Most people cringe or fill with fear when they discover an audit might happen to them at work. You may wonder why any employer would ever choose to have an audit. Usually, an audit is required due to a regulatory requirement or some other legal or contractual requirement. Even with some of the negative connotations, is an audit really so bad? Might an audit actually be welcomed? You will see below some of the reasons for which an audit is actually requested. But wait ... what is an audit?
A financial statement audit is comprised of various procedures designed to provide reasonable assurance that an entity's financial statements are free of material misstatement, whether caused by error or fraud. While this sounds simple enough, a lot actually goes into the audit process to ensure the hundreds of accounting and auditing standards are complied with not to mention the additional standards applicable to specialized industries, such as governments, nonprofits, employee benefit plans, etc. It can even be difficult just to determine whether an audit is required.
So, let's expand on why and when an entity might have an audit. Audits are often mandated as a result of regulatory requirements. The following listing provides many of the circumstances in which an audit is mandated (so you can now breathe a sigh of relief since the audit that is occurring at your place of business probably hasn't been requested because of you):
* Most local governments in Nevada are required to have an annual financial statement audit in accordance with Nevada Revised Statute (NRS) 354. This requirement applies to school districts, counties, cities and other special districts. The state of Nevada is also required to be audited; a process carried out pursuant to the provisions of NRS 218G.
* Along these same lines, governmental and nonprofit entities expending federal funding in excess of $500,000 are required to have what is called a "single audit" or OMB A-133 audit, which involves compliance with specifically defined criteria related to the management and use of the federal funds in addition to the financial statement audit.
* Employee-benefit plans of a certain size are required to have an annual financial statement audit in accordance with federal requirements. Employee-benefit plans include defined-benefit and defined-contribution retirement plans and health and welfare plans, all of which can take a vast variety of forms. Generally, employee-benefit plans with 100 or more participants are required to have an audit as part of their obligation to file an annual Form 5500 series return/report with the Internal Revenue Service (IRS), U.S. Department of Labor (DOL) and Pension Benefit Guaranty Corporation (PBGC).
* Under DOL regulations issued on Nov. 16, 2007, retirement plans sponsored by charitable organizations and schools under Internal Revenue Code (IRC) section 403(b) and covered under the Employee Retirement Income Security Act of 1974 (ERISA) are now subject to the same reporting requirements that currently exist for IRC section 401(k) plans. ERISA-covered 403(b) plans with 100 or more participants generally will be required to file audited financial statements beginning with their 2009 Form 5500 filing.
* Casinos and gaming licensees of a certain size are required to have an annual financial statement audit in accordance with Nevada Gaming Control Board Regulation (NGCB) 6.080. Non-restricted licensees having gross gaming revenue of $11,739,000 or more, or accepting $87,210,000 or more in wagers if the operation consists primarily of a race book or sports pool or both, during the 12 months ending Dec. 31 each year, and each operator are required to have an annual financial statement audit.
* Homeowners' associations (common interest ownership communities) are required to have an annual financial statement audit in accordance with NRS 116 if the annual budget of the association is $150,000 or more.
* Publicly traded commercial entities are required to have annual financial statement audits, in addition to quarterly filings and other compliance-related audits; these entities are governed by the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB).
At other times, an audit may be required as a result of grantor restrictions, debt covenants and/or related agreements, an entity's organizational charter, bonding and/or insurance requirements, or to obtain financing; specific examples follow:
* Nonprofit entities or other organizations that receive funding from private or other sources may be subject to restrictions or conditions related to that funding, including the possibility of an annual audit requirement.
* Debt and financing agreements may contain audit requirements, including the possibility of an audit when the entity does not maintain compliance with a covenant or condition within the debt agreement.
* An audit might also be needed in order to obtain financing, particularly in today's more tenuous lending environment.
* An entity may have an audit requirement within its own organizational documents or charter.
* An audit or financial statement "review" (which is another financial service applied to an entity's financial statements, but that provides for a lower level of assurance than an audit) may be required in order to obtain a surety bond as related to construction projects.
Finally, there are in fact occasions when an audit is requested even when not required:
* The rate of fraudulent and illegal activity increases during periods of economic crisis, particularly when the factors of incentive/pressure, opportunity and attitude/rationalization are present. Suspicions of or confirmed fraudulent activity may prompt the demand for an audit.
* When seeking funding or financing, audited financial records provide assurance and reliance on those records and may streamline the financing process.
* An entity's board of directors is typically charged with governance and oversight of the respective entity; making the choice for an audit of the entity's financial statements may demonstrate the requisite financial stewardship and fiduciary responsibility inherent in a board's responsibilities.
* Any time that management or the owners of an entity want to obtain assurance on the financial information they are responsible for, an audit is the best means by which to reach that end.
* In connection with a transfer of ownership of an entity, the buyer, seller or both parties may request audit services related to the financial statements as of the sales date in order to provide assurance that the transaction is based on fairly presented financial information.
Hopefully it is now clear that an audit very often results from a regulatory or other contractual requirement; however, that doesn't lessen the myriad benefits that an audit provides. And, as described, an audit is often opted for by the owners or management of an entity given the assurance provided. In understanding the rationale for having an audit, important business decisions can be made to ensure compliance and financial transparency.
Kelly Koliha is a senior manager for Kafoury, Armstrong & Co. She is a licensed CPA in the state of Nevada and is a member of the American Institute of Certified Public Accountants and the Nevada Society of CPAs. For more information, contact her at kkoliha@kafoury.com or call 689-9100.
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