Audit Quality

Audits are an important part of any business. How can you tell if the audit quality is good? This question has plagued professionals. Does the quality relate to the person performing the audit, by their ability to discover misstatements, or their ability to meet legal and professional requirements?

In the past, audit quality has been assessed after the audit is finished. It is determined by if the company’s financial statements require restatement, or if a business fails. Recently the quality has been determines by the number and nature of the findings identified during PCAOB inspections. Congress has even tried to regulate auditors and audits with the Sarbanes-Oxley and Dodd-Frank Acts. However, these efforts have done little to reduce the number of restatements or deficiencies reported during PCAOB inspections.

With the inconsistencies in determining a quality audit, the PCAOB and two other organizations have made it their priority to define what constitutes a quality audit. In an effort to create a guide to quality audits, the AQI has three indicators: better informed regulators about audit quality; aid the decision making of audit committees, investors, and managers; positively influence the practices of auditing firms.

Much of what the organizations are pushing is more transparency of audit firm discoursers. This requires publicly releasing information that in the past has remained confidential. Other information would include the number and nature of deficiencies found, the number and size of auditors that resigned, frequency and impact of financial statement restatements, etc.

While there seems to be no answers yet, they are working towards a common goal. Care should be taken when setting regulations so they do not put any undue stress on smaller auditing firms by creating competitive disadvantage that could put the smaller firms out of business. There will be more debates on what is expected, but the results should be beneficial to everyone involved.

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Audits for Not-For-Profit Organizations

This is the time of year audits are conducted  in full force, but not all audits involve the IRS. Most audits are a review of procedures, internal and external management reviews, etc. Many time federal and state governments require a yearly audit for all businesses, whether for profit or not-for-profit. The federal government requires organizations receiving federal funds of more than $500,000 a year to go through a single audit, which is a yearly audit covering and entire year of the program in question.

If it is determined that your business needs an audit, then it is important that a licensed independent certified public accountant prepares it. The accountant will know that proper forms and procedures that the audit will need, and the requirements for the federal and state government.

Once the auditors determine what is required and beneficial then they can prepare to look into you organization. Auditors will examine many procedures during an audit, but you can expect them to look at:

  • Bank reconciliations
  • Selected restricted donations (To ensure that they are handled properly)
  • Grant letters
  • Physical assets
  • Journals
  • Ledgers
  • Board Minutes

Once they have examined everything then they will formulate a report on the accuracy of the financial reports.

If your company undergoes an audit, the board of directors should establish an audit committee that is responsible for selecting the auditor, reviewing the auditor’s outputs, and meeting with the auditor for the pre- and post-audit to address any issues or questions. This committee typically has ongoing responsibilities for the organization that includes the overall financial over-sight and internal financial controls.

Audits do not have to be a scary thing for companies to go through. It is important to review the internal controls and procedures that run the day-to-day part of the organization. It is important that everything runs smoothly, and audit will help with this process.

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Assessing Internal control Procedures

There are different kinds of audits. The IRS can audit your financial records, but another way to audit is assesses the systems and procedures of your company. Assessing internal controls is an important component to establishing the integrity of a business. By assessing the internal controls, a business owner finds places where they can improve procedures.

When a company goes through an internal audit, there are certain procedures looked at. The first thing is how external factors, such as the environment, economy, or technology, are affecting the business. They also look at how the company has modified their internal controls in response to the external influences.

The auditor also evaluates how management assesses internal controls. Each publically traded company creates a written self-assessment document which demonstrates how well it believes the internal controls are working. This is a good exercise for non-publically traded companies. It demonstrates how well you know your internal controls. When performing a self-evaluation you should review the controls for significant accounts. You should also determine which locations, if you have multiple locations, should be evaluated. Management should also assess the design and operating effectiveness of its controls.

Once management has a chance to review, the current controls it is the auditors turn. They will review what is written and determine how well management is performing. The auditor will fill out a yes and no questionnaire that allows them to evaluate the company’s structure, who performs which employee performs each operating task so the auditor can track down the person who performs the task.

The final step is to test the controls. The auditor will design the test and decide which procedures to test. The test included five procedures which include talking to management, looking through the companies documents, observing the company’s operations, and conducting walkthroughs to trace a transaction, and finally do reperformance by redoing the company’s work though a specific transaction.

This can be a complicated process, but in the end it will make your company stronger and more efficient.

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Chance of Audits: Lower Than Normal

Now that the tax deadline has come and gone, the time for audits is here. But what are your chances of having an audit this year? The chances are the lowest they have been in years. Last year the IRS only audited 1% of the individual returns, and this year they are expecting the numbers to go down.

Several things are causing this decline in audits. The biggest factor is budget. The IRS’s budget has declined from $12.1 billion in 2010 to $11.3 billion. This decrease in finances is attributed to overall budget made by Congress to help balance the budget. According to the IRS Commissioner, John Koskinen, there are three areas that can be cut, enforcement, taxpayer services and technology. Since technology upgrades can only be put off for so long, so to ensure the upgrades are made, enforcement and services are taking a hit.

