Let’s talk this month about an increasingly important topic, namely how to prepare for a financial statement audit. But, why is this gaining such importance?
Well, with the growth of the cannabis industry as more states legalize either medical marijuana, recreational marijuana, or both, investors are increasingly looking to enter the capital market cycle of cannabusinesses.
And, typically, when you receive investments, those investors or lenders will want to know their money is being taken care of. Financial statement audits are the typical method to give your stakeholders that assurance.
The benefit of an audit is that it provides assurance that management has presented a “true and fair” view of a company’s financial performance and position. An audit underpins the trust and obligation of stewardship between those who manage a company and those who own it or otherwise have a need for a “true and fair” view, the stakeholders. In addition to management reporting to the board of directors or shareholders’ group, a financial statement audit report is the most common communications tool to present that “true and fair” view.
Being audited the first time can be confusing and intimidating. Whether it’s a financial statement audit, an IRS audit, or an examination from a state regulatory board, audits can get your heart rate up!
So, if you need a financial statement audit, or are thinking you might need one in the future, read on. We’ll try to take some of the mystery out of it.
How should your cannabis business prepare for the financial statement audit beforehand?
First, confirm the dates that the auditors will be at your location. You’ll want to ensure that your books and records are complete for the time period the accounting firm is scheduled to audit.
This includes preparing reconciliations for all balance sheet accounts from the subledgers to your general ledger. This is a critical pre-audit step because you’ll want to make sure your account balances are correct. Go through this analysis and ensure your books and records are accurate before the auditors come. It’ll reduce the number of potential audit adjustments. It also reduces the back and forth with your auditors, and ultimately the cost of the audit.
Their job is to examine documents and perform analytics to ensure your books and records are “materially correct” and to provide your stakeholders written assurance of that in the form of an audit opinion. So, the more accurate things are at the start, the more efficiently they can perform their duties. And, the quicker you can get them out of your hair and get back to growing your business!
The PBC List
The accounting firm will send you a list of all items for which they would like support (the “prepared by client” or “PBC” list). While this list will include most of the items the auditors will need for the audit, be prepared for follow-on requests as the auditors analyze data.
A best practice is to designate someone in your organization (or an experienced outside consultant) to handle all the requests. From completing the PBC list to placing items into a virtual data room if your auditors use one, a single point-of-contact is critical. And, they can also act as the liaison between the auditors and the business. Now, you can do it yourself, but that takes valuable time away from operating and growing your business.
Ideally, you want everything on the list completed a week prior to the start of the audit. What you don’t want is to not have the information on the PBC list available when the auditor comes out. Delays in completing this list can lead to audit cost overruns and increase the cost of your audit. If you run into a bind with getting it completed, communicate with your auditors as soon as possible. They will likely help you prioritize the list.
Once the audit begins, how can business owners help ensure everything goes smoothly?
The key here is to be available to the auditors when they are on site, and to respond to auditors’ requests. Every auditor understands you have other things to do. But if you’re not available, it could delay the audit’s completion.
A best practice is to communicate to the auditors up-front as to the best method to communicate with you (i.e., by e-mail, phone call, or stop by your office). Also, let them know if you’d like weekly status update meetings. These status updates, or “take-stock,” meetings can be accomplished in 15-30 minutes. And, they can really help address any roadblocks on a real-time basis. Thursday afternoons or Friday mornings are excellent times for these meetings.
And, again, consider getting someone to manage this process for you.
If the auditors don’t get the information they need to complete their audit procedures, the report may be delayed, which can add to the overall costs.
Additionally, after the auditors leave your facility, they will usually have follow-up questions. So, you’ll want to continue to be responsive. You’re almost done, but not quite. Answer their emails, take their calls and let them know the best way to communicate with you.
An efficient audit will minimize additional audit fees. If your company’s records are a mess and require various audit adjustments, the audit will require more hours. And, more hours can mean additional fees as most audits are quoted on an estimated basis.
In addition, the audit firm also may be required to issue a letter that states if the company has significant deficiencies or material weakness in internal controls. No company wants a letter like that. One of the primary causes of such deficiencies are the auditors having to post too many adjustments to clean up the books.
Wrapping up the audit
Near the end of the audit, the audit firm will prepare a letter on your behalf that lists all the matters you told them over the course of the audit, known as “representations.” They’ll ask you to sign and return the letter to them. This representation letter is one of the last steps in the audit process, but it is also one of the most important.
You are certifying under penalty that everything you told the auditors is true to the best of your knowledge. You’re also certifying that all the documents you gave them (or made available to them) are authentic. Take the time to read each of the representations before you sign the letter. If you have any questions, reach out to the auditor.
How does a cannabis business know whether it’s received a quality audit?
Auditors are generally qualified accountants who are members of a professional institute in their respective countries. Although this varies between countries to become qualified, accountants normally must meet certain educational requirements, take several years of studying and professional exams and have sufficient practical experience. So, ensure your auditors are enrolled in a “peer review” process. And, make sure you understand the cannabis-specific industry knowledge of the audit management.
Nothing will agitate you more than having to explain the purposes behind a “seed-to-sale” report or the difference between a male and a female plant! Since not all firms serve the cannabis industry, ensure that your firm has the requisite industry knowledge. And, this is especially important when it comes to financial matters.
In addition to their qualifications, there are questions to consider. Was the audit team present during the audit? Did they spend sufficient time asking questions and having discussions with your team? Was the partner that signs the audit report present? Did he or she interact with the staff, with the CFO and with you? Did the auditors give you recommendations to improve processes or internal controls?
A note about professional judgement, skepticism, and the auditors’ tone
In undertaking an audit, the auditors must consider a litany of things. There’s the mandatory and detailed accounting principles that set out how a company should account for and disclose even the most complex transactions. However, many of the issues that arise in an audit—particularly those involving valuations or assumptions about the future—involve estimates. And, that’s where the auditor must bring their professional judgement and experience to bear.
Auditing standards also require auditors to maintain professional skepticism. And, this attitude includes a questioning mind and a critical assessment of audit evidence.
So, what’s integral to a quality audit? The ability to think in a critical manner about how the current economic environment may affect the company’s financial statements. The ability to identify significant risks of material misstatement and to develop appropriate audit responses. And, the work of obtaining and assessing the sufficiency and appropriateness of audit evidence.
All are important to reaching well-informed professional judgements in a quality audit. So, don’t be offended if the auditor’s tone is “all about the business” because they are just doing their job.
To sum it all up
Since its introduction, the need for certain companies’ financial statements to be audited by an independent external auditor has been a cornerstone of confidence in the world’s financial systems. And, the cannabis industry is no different. While being audited can be confusing, it doesn’t have to be. Borrow some of these tips to get prepared for your audit, and you’ll be just fine.
Want to learn more? Speak with us about how we can help you grow your cannabusiness while staying compliant with the myriad rules and regulations, including managing the entire financial statement audit coordination process for you.