Year-End is Coming - Are You Ready for Your Annual Audit?

Many companies are realizing that working from home is here for the foreseeable future. With this in mind, as leaders of finance departments in companies operating in the manufacturing industry head into their fiscal year-end, they should be prepared for their annual financial statement audit with an understanding that their audit might look a little different than in the past. The “good old days” of audit teams working long hours in small conference rooms with predictable access to management is likely not going to happen this year end.

Leaders should consider what their year-end audit will look like in this environment and identify areas in which they can get ahead and proactively manage. Communication is critical both with management teams across departments and locations, as well as with your external audit firm. This is an area that was likely challenging pre-COVID-19 and is expected to be even more so for the near term. As you prepare for year-end and the audit, discussions with your internal teams and external auditors should not only be about changes in accounting standards and other annual pre-audit activities, but also other areas of the audit as outlined below:

Area

Considerations

Inventory observations

The pandemic and resulting restrictions to travel and on-site visits has forced manufacturers to explore alternative ways to perform inventory counts. For example, remote inventory observations may be performed effectively and safely utilizing Facetime, Zoom or a similar video conferencing application. Finance leaders should discuss alternatives with their auditors to obtain information on how the observations will be conducted, required changes in the process if an alternative observation method is used, who will perform the count for management and the auditors and the subsequent impact on audit testing.

Another consideration brought about by the uniqueness of this year-end is the time required to plan for the inventory observation. Your external audit firm may need to have consultations with their national office or other partners to discuss and ultimately approve the inventory observation approach. This requirement could lead to additional time needed during planning for the observation.

Forecasts

The pandemic has called into question management’s ability to accurately forecast the results of operations. It is unlikely that management at most companies could have predicted what the pandemic would do to their operations (either positively or negatively). Typically, the starting point for assessing the effectiveness of a company’s forecast was to evaluate the prior year forecast versus the prior year actual. To the extent there were significant fluctuations, the amount of weight put on the historical accuracy of the forecast might have to be revisited this year.

Compounding this issue is the challenge, as well as ultimately supporting forecasts of future results, including the ability to accurately record estimates. Some areas in which a company might be using estimates or forecasts of future results include:

  • Going Concern
  • Inventory valuation (net realizable value and capitalization of variances)
  • Goodwill Impairment
  • Long-lived Asset Impairment
  • Allowance for Doubtful Accounts
  • Adherence to Debt Covenants
  • Deferred Tax Assets
  • Equity Awards
  • Fair Value Considerations
  • Lease Modifications/Idle Capacity in Facilities
  • Bonuses

Field work / Communication plan

From a logistics perspective, management should discuss health and safety protocols and considerations around reopening and how they impact having outside personnel at their facility.

Management and auditors should discuss the hours that their team members are working and how the teams will communicate and share requested information (i.e., frequency, status and medium).

Management should engage with their auditors to understand if there are any new or different audit requirements in order to properly prepare for any changes to the year-end audit plan.

Testing plan

While external auditors do not generally share their materiality in quantitative terms, it is a good practice for management to engage in discussions with auditors to understand the considerations around materiality and how volatility in operating results and possible changes in the risk assessment brought on by the pandemic could result in changes to the nature, timing and extent of audit testing. This could include changes in sample sizes, additional procedures and the split between interim and year-end testing.

Internal controls

To the extent applicable, management should identify changes in people, processes and technology, considering also changes in service providers to ensure their auditors are aware of changes and have the opportunity to respond.

The Importance of Internal Communications

An area that poses an opportunity for management is in internal communications and how the year-end close and audit preparation is performed. Potentially this provides “permission” to revisit how the books have historically been closed, and reconciliations and other schedules are prepared, as there might be better ways to execute these tasks. Management might look at automating some parts of the close to gain efficiencies and/or bring in-house some of the reporting to centralize tasks. On the talent side, team members may be challenged to perform their jobs differently. For example, team members may need access to scanners to send invoices and other evidence to their auditors who may be in remote locations. Either way, the entire accounting and finance team will have an opportunity to review how audits requests were managed in the past, and it might be beneficial to take a fresh look at the processes in place.

Conclusion

As the end of 2020 approaches, and with the acceptance that things will likely have to be accomplished differently, it is critically important to meet with your auditors to discuss their plans for year-end and how the year-end audit will be conducted in the remote environment. Some decisions (for example, how to audit inventory existence) may need to be consulted upon with the team’s “national office,” or need additional approvals from other partners, which may add to the time required to reach a conclusion on audit approach. We suggest staying proactively ahead of these discussions and engaging with your audit teams soon to prevent as many surprises as possible at year-end.

For more information about preparing for your year-end audit in a remote environment, reach out to us at manufacturing@dhg.com.

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