With the decline in the budget for the IRS this leads to fewer agents employed to be able to conduct audits. With fewer agents, the IRS will be more selective on who they choose to audit. The IRS will still be looking at red flags that put someone at risk of an audit. Some of the red flags are:

  • Reporting less than actually earned
  • Earning more than $200,000
  • Making excessive deductions
  • Having extensive losses in stocks
  • Owning  your own business
  • Having accounts in foreign countries
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Warning Signs of an Audit

We know that with tax season in full swing there is another side that will go unnoticed until April. Audits are a part of tax time, and they begin as soon as tax season is closed. Many of us don’t worry about how an audit might affect us. Is there a way to figure out if our tax return might trigger one of those red flags? Let’s look at some triggers that the IRS may find interesting.

There are typical risks that the IRS looks for when deciding if a return needs an audit. One of them is high income. If your income exceeds the $200,000 mark then you have a great chance of an audited. As the income become greater, then so does your chance of an audit. There is nothing more to it. You made so much money that you have earned the special right to a red flag.

Another part of the return that is scrutinized is deductions. The IRS tracks the average deduction taken by individuals in certain tax brackets. Anything above that average can trigger a flag. If you are deducting large items from charitable donations, etc., such as a house or sold off large amount of stock, then specific form are to be filled out and filed with your tax return. Any charitable donation exceeding $250 in one transaction requires paperwork from the charity or organization stating the specifics of the donation.

Another group that is targeted for audits is entrepreneurs. There is something about people running their own business that screams red flag to the IRS. If your business is run from home, the chances are even higher than if you own a place of business. Business expenses that are claimed too aggressively will also cause problems.

The last group is people that own a large amount of real estate. Anyone with a vacation home, especially if the house is rented out, can cause another red flag. Not all vacation home expenses can be deducted and the limitations need to be known.

Remember that lack of information can be just a harmful as too much information. Leaving unanswered questions will also cause problems.

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Improving Audit Quality: The Debate

There has been a lot of discussion recently about ways to improve audit quality. Two proposals made by the PCAOB that would, in their opinion, improve audit independence and accountability. The two proposals have also received a lot of attention both bad and good. The PCAOB wants to require mandatory audit firm rotations and a signature from the lead engagement partner. While these proposals may seem like a good idea in theory, will it really work in practice?

The ideology behind each proposal is the same; both are discouraging forming social relationships that would interfere with auditor independence and create more transparency with in the audit field. Auditors should question procedures, financial statements, etc. and if they feel like they are too reliant on the client for social or economic status then it may erode their objectivity and skepticism. If the auditor’s objectivity and skepticism are decreased then their overall independence is compromised.

Many of the critics of these proposals feel that it the mandatory rotation will have increased costs and decreased quality. Many companies feel that new auditors will have to spend extra time playing catch up and the efficiencies and specific knowledge about the business will be lost in the change. The supporters of the proposal come from people who feel like the relationship has become too cozy and comfortable. This can then lead to unintended lapses in objectivity. There are always two sides to the coin.

While the mandatory audit firm rotation has garnered the most attention, another proposal of requiring a signature from the lead engagement partner has also come under scrutiny. The proposal is to increase accountability, when what is really does is increase identifiability. When a person is identified on a report, one of two things will happen. They will be very cautious to avoid disapproval, or they will become the scape goat if something goes wrong.

Neither one are perfect and will work the same way every time, but by examining the procedures and mixing in a little of both they may be a way of creating a better solution.

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Simple Tips to Selecting an Employee Benefit Plan Auditor

Under federal law, businesses with at least 100 participants must provide an audit as a component of their annual return. Even small businesses will benefit from this process. However, selecting an employee benefit plan auditor can seem like a challenge. Numerous companies may tell you they can provide this service to you, but the question may be more clearly defined as, “what should you look for in a business auditor for an employee benefit plan.”

Invest Time in the Selection Process

Perhaps the biggest mistake a business can make when selecting a employee benefit plan auditor is to rush to a decision. This person you bring on board will need to provide a quality audit that looks at the overall financial integrity of the business’s funds and assets. If this process is not conducted with care, not only will the company become required to undergo more thorough investigations of the employee benefit plan, but the company will, undoubtedly be faced with fines and more complications. Choose a well-qualified professional for the job.

Avoiding Errors Is Easy

The Department of Labor reports that the most common reason for reporting failures are inaccuracies filed by a deficient accountant’s reports. To avoid these errors, ensure the auditor is given full information and that nothing is left to be “found” on its own. That is, providing accurate, thorough records and files is important. The employee benefits plan auditor will work closely with you to provide you with methods to fix errors you may have, but not sharing important information sets your business up to fail.

