Best Practices for a Year-End Audit

Are you ready for your annual audit? Follow these tips to avoid pitfalls and issues during your year-end audit. Implementing these best practices will enhance the value your organization receives from the audit process and help you comfortably meet your deadline for distributing audited financial statements to your investors and other users.   

Prepare Financial Statements  

It is the management’s responsibility to prepare financial statements and to design, implement, and maintain internal controls relevant to the preparation and fair presentation of financial statements.  Management’s first step is to have an in-house accounting team capable of achieving effective financial reporting, which enables management to prepare fairly presented financial statements. 

While management can alternatively outsource the accounting function to a third-party service provider (for example, an external fund administrator) who can assist with the preparation of the financial statements, it is important to keep in mind that management retains responsibility for the financial statements.    

Schedule a Planning Meeting with Your Auditor  

If you haven’t already set up a planning meeting with your auditor, set it up now to discuss and provide an update to your auditor about what has occurred during the year.  Matters of interest to your auditor include amendments to the partnership agreement and other fund documents, capital activity, fund performance, any new or private investments, and any other notable changes that occurred during the year in your operations and your internal controls.  The audit planning meeting should also discuss the expected timing of audit fieldwork and completion. If you have outsourced your accounting function to an external fund administrator, plan ahead so the expected timing fits into their schedule.  

New Accounting Pronouncements  

Ask your auditors if they are aware of any new accounting pronouncements that are applicable to you that you should consider while preparing your annual financial statements. For example, the following accounting pronouncements issued by the Financial Accounting Standards Board (FASB) are effective for nonpublic calendar year-end entities in 2024 and 2025: 

• ASU 2022-03 Fair Value Measurement (Topic 820): Clarifies the guidance when measuring the fair value of an equity security subject to contractual restrictions that prohibit the sale of an equity security. ASU 2022-03 also introduces new disclosure requirements. The guidance is effective for nonpublic calendar year-end entities for annual periods beginning after December 15, 2024, with early adoption permitted. 
• ASU 2024-01: Clarifies how an entity determines whether a profits interest or similar award is within the scope of ASC 718 or within the scope of other guidance. The amendments are effective for nonpublic calendar year-end entities for annual periods beginning after December 15, 2025, with early adoption permitted. While ASU 2024-01 is not expected to impact investment funds, it will impact the evaluation of profits interest or similar awards in reporting entities such as investment management firms and broker-dealers. 

Ask For Your Auditor’s Year-End Request List 

Also known as the PBC, or Prepared by Client list, it is a standard practice for auditors to provide their clients with a list of items they will need to complete the audit. Ask your auditor to provide this list well in advance of your fiscal year-end. Knowing ahead of time about some of the schedules and documents your auditors will need will help you keep these items in mind when going through your year-end close process. Make sure you share the list with your external fund administrator and agree on the expected timing of any audit schedules that they can help prepare.  

Carefully consider each of the schedules you may be preparing for the auditors. If any of them are time-consuming for you or your external fund administrator to prepare, ask the auditors to explain why they need them. It is possible that they could get the same information from another resource. 

For continuing or repeat audits, it is worth saving copies of the current-year schedules and documents you’ve submitted to your auditor for future reference. Note the source within your accounting system and the methods you have used to extract specific customized reports that were part of the auditor’s current-year request list. Without significant changes in your business or operations, your auditor will most likely request those specific customized reports annually. Revisiting your notes from the prior-year audit will reduce your efforts to extract those reports for the current year. This step is particularly helpful if you have had turnover in your accounting department and a new employee has taken over the responsibility of preparing and submitting information to your auditors.  

Review the Schedules You Submit to Your Auditors 

Before providing any of the requested schedules, documents, or backups to your auditor, check to make sure that the information agrees with your trial balance and/or internally prepared financial statements.  For example, suppose you provide a schedule of partner contributions and withdrawals that do not reconcile with the corresponding amounts in your trial balance. In that case, you will have opened up a whole can of worms. Even if you ultimately provide a corrected schedule that agrees to the trial balance, your auditors will want to know what changed and the reasons for the mismatch.  Any errors and/or reconciliations during the audit process add to the cost of the audit. Reviewing the audit schedules in advance can save you time during the audit and help everyone focus on more important issues.     

