December 19, 2023

As in previous years, we are pleased to provide restaurateurs with an annual reminder of items to keep on the radar before the annual financial statement audit. Planning is the key to a successful and efficient audit. Staying in touch with your external audit team is instrumental, as well as ensuring a thorough review of control processes, staff preparedness, and financial record readiness is completed ahead of scheduled audit fieldwork. All of those steps will minimize day-to-day interruptions and alleviate your accounting staff’s concerns about having the proper documentation and related materials ready when the audit team requests. 90% of our audit requests are based on the balance sheet accounts being reconciled.

Below is a list of steps to follow to enable your accounting team to be as prepared as possible for the audit work.

Address Accounting Issues Before The Audit Commences

Evaluate your accounting practices in relation to common accounting issues, as noted below. Identify any concerns/questions beforehand to address questions with your auditor promptly before the audit begins.

Please note that one new accounting standard could impact your financial statements related to credit losses.  Although we do not expect this to have a material impact for most, it is important to understand the standard and how it applies to your business.  There will be new disclosures describing the implementation.

Lease Accounting Reminders

Although we are now in year 2 of accounting for leases under ASC 842 for many of you, and your adoption of this standard is in the past, there are still multiple items to consider regarding leases as you prepare for your year-end close and annual financial statement audit or review.

Adoption memo and policies – As part of ASC 842, all material leases with a term of greater than 12 months are required to be reported within ROU assets and lease liabilities on the balance sheet at the present value of future lease payments. Various practical expedients are available to assist with and ease the burden of lease accounting. See our ASC 842 Lease Implementation Portal for additional information and timely tips associated with the adoption and recognition of lease assets and liabilities, as well as internal control and corporate policy recommendations for lease accounting.

Inventory new leases — It is important to keep an updated listing of all leases entered into, including any new leases entered into during 2023 that need to be accounted for under ASC 842. Your auditor will want to see this updated listing to test for the overall completeness of leases.

Reconciliation process — Right-of-use (ROU) assets and lease obligations will need to be reconciled as part of your year-end close process. To the extent that you utilize a third-party software solution, the software will provide the entries for you after any applicable lease additions, remeasurements/modifications and any other changes to the lease portfolio have been accurately input.

Depending on how you have been recording your lease payments throughout the year (e.g., directly to lease expense, through the ROU asset and lease liability accounts as part of more frequent lease portfolio reconciliations or by another method), there may be a P&L impact for this annual reconciliation due to the difference between cash paid and straight-line rental expense.

If variable rent clauses are present in your leases (e.g., percentage rent based on restaurant sales), these will need to be reported on for financial statement disclosure purposes as variable rent, so it is best to have a separate GL account for variable rent to identify easily.

Impairment testing — Similar to property, plant and equipment, ROU assets are required to be evaluated annually for impairment. This includes analysis of whether any “impairment triggering events” have occurred and, if so, performing a recoverability test and potentially a full-blown impairment calculation depending on the results of the recoverability test.

For an example of this and further guidelines surrounding impairment, please refer to our article on Evaluating Your ROU Asset for Impairment.

Remeasurements — Various items and events can cause the ROU asset and liability for a lease to need to be remeasured, such as a change in the lease term or whether a renewal term is reasonably certain to be exercised. When a remeasurement event has occurred, the ROU asset and lease liability will need to be remeasured based on the current fact pattern, and this may result in updating the discount rate and a reassessment of lease classification depending on the type of remeasurement event that has occurred.

Modifications — Lease modifications typically occur when a lessee is granted an additional right of use not included in the original contract (e.g., lease of additional space). If the change in lease payments is commensurate with the additional right of use’s standalone price, then the original contract is unaffected, and the modification can be accounted for as a separate contract. Alternatively, if this is not true, the full lease will need to be remeasured under the remeasurement guidance discussed above with an update to the discount rate and reassessment of lease classification.

Further guidance —

Internal Control Reminders

Part of your auditors’ responsibility will be to obtain an understanding of your IT control environment, specifically, segregation of duties (“SOD”) based on general ledger system access profiles. This analysis will be required to be more thorough in 2023 compared to years past due to new audit standards that became effective in 2023 (specifically SAS 145).

