August 2018 Vol. 7 No. 8
charlie goodrich

When it comes to audits, there are significant differences among the firms who perform these services.

Choosing a firm well matched to your business and circumstances will help ensure the best outcome in terms of cost, efficiency, outside perception and final result. 
All the best,
Charlie Goodrich
Founder and Principal
Goodrich & Associates
In this issue…
What to Consider When Choosing a Firm to Audit Your Financial Statements
Heard On The Street
About Us
What to Consider When Choosing a Firm to Audit Your Financial Statements
Over the past several decades, I have worked with many different accounting firms. As you might guess, there are significant differences between them regarding their approach to financial audits. Beyond price, there are several other factors to consider when choosing a firm.

Let’s begin by remembering just what audited financial statements are, in the first place:

An outside firm reviews a company’s financial statements to make sure they comply with Generally Accepted Accounting Principles (GAAP) and tests a sample of transactions to assure readers of the statement that they are indeed correct. The additional step of testing (beyond just reviewing) is significant — it helps ensure that all detail is true, accurate, and GAAP compliant.

Who is the audience?

The first factor to consider is the audience of the financial statements. Are the owners the same as the operators, or are they individual investors, institutional investors, private equity funds and so forth? Among any of these “professional” investors, who are their underlying investors or limited partners? Ask the same question about your lenders, too.

All of this matters because the more national in scope your audience, the more national the auditing firm needs to be. If the readers have never heard of the auditing firm, they will doubt the audit's veracity and the business won’t get the full value of audited financial statements.

Is your company public or private?

Companies with publicly traded securities, and their auditors, must comply with SEC and other rules that do not apply to private companies. As a result, the audit for public companies is more cumbersome, burdensome, and costly. And yet (despite what they may tell you), very few auditors have different audit approaches for public vs. private companies – it is simply too costly to run two different methodologies.

So, if you are a private company, you will benefit by finding an audit firm whose clients are predominately private as well. If you need a larger national firm for reasons mentioned in the prior section, check to see if the auditor truly does have a separate, “private company audit group.” (One of the Big 4 does claim to have that in some of its markets.)

Where is the audit firm located?

If you have significant operations distant from your main location, consider a firm with a matching geographic foot print so they can use local staff and you can minimize travel costs.

Also, since not all operations are significant to the financial statements, a regional auditing firm may be able to use a sister firm that belongs to a consortium. Keep in mind, however, that in those cases, the firm signing the letter in your financial statements will want to review the other firm’s work, which will cost additional money.

How is your company owned for Federal Tax purposes?

This is very significant. As a practical matter, for private companies, the auditor also does the taxes. C Corporations pay federal income taxes directly. This means the specific tax situation of the owner(s) can be ignored.  Not so, however, with so called “pass through” organizations, such as S Corps, partnerships and limited liability companies (LLCs). (“S” & “C” refer to sections of the US Tax Code that detail how these companies are taxed.)

In a “pass through” entity, the taxes are passed through to the shareholder and the shareholder pays income tax individually. So the individuals’ circumstances need to be considered and guidance is needed regarding the payment of estimated taxes. Also, because these are individuals, there are tax planning and estate planning issues that must be considered. All in all, pass throughs involve lots of complexity that requires special skill and expertise that is different from C corporation work.

One last thing regarding the overlap of audits and taxes: Strong people skills are required in tax people for private companies – it’s not just about the numbers. One client of mine changed auditors for a variety of reasons, but one of them was the way the owners were treated by the tax people. The “problem” accounting firm was geared to working with “tech” companies, mostly C Corps. My client was an S Corp and the owners also had real estate investments (these are pass through entities as well). While the accounting firm was perfectly capable in terms of technical tax expertise, my clients “didn’t feel the love.” (Last minute and large estimated tax payments didn’t help the relationship either!)

How large is the audit firm?

If they try, a large firm might be able to give lots of partner attention… but they can’t give “firm” attention. Additionally, large firms have lots of turnover at the junior levels (the folks that actually do the audit work). That means your firm will be explaining your accounting to a new set of people every year.

In the aftermath of some of my projects, creditors sue the auditor for malfeasance. In all cases, what was clear is that the wrong size firm did the audit. In one bankruptcy case I worked on, the former management of my client committed outright bank fraud. The company had close to $200MM in revenue and the audit firm performed the actual physical inventory for its client and then audited their own inventory count. The auditor was a small, local firm whose bread and butter was reviews, not audits, of companies with less than just $20MM in revenue. In another bankruptcy case of mine (a similar sized retailer), one of the Big 4 was sued for malfeasance in not spotting fraud. Here the problem was the audit firm didn’t pay enough attention to the client, because for them, it was a smaller client.

Some smaller firms have been able to differentiate by having the same people do the audit year over year. That way the company doesn’t have to educate new audit staff annually. There are some downsides to this, too, however. I have a client whose auditor has been the same small firm for many years, supported mostly with the same staff. Detailed accounting records, account reconciliations and so forth don’t have to be explained to a new person every year. However, when this company went through a quality of earnings review by a national accounting firm for a prospective buyer, the accounting records raised all sorts of questions solely because they were not prepared in a manner easily understood by an outsider. Ultimately, for a variety of reasons, the buyer walked away.

How professional is your finance organization?

Some companies have a veteran CFO and staff that know what to do to support the audit process and get the work done on time. Other companies have a less seasoned CFO, and while there may be staff, it’s never enough. Companies in this latter category will struggle to get their accounting records in shape and on time to meet the auditors’ deadlines.

Whichever category you may fall into, it’s important that the accounting firm you choose aligns with the level of financial professionalism of your business.

The company mentioned earlier, for example, began with a highly professional, respected firm. Unfortunately, my client never had the necessary information ready when needed. This wreaked havoc on the accounting firm’s staff planning and utilization. The firm’s internal control review was limited and designed to highlight areas for audit focus, a process that assumed a well-oiled accounting function.

When my client switched firms, and while the replacement firm did cost a little more, everyone was much happier. The firm did a very thorough upfront internal control review — beyond that even required by audit standards — that highlighted several accounting and control deficiencies before the audit began, allowing my client to fix the problem. And, when my client didn’t have the accounting records when they were supposed to, the auditor easily adjusted its work schedule.

Choose wisely

As you can see, the auditor you choose matters quite a bit, in terms of cost, efficiency, outside perception and final result. Clearly, it’s about much more than just the price tag!
Heard on the Street
One argument for import tariffs is that somehow we will make more stuff — the currently imported stuff — and therefore we will be better off.

Donald J. Boudreaux , Professor of Economics and the Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center at George Mason University, succinctly explains why such thinking is wrong. Read his short post, here .
About Us
Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent liquidity problems. Our Founder and Principal, Charlie Goodrich, holds an MBA in Finance from the University of Chicago and a Bachelor's Degree in Economics from the University of Virginia, and has over 30 years experience in this area.

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