Designate an Audit Point-Of-Contact 

The audit schedules you submit to your auditors provide a good data point for them to begin their audit.  The auditors will have additional questions and most likely need to talk to you and/or your external fund administrator throughout the audit process.  Designating an individual to handle all audit-related requests and to provide timely responses to all their questions will ensure an efficient audit.  A weekly or bi-weekly audit status meeting between management and auditors provides touch points to discuss progress and resolve any issues identified during the audit.    

Send Bank, Custody, and Other Audit Confirmations 

It is standard procedure for auditors to request bank confirmation on account balances on all significant cash accounts. Other audit areas involving the confirmation process include investments and cash held at a qualified custodian, private investments (whether or not held at a qualified custodian), and capital activity, including contributions, withdrawals, and transfers of interests.  Auditors must transmit the confirmation requests themselves directly to the bank, custodian, or investor. In turn, the auditors must receive the confirmation reply directly from those parties to be valid.  When inaccurate balances or incorrect information are provided on the audit confirmation, someone has to spend time following up to get corrected information.  The best chance at improving the accuracy of your confirmations is to prepare them as close to the confirmation date as possible.  So, if your auditor needs a confirmation as of December 31, make sure that you have either signed any paper confirmations or given electronic approval before this date.  The approved confirmation requests need to go out in the first week of January or as close to the year-end as possible.   

Request Advance Testing Selections or Interim Testing  

Auditors are required to include some element of “surprise” in their audit, so they are unable to tell you in advance absolutely everything that they plan to test. However, you can ask if any tests or testing selections can be done ahead of time. Your auditor may plan to perform interim work covering transactions occurring in the first three quarters of the year. Interim procedures help avoid surprises at year-end as they provide your independent auditor an opportunity to look at your accounting records and provide recommendations way before the chaos of year-end hits you.   

Private Investments  

Valuation of private investments (referred to as level 3 investments) is critical to investors and is often closely examined by auditors and their valuation specialists due to the measurement uncertainty and degree of judgment inherent in valuing such investments.  

Most auditors expect management to prepare a comprehensive year-end valuation package for all private investments. The valuation package should provide a comprehensive write-up for each private investment being valued, including references to applicable support and documentation included within the valuation package. Clearly explain within the valuation package your rationale for any specific factors, such as discounts due to lack of marketability or lack of control inputs. Providing rationale for any changes in valuation methodology or inputs that have changed from prior valuation periods helps avoid follow-up questions from your auditors.  

Utilizing AICPA’s Guide 

Management can utilize the accounting and valuation guide published by the American Institute of Certified Public Accountants (AICPA) as a resource while preparing their private investments valuation package. This guide provides guidance and illustrations for preparers of financial statements, independent auditors, and valuation specialists regarding the accounting for and valuation of portfolio company investments of venture capital funds, private equity funds, and other investment companies. AICPA’s guide aims to provide user-friendly guidance with case studies that can be used to reason through real-life situations fund managers face. 

If it seems that your auditor asks more questions and requests more information this year regarding accounting estimates, such as level 3 valuations, you are correct. This is by design and is the result of a new auditing standard that became effective for audits of 2024 financial statements. The new standard enhances guidance on understanding your organization and its environment, focusing on evaluating your internal controls relevant to preparing estimates such as level 3 valuations. Therefore, expect increased auditor scrutiny and professional skepticism regarding your accounting estimates.     

Conclusion 

Preparation for a successful annual audit requires ongoing efforts from management to establish and maintain a financial reporting system capable of generating accurate and reliable financial information throughout the period covered by the audit. The audit process is a two-way street requiring management and their auditors to fulfill their respective responsibilities. Plan ahead and implement the best practices discussed above for a successful annual audit.  

Still have questions? Contact our team using the form below.