This means more inspection of source documents and observation of processes in addition to annual inquiries being performed. SOD issues are common and most often occur when the CFO/Controller has no restrictions within the general ledger system, thereby eliminating any checks and balances expected to be in place.

Sometimes, increased risk is unavoidable, but there are ways to mitigate segregation of duties regardless of company size. Indeed, avoiding a material weakness due to the audit is important, but safeguarding the company’s assets through proper segregation of duties is paramount to the company’s success. Discuss any concerns you have with your auditor early on.

Get A Review

Getting a review before you embark on a full-blown audit may be wise. First-year audits can be complicated because auditors must establish a baseline understanding of the business, and you may be converting from tax basis to GAAP.  If you commission a review the year before you plan to get an audit, your engagement team can recommend what to tweak and adjust before the full-scale audit commences.

Review Your Engagement Letter

The engagement letter is the roadmap needed to navigate the annual audit. It provides all the necessary information about the audit, from purpose to fieldwork specifics, through final audit report delivery. The specific information includes:

  • Objective, period, and scope of the audit
  • Catalog of professional standards the auditors will be following
  • List of the auditors’ responsibilities, including a brief explanation of the procedures they will perform both on- and off-site
  • List of management’s responsibilities, including what information you and your staff will be responsible for collecting
  • Fees and billing expectations

Attend Pre-Audit Meetings

The auditors will schedule a time to discuss the upcoming audit. This is where you should bring up concerns identified in the engagement letter and ask clarifying questions. At this meeting, the auditors should discuss the documentation requests and expected timeline, including when they plan to be onsite. Remember, the schedule will include timelines and deadlines for both the auditors and internal team members. Pay careful attention to ensure the expectations around requests and the timeline are clear.

Collect The Right Documentation

Most of the audits that incur additional costs almost always have reconciliation issues. If you can collect all the documents the auditors request, the audit will go smoothly. Here are a few things you should have ready:

  • Trial Balances – up to date, adjustments posted, any missing journal entries (e.g., bonus accruals) flagged for auditors
  • Reconciliations – reconciled to bank statements, loan balances tied to loan agreements and statements, PP&E balances tied to sub-ledger reports, AP tied to sub-ledger, lease accounting reconciliations, and accrued expenses properly analyzed and recorded

Permanent Files

Auditors keep a folder of long-term agreements to reference at each successive audit. This includes agreements that span multiple years, like lease agreements and loan documents, and it also includes internal documents like organizational charts, accounting policies, operating agreements, chart of accounts, and documentation about your internal control environment.  Be sure to have these ready to provide your auditors with an electronic copy.

Bank Covenants

Calculate your bank covenants and determine whether any issues exist. Your auditors will want to see if you meet the conditions of those covenants. If you are concerned you may soon violate those covenants, work with your banker to renegotiate the conditions. To issue a clean report, your auditors need confidence that you can service your debt with your bank in future years.

Going Concern

Evaluate your going concern projections to ensure the Company can sustain operations 12 months after the issuance date of the financial statements.  If your financial statements are issued on April 30th, your projections will need to go through April 30th of the following year.

List Of Subsequent Events

Subsequent event testing is when auditors evaluate events that occurred after the period that is being audited. Even if these events do not impact your reported financials, the auditors may need to disclose them. Some common events worth mentioning are:

  • Opening or closing a restaurant
  • Temporary closure of stores due to remodels or labor shortage
  • A damaging fire in an existing location
  • Signing a new lease
  • Negotiating new debt terms
  • New capital investment from investors

Schedule Time For The Audit

Two to three weeks before fieldwork begins, the auditor should provide a list of accounts, reports, transactions, vendors, etc., that they plan to test. You will need to pull supporting documentation for those selections. Ensure you have enough time to find those documents and complete your day-to-day work. In addition, although it is not strictly necessary, many restauranteurs choose to clear their schedule the week your auditors arrive for fieldwork. Responding to their requests quickly will help them stay on track.

Questions?

Preparation is the key to success.  Annual audits do not have to be daunting and should not fill you with dread. With the proper preparation and support from your auditors, your staff can avoid interruption, and you can oversee the work with minimal stress. Although much work is needed, audits will not be burdensome or scary if prepared.

If you have questions about the audit process or need assistance with a restaurant audit, GBQ can help. For additional information, click here to contact us. We look forward to speaking with you soon.

 

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Tags: Audit/GAAP