Get an Engagement Letter

At the start of the employee benefits plan audit, the auditor will provide an engagement letter. Read it. Understand specifically what work will be performed and what will not. Ensure that the timing is accurate. It should also clearly list the cost of this service, something you can negotiate if you believe the service is not accurately represented. The letter should also provide a description of the responsibilities of the auditor as well as your employee plan administrator. If there are questions about the engagement letter’s details, review them now. Do not put this off or assume it is a standard form.

When taking these steps, the employee benefit plan auditor can work for you to provide an accurate, detailed outline of what you can expect. You also can ensure that the process will provide you with helpful information that can help you to manage your business. This information is invaluable to you not just to the IRS.

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Top 5 Myths About Business Audits You Believe

Business audits are a type of service that can answer questions and provide clarity to any business owner. No matter the size, type, or structure of your business, without a third party investigation of your finances and assets, there is no clear way for you to know what to expect. You should never be okay with assuming information you have on hand is accurate.

Take a look at some of the most common myths that small business owners believe about business audits. Some of these are costing you money if you believe them.

#1 – Business audits are too expensive to have done. Not only can this be a business expense you write off (check with your accountant for clarification on this in your situation) but it is also nearly always the best method for understanding the financial strength of your organization. That’s more valuable.

#2 – It’s too time consuming. Yes, it will take some time to go through your documents and accounting records. However, this does not get in your way of doing business. It does not limit your resources and cause your business to be held back during the process. So, there’s really no time hindrance here.

#3 – Your records are accurate. It is rare that, during a business audit, that the auditor will find no errors. In some cases, companies have continued operations with massive errors and inaccuracies only to learn about these when the financial implication were severe. There are likely errors but they can be fixed now.

#4 – You don’t have to. Not all businesses are required to use business audits. However, just because you do not have a federal law requiring this does not mean you should put it off. In fact, as a business owner, you need the reassurance of knowing your business is financially sound.

#5 – Tax time is enough. Many businesses put off business audits until tax time. They find that the reporting requirements then and the work their business accountant does at tax time is enough. However, a business audit now will give you the best indication of the steps you can take now to ensure that tax time goes well.

Business audits are a valuable tool not to be overlooked. Bring in an external auditor to give you a clear picture of where your business stands. Doing so could be the difference in financial success and financial risk. As a business owner, the information given to you in a business audit is invaluable to making management decisions.

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Tax Audit Red Flags

Many people know that an audit is not typically a good experience, but what triggers an audit from the IRS. There are several red flags that the IRS look for when determining what tax returns will be audited.

The first red flag is foreign assets. Since 2009 the IRS has been increasing efforts to regulate offshore accounts. On Schedule B, a taxpayer is asked about ownership in foreign accounts. If they check the box but do not provide any information on the assets it will automatically trigger an audit.

The next red flag can be ex-spouses. Many time following messy divorces and ex can want to cause problems for the other spouse. They contact the IRS with information about the other spouse which may include money laundering, serious financial crimes, underreporting income, etc. Some of the claims are real and others are not, but they have to be investigated.

Too many zeros on a tax return will also be a red flag. It is ok to round to the nearest dollar, but not to the nearest hundred or thousand. It is unlikely that all the sums come out perfect, so too much rounding will cause problems.

Many times a home office credit will send up the red flag. The IRS is cracking down on home office deductions. The credit can only be claimed if your home office is the primary place of business and  used just for work.

Other red flags are miscellaneous income over $600 that was not reported; fishy tax deductions; earning over $5 million; say the wrong thing to the wrong person, even if it is a  joke, you never know who will turn you in; too much work-related driving; exaggerated donations; owning a business that is losing money; and unreliable tax preparers.

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How to Prepare for an Audit

This is the time of year that the IRS conducts tax audits. While it can be scary, there are ways to prepare before the audit. If you are meeting the auditor in person there are a few things you should prepare ahead of time.

Before the Audit

Whether you are meeting an auditor by yourself or with a professional, it is important to be prepared. Find all records that relate to and back up your tax return. The IRS has the right to look any records used to prepare your tax return, so to make it easy. Organize the records use to prepare your tax return. This will also help refresh your memory before the audit meeting.

Remember that neatness counts. The more receipts the auditor goes through, the more chances they will find something else. Auditors tend to reward good recordkeeping and give the benefit of doubt if any problem arises. Pinpoint potential problems and be able to show why your right to take a deduction. Do some research, if necessary.

What to Bring to the Audit

A successful audit is backing up your tax return with documentation. Proof should be in writing, even though auditors are allowed to accept oral explanations. You should bring bank statements, canceled checks, and receipts. Also electronic records, ledgers, journals, and printout of any computer data will also make it easier to show proof. Do not make the IRS guess because they will assume guilt. Anything that will help give proof should be available for the auditor to review.

It is important to stay calm and be prepared to answer any questions the auditor would ask. The success of the audit depends on proving the return is correct.

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