Getting your equity audit-ready

Introduction

There are only two certainties in the life of a business once it reaches a certain scale: taxes, and audits.

Audits are a core part of any company’s lifecycle. They’re renowned for being stressful for businesses to address: after all, the purpose is to test the completeness and accuracy of financial statements and reporting. There can be serious consequences if an audit finds significant misstatements or inaccuracies in a business’s finances.

Auditors also seek to understand how companies handle equity and share plans. But equity data, spread across spreadsheets, contracts, software platforms and board minutes, is tough to handle.

Accounting for equity is a mix of art and science. It’s important for companies to have robust quantitative analyses of how share-based payments are represented on the balance sheet and in financial statements. At the same time, though, other elements like valuations often come down to subjective conversations and mutual agreements between the company, its auditors and other important stakeholders like tax authorities. So it’s vital for companies to be ready for audits as and when they arise.

Audits are a valuable opportunity to stress-test financial best practices, but they demand solid collaboration across business functions and a sound understanding of financial fundamentals. Don’t let equity hold you back from successful audits: get your equity and share plans audit-ready with this Ledgy guide.

Why do you need an audit?

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Audits offer several benefits for companies. A successful audit allows the company to enter into discussions with lenders or investors with an objective assessment of its financial structure and record-keeping. Audits also offer teams opportunities to rectify any gaps or inconsistencies in financial statements, and get a tighter grip on reporting processes.

Most audits are focused on a particular financial reporting period, such as the previous financial year. Larger, more complex companies may engage in interim audits, which assess a portion of the financial year. Interim audits allow companies to check in with auditors midway through the year, to ensure they are reporting activity accurately and to carry out valuable preparatory work ahead of fuller annual audits. Catie Wood, Group Financial Controller at beauty buyer’s club Beauty Pie, says that “An interim audit is usually shorter than a year-end audit, and doesn’t necessarily cover all areas of the financial statements. The year-end process is more in-depth: for a small-to-mid-sized company, it might take around a month from start to finish.”

Auditors thoroughly assess the company’s financial systems and processes in order to reconcile reported financial statements with the transactions and payments that make up a businesses’s revenues and costs.

Auditors test for a few important assertions. They seek to assert that reported transactions did occur; that recorded transactions are complete, and that data relating to recorded transactions are accurate. An audit will also draw conclusions on elements like the quality of presentation – essentially, whether the company’s relevant disclosures are clear and understandable.

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Internal and external audits

Not all audits are the same. The purposes of internal and external audits are clearly defined by the Institute of Chartered Accountants for England and Wales (ICAEW), which says that external audits are designed to “report on the truth and fairness of financial statements”, while internal audits “are responsible for assessing the effectiveness of controls in mitigating risks”.

So in practice, how do internal and external audits differ?

Internal audit

An internal audit is carried out by an internal audit team – usually designated employees – and the results are not normally made public. Internal audits generally focus on internal controls and processes. They are scheduled in advance and company leadership is able to prepare records and statements ahead of the audit.

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External audit

An external audit is carried out by an independent third party. Any statutory audit, as described in the previous section, must be an external audit. External audits normally involve more preparation than an internal audit.

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In an external audit, the company’s balance sheet, profit and loss statements and cash flow statements are all assessed and reconciled with transaction data. With foresight of audit deadlines, companies can prepare to make sure the timing of the audit (whether it’s statutory or voluntary) does not create additional complexity. Remember key milestones, such as the date your balance sheet snapshot is recorded. Your balance sheet will necessarily ‘lock in’ certain payments, conversions and transactions. They can be corrected in subsequent financial statements, but good preparatory work will ensure that a business knows what the balance sheet will show before it’s finalised and reported.

Equity in your audit: key questions to answer

Companies may wish to begin from first principles when preparing equity plans for an audit, especially if it is the company’s first audit. It’s imperative to walk through your equity plans and clarify answers to the following questions. Some of these questions will be asked of the business directly by auditors, but delivering on the below will ensure the business can have constructive conversations with auditors, minimising additional workload during the busy audit period itself.

Providing an auditor with answers to these questions at the outset will enable constructive dialogue and prevent equity and share plans from throwing up additional complications as the audit progresses.

Having a single source of truth for equity data helps companies and auditors understand what has happened in a given financial reporting period. To Catie, “your equity software almost functions as a second set of eyes so you can validate your calculations and assumptions before you share your work with the audit team.”