First-Year Audit Readiness Checklist for Owner-Managed Businesses

A lender, an investor or a regulator has asked an owner-managed business for audited financial statements for the first time. The owner expects a bigger version of the tax return work. The audit is different: the auditor tests the books against evidence, asks about controls, and wants written representations. A client that understands this at the start finishes sooner. The firm's side of the first year is in first-year audits and opening balances, and a shorter general list is in the audit readiness checklist for clients.

Why the first year takes longer

Auditing standards treat a first audit as its own case. An initial audit engagement is one where the prior period's financial statements were either not audited or were audited by a predecessor auditor. The auditor has no prior-year workpapers to lean on, no history with the business, and must reach a conclusion on balances that existed before the engagement began.

The planning standard (AU-C 300, with ISA 300 as the international counterpart) recognizes this. The purpose of planning is the same for initial and recurring audits, but for an initial audit the auditor may need to expand planning because there is no previous experience with the entity. The auditor also considers arrangements with the predecessor auditor, including review of the predecessor's workpapers where the law and professional ethics rules allow, and the procedures needed for opening balances.

Twelve weeks out

• Confirm what the audit covers. Ask the lender or investor for the exact requirement: which years, which framework (GAAP or another basis) and the due date.
• Sign the engagement letter. The engagement letter records the objective and scope of the audit, the responsibilities of the auditor and of management, the reporting framework and the expected form of the report. Management acknowledges its responsibility for the financial statements, for internal control, and for giving the auditor access to all relevant information and to people in the business.
• Name one person as the audit contact, with authority to get documents from the owner and others.
• Decide on cleanup. If the books are on cash basis or have not been reconciled, schedule the conversion. See converting cash basis books to accrual.

Eight weeks out

• Obtain prior-year financial statements and tax returns, and the name of the prior accountant or auditor. Where the business changed auditors, the new auditor communicates with the predecessor before starting.
• Reconcile all bank and credit card accounts for the full year and, for the first audit, the prior year-end.
• Collect contracts, leases, loan agreements, insurance policies and minutes.
• List all related party dealings. See PBC list for taxes, legal and related parties.
• Plan the inventory count date, and tell the auditor so they can attend.

Four weeks out

• Finish the year-end close and lock the books. See the year-end close checklist.
• Prepare the PBC schedules with tie-outs.
• Brief staff on audit confirmations: customers, vendors and banks will get requests, and prompt replies speed the work.
• Prepare a draft of management's discussion of any unusual events in the year.

What the auditor does with opening balances

The auditor must obtain sufficient appropriate evidence that the opening balances contain no misstatements that materially affect the current year, and that accounting policies were applied consistently. ISA 510 sets the steps, and AU-C 510 follows the same approach:

1. Read the most recent financial statements and the predecessor's report, if any.
2. Determine that prior closing balances were correctly brought forward or restated, and that the opening balances reflect appropriate accounting policies.
3. Do one or more of: review the predecessor's workpapers, evaluate whether current-year procedures give evidence about the opening balances, or perform specific procedures.

Current-year work helps differently by account. Collections of opening receivables and payments of opening payables give evidence about those balances. Inventory is the exception: testing the closing balance gives little evidence about inventory at the start, so the auditor may observe a current count and reconcile it to opening quantities, test the valuation of opening items, and test gross profit and cutoff. For long-term debt and investments, confirmations with third parties can supply evidence.

If the auditor cannot get enough evidence about opening balances, the opinion is qualified or the auditor disclaims an opinion. If opening balances contain a material misstatement that is not fixed, the opinion is qualified or adverse. A lender will not accept either one quietly, which is why the client's schedules matter.

Worked tie-out 1: opening equity

The client's prior-year ending trial balance shows equity of $1,480,000. The first-year opening balance schedule:

• Prior financial statements issued: total equity $1,480,000.
• Adjustments the client found during cleanup: unrecorded accrued bonuses of $(60,000) and an unrecorded customer deposit released to revenue of $20,000.
• Restated opening equity: $1,480,000 minus $60,000 plus $20,000, or $1,440,000.
• Opening equity in the new year's ledger after the entries: $1,440,000. Difference: zero.

The auditor will test the $80,000 of adjustments (the $60,000 and the $20,000 together) and may need to extend work to the prior year. Present them as a schedule at the first meeting.

Worked tie-out 2: opening inventory

A client engaged its auditor after its year began. The count took place on January 6, and the auditor observed it. The count at cost is $520,000. Between January 1 and January 6 the company received $60,000 of purchases and recorded $45,000 of cost of sales.

• Count at January 6: $520,000.
• Less purchases received January 1 to 6: $60,000.
• Add cost of sales January 1 to 6: $45,000.
• Derived inventory at January 1: $520,000 minus $60,000 plus $45,000, or $505,000.
• Opening inventory in the ledger: $498,000. Difference: $7,000.

The client investigates the $7,000 before the auditor sees it: a cutoff error, a costing difference or a count error. The same schedule format works for any count taken a few days away from the balance sheet date.

The owner's role

The owner signs a management representation letter at the end, stating that all transactions are recorded and all related parties disclosed. The owner should expect questions on controls, fraud risk and estimates. Time spent in the planning meeting prevents late surprises. See management representation letters.

Sources

• International Auditing and Assurance Standards Board, ISA 510 Initial Audit Engagements, Opening Balances (paragraphs 4 to 13, A4 to A8; AU-C 510 is the US counterpart): https://www.ifac.org/_flysystem/azure-private/publications/files/A025%202013%20IAASB%20Handbook%20ISA%20510.pdf
• International Auditing and Assurance Standards Board, ISA 300 Planning an Audit of Financial Statements (paragraph 13 and A20 on initial audit engagements; AU-C 300 is the US counterpart): https://www.ifac.org/_flysystem/azure-private/publications/files/A016%202013%20IAASB%20Handbook%20ISA%20300.pdf
• International Auditing and Assurance Standards Board, ISA 210 Agreeing the Terms of Audit Engagements (paragraphs 6 and 10; AU-C 210 is the US counterpart): https://www.ifac.org/_flysystem/azure-private/publications/files/A009%202013%20IAASB%20Handbook%20ISA%20210.pdf
• American Institute of CPAs, AICPA Professional Standards (AU-C 210, AU-C 510, AU-C 580): https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards

CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error