come under the microscope.

And in these uncertain times, with a gloomy economic outlook, credit harder to come by and fears of recession, FDs will find their decisions are more closely scrutinised in 2008 than in the happier climate of the mid-2000s. So what can they expect from their auditors this financial year?

'FDs should expect an increase in professional scepticism and a more rigorous and robust challenge in certain areas,' warns Chris Voogd, Ernst & Young's head of audit for the Midlands and South West.

He's backed up by Andrew Ratcliffe, a senior audit partner at PricewaterhouseCoopers, who explains that this year there are areas 'people are thinking about harder than they've had to do before because the risks have changed'.

The prospect of auditors taking an even tougher stance than usual might sound terrifying but Richard Bennison, head of audit at KPMG, says there's nothing for FDs to be afraid of. 'Approached in a proper, independent, yet practical, way, an audit can actually be a help,' he insists.

There are several areas auditors are likely to focus on when they review company accounts for this financial year.

On the money

Finance is undoubtedly of major concern with banking loans and covenants being seen as potentially high risk areas by auditors. They will be looking for reassurance that companies that rely heavily on banks to borrow money have sufficient headroom within their banking covenants that they will be able to renew their loans. Ratcliffe points out that the banking sector is now 'much more nervous' and has become increasingly restrictive on credit terms as a result.

But getting on top of your banking doesn't have to be a nightmare, according to Bennison. 'Discussions throughout the year, and understanding what sort of evidence and information an auditor will want, will enable the FD to get the banks in the position where it becomes a smooth exercise at the year-end rather than a massive scramble to get everything together.'

Linked to banking is the not-so-small matter of working capital. 'We do find that where economic conditions become more difficult, companies' working capital gets out of control so they end up with more obsolete stock they haven't been able to sell,' says Bennison. 'Having an ongoing discussion about that and getting the auditor's view on appropriate provisioning during the year enables the FD and the company to plan in full agreement with the auditor rather than the auditor turning up at the year-end and thinking: "Actually we would rather this was done some other way."'

The relative financial health of your company's customers and suppliers is another consideration for auditors. If your customers are particularly vulnerable to a difficult economic climate, that's a risk for your business. So is over-dependence on a small number of suppliers.

Fair value

Then there is the highly topical question of asset values and the valuation models used to support those models. E&Y's Voogd says that auditors will be looking at companies' forecasts within a valuation model and whether assumptions that were previously used remain valid in this climate.

The valuation of complex financial instruments in particular is set to remain in the spotlight following write-downs related to the US subprime mortgage crisis by banks including Barclays and HSBC.

'These valuation problems are not just in the financial services industry,' says Ratcliffe. 'It would be wrong to say that this is just the banks' problem because it does leak out into the general commercial world as well.'

Ratcliffe also warns that FDs who successfully navigated their 2007 year-end shouldn't feel complacent that they have a good handle on valuing financial instruments going forward. 'The market will have shifted, things will have changed, some instruments they may now be able to price when they weren't before. Some, although they were able to price before, may now be more challenging,' he says.

Inevitably pensions will remain a hot potato for those FDs whose companies still operate defined benefit pension schemes as equities are volatile. 'FDs are constantly caught about what decision to make to mitigate pension liabilities,' says Don Hutchison, national head of audit at BDO Stoy Hayward.

Risky business

Last December the Financial Reporting Council issued a four-page document entitled Key Questions for Audit Committees, which outlined some important areas for committees to consider with regard to their audits including risk management procedures, the business review and auditor independence. Ratcliffe recommends that FDs take a good, hard look at the guidance. 'If that's what the audit committee is thinking about, then the FD might be well advised to think about it before he or she goes to see them and work out what their answers are,' he suggests.

Among the points the FRC's guidance covers is the 'heightened risk of manipulation of reported financial results'. Meanwhile, statistics from KPMG show that there is a greater occurrence of major corporate frauds during economic downturns. Bennison says that while he hasn't been approached by many FDs who are concerned about fraud, KPMG is encouraging companies to be 'extra vigilant' in looking out for it.

Meanwhile, Hutchison believes that FDs can easily trip up come audit time if they have overseas subsidiaries where the local reporting personnel haven't been properly trained in group policies. 'There should be good communication in flagging issues that need to be addressed,' he says. 'In the past there have been timing issues where things have come out of overseas subsidiaries that FDs haven't necessarily been on top of.'

Public scrutiny

It's not just within the private sector that FDs face a challenging time this year. Public sector FDs have the implementation of International Financial Reporting Standards to prepare for. These will be applied to all government departments for the 2009/10 financial year leading to Whole of Government Accounts being published for the first time for the 2008/09 financial year. 'Directors of finance within the public sector are having to grapple with that, but they can learn from the way the project has gone in the private sector,' says John Capper, head of audit business services at RSM Bentley Jennison. He points out that IFRS is 'not a natural territory' for the public sector and it lacks finance people with IFRS experience.

There are also parts of the public sector that will be feeling the impact of the credit crunch - such as social housing, further and higher education and foundation trusts in the health service - which go to the private market for funding. 'They will need to ensure they have the appropriate banking facilities in place for the working capital needs of their organisation to satisfy external auditors,' says Capper.

Also, rising costs for energy and food mean auditors will be keeping a close eye on their public sector clients' methods of procurement and checking they are using 'an advanced stage of procurement' such as electronic procurement to get the services they need at a competitive price.

Avoiding conflict

Talking of money, it's not just accounting treatments that FDs and auditors tend to cross swords over. The question of fees remains a thorny subject.

Bennison is adamant audit fees aren't likely to rise and maintains that there is 'as much pressure on fees as there has ever been'. 'Most clients are very vigilant on their costs,' he explains. 'There might have been a debate about choice, but there's certainly a lot of competition and we know if we push fees too hard there will be another firm that will come and undercut us.'

So what is the secret to a painless audit? Apparently it all comes down to proper preparation, planning and, of course, communication - no surprise there. It's about making sure the board and the audit committee are aware of the risks and briefing the commercial, tax, legal and treasury teams, as well as the finance team, far in advance of the audit.

Hutchison says it's important that 'everybody's got their cards on the table' at an early stage. 'With early, open discussion in good time, there's absolutely no need for conflict to arise,' adds Voogd. 'The conflict arises when one of the parties doesn't recognise an issue until late in the day. Then it becomes more difficult to get a satisfactory resolution because there just isn't the time to do it.'

Be the first to vote

Rate this article

Related Articles