WipFli: Audit Readiness, a Recipe for Success
This is a guest blog post from Colleen Varallo, CPA and Partner at Wipfli LLP
So, you made it through a grueling Series A round and are now eager to put that capital to good use, growing the business and developing the product, but there’s always a catch. In order to receive the funding, you agreed to have an independent financial statement audit performed annually in compliance with US Generally Accepted Accounting Principles (GAAP). Are you ready?
If the answer to that question is no, you’re not alone, as most startups put GAAP on the back burner until they are forced to comply by lenders and/or investors. This approach, while understandable, can be costly to a startup, both in dollars as well as time.
Although the organization may be small, many emerging growth companies have a number of complicated GAAP issues that need to be understood and addressed – for instance, revenue recognition, stock-based compensation, software development costs, and estimating state and local tax liabilities. The list goes on and on. And if you are not in front of that list, those issues could not only slow down the audit process but will almost always result in a material weakness or significant deficiency in internal control as well as audit fee overruns, not to mention a drain on the company’s valuable internal financial and operations resources. All of which may result in missed deadlines and diminished confidence of stakeholders.
To avoid these mistakes, we suggest you take the following steps:
- If possible, consider addressing GAAP readiness before seeking funding. This requires that the organization adopt and implement the proper policies, procedures, and internal controls early in its life cycle to create the framework required to ensure GAAP compliance. This may include:
- Assessing and documenting the organization’s accounting policies
- Maintaining financial statement support, reconciliations, schedules, and related source documents that agree to the closing trial balance
- Documenting and enhancing your key control activities as they relate to financial reporting
If addressing your GAAP readiness prior to seeking funding is not an option, consider at least addressing your GAAP readiness before its time to have your annual audit completed.
- When in doubt, do what the auditors do and take a risk-based approach to financial reporting. In other words, identify the areas of GAAP within your organization that are most susceptible to errors and/or irregularities and focus your attention on those areas first. For example, revenue recognition, equity transactions (including entity formation or restructuring, warrants, convertible notes, and stock-based compensation) and capitalized software costs. These are some of the common complex GAAP areas that startup companies will need to address.
- If you don’t have in-house financial expertise, consider hiring a consultant or accountant that not only understands the requirements of GAAP but also has experience applying it to your specific industry. This will ensure common pitfalls are identified and avoided, or at least corrected, prior to the start of your audit.
- To the extent that you are able, invest in the necessary software to aid you. For example, if you create intellectual property such as software, consider investing in project management software so that the various stages of development can be adequately tracked to support amounts required to be capitalized by GAAP. In addition, we further suggest you invest in a time tracking software and that such software is set up to include the various stages of development as defined by GAAP. As part of this process, development team members should be educated on the GAAP requirements and the process to accurately record their time. Finally, management should review and approve time entries on a consistent basis. These steps are crucial to substantiating your development process and the related costs.
- If you conduct business in more than one state, i.e. you either have customers located in various states or you have physical nexus in more than one state, we suggest that you review the tax requirements of the identified states early and/or seek the guidance of a tax professional who specializes in state and local tax to ensure you are properly registered and are complying with the applicable regulations. State and local tax laws are continuing to evolve, especially as they relate to cloud services. As a result, many startups are not in compliance with the state and local tax regulations they are subject to, which can result in substantial unrecorded liabilities of the company, including penalties and interest.
Knowing and addressing the key GAAP areas that are applicable to your organization can take your organization to the next level, putting in place sound practices and procedures allowing your organization to grow in a healthy, controlled environment and instill faith in your stakeholders.
As Benjamin Franklin said, “By failing to prepare, you are preparing to fail.” Ensure your success, become audit ready.
How can Wipfli help?
Does your organization need help becoming audit ready? At Wipfli, experts are available to walk through the process of becoming audit ready with you. Whether it is help evaluating your internal controls, assessing your accounting policies, or analyzing your state and local tax exposure, Wipfli has just the right expert to help you out.