Auditing Standards for Private Companies

At one point or another, everyone and every business will be subject to an audit. Whether it is a standardized test to get into college, an IRS audit to make sure taxes are properly paid or a quality check from management to make sure products are being manufactured to the right standards, the audit is a part of life.

A financial audit is a part of life for most businesses, and for publicly held companies, it is a requirement that one must be done once a year by an independent certified public accountant (CPA). Private company audits can be done either internally by an audit committee which then reports to management and board members, externally by hired CPA firms or by a government taxing authority such as the Internal Revenue Service (IRS).

No matter what kind of an audit is undertaken or by what type of company, there are several strict rules that must be adhered to when an audit is being performed. These rules and standards ensure the accuracy, consistency and verifiability of all information contained within the audit.

When a business in the United States has its finances audited, the process is normally carried out by accountants that are held to universally accepted standards known as generally accepted auditing standards, or GAAS for short. This is a set of accounting standards, against which private company audits are performed and judged.

U.S. GAAS for private companies are set and overseen by the Auditing Standards Board (ASB), a committee designated by the American Institute of Certified Public Accountants (AICPA). There are 19 members on the ASB, representing various industries and sectors, including public accountants and private, educational and governmental entities.

The AICPA issues statements, interpretations and guidelines that all CPAs must adhere to when performing private company audits.

Most every country has their own version of GAAS, but in the U.S. it is a version which has been adopted by the U.S. Securities and Exchange Commission, otherwise known as the SEC, the arm of the government responsible for enforcing federal securities laws, proposing rules and regulating all stock and options markets in the U.S.

The U.S. GAAS for private companies have been in place in the U.S. in one form or another since 1939, when the AICPA created the Committee on Accounting Procedure. In 1959, that was replaced by the Accounting Principles Board and later by the Financial Accounting Standards Board.

There have been several attempts since 2002 to merge U.S. GAAS with International Financial Reporting Standards, accounting standards used worldwide by about 100 countries, to try to create a globally recognized system of accounting. As of 2012, it was announced by the SEC that U.S. GAAS would remain separate for the foreseeable future.

The U.S. GAAS for private companies are sets of accounting principles that are divided into 10 standards, which are themselves broken up into three separate sections.

The first section consists of three general standards, which outlines essentially who is allowed to complete an audit. The standard states that an auditor, or group of auditors, must have adequate technical training and proficiency as an auditor. For many, this simply means keeping current CPA certifications, and any specialty designations depending on the CPA’s field of expertise.

Next, the standard makes it clear that the auditor must maintain an independent mental attitude, and must cooperate in good faith with the IRS or any other auditors or regulatory bodies that may be involved. Last, the auditor must exercise professional care in the audit performance and preparation of a final auditor’s report.

The second section contains three standards related to field work, and outlines how the auditor should go about the work itself. It states that the auditor must adequately plan the work and supervise any assistants properly.

It requires the auditor to work with integrity, objectivity and serve the client to the best of their ability, regardless of whether they agree with information contained in the financial statements they are working with.

Next, the auditor must take the time to gain a sufficient understanding of the company and its environment, as well as internal management, in order to assess the risk of mismanagement of financial records from fraud or error, and use that information to design any further auditing procedures.

Last, this section states that the auditor must obtain proper evidence by performing auditing procedures in order to form a professional opinion about the company’s financial statements. In many cases, this means obtaining evidence from third parties, such as clients, in order to verify information contained within a company’s financial statements.

The third and final section of U.S. GAAS for private companies outlines the standards of reporting to which auditors must adhere. First, an auditor must state in a final report that the audit was performed using GAAS. If there is a different auditing framework that was used, such as U.S. tax code, cash accounting, or another type of framework, it must be stated in this section.

Next, the auditor must identify in the report those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. If informative disclosures in financial statements are not sufficient, the auditor must state so, and finally, the auditor’s final report must express an opinion about the company’s financial statements – or whether one cannot be made.

Of course, the auditor is required to explain the reason for every opinion or why one cannot be made, as well as full disclosure about the scope of their work.

An audit is essentially a systematic and thorough examination of a company’s books, accounts, records, documents and other items that give a clear view of the company’s business and financial dealings. There are many different types of private company audits that can be performed to keep a business accountable.

A performance audit examines a program, function or operation to determine if it is running economically and efficiently. At its simplest, a person auditioning for a part in a performance or interviewing for a job is being subjected to a performance audit. Government agencies and non-profit organizations are commonly audited for performance to make sure they are run efficiently and fairly, while maintaining objectives and missions of the organization.

A quality audit can be performed to ensure that all products and services are running or being produced to certain standards. In some industries, quality audits are required to ensure certain safety, security and environmental compliance standards and certifications are upheld. Quality audits are performed routinely during manufacturing processes to make sure that products are safe and made according to standards.

Project audits are private company audits that are conducted during the course of a project to ensure that things are running smoothly and according to plan. This type of audit is usually conducted during the project and helps to uncover any issues, concerns or challenges faced during the project so they may be corrected. An example of this type of audit would be done during construction of a building, for instance, or in the middle of manufacturing a consumer good such as an automobile or airplane.

An operational audit is a large-scale audit performed to review the effectiveness, efficiency and economy of an organization. It is generally done to appraise the effectiveness of business practices and identify what can be done to improve the operation of the organization. By doing this type of audit, executives can be made aware of problems within the organization and use lessons learned to gain new perspectives and motivate employees to improve performance.

Most businesses, especially ones that are publicly held, are subject to financial audits, which are thorough examinations of a business’s financial records by a third party, most commonly a CPA. This audit is performed to provide credibility to an organization’s (or individual’s) financial statements. In the case of publicly held companies (which register their securities with the SEC) or companies doing business with U.S. or state governments, an audit is required to ensure funding is being spent efficiently and effectively, especially when the money for operation is coming from taxpayers.

In a word, no. It all depends on the size of the company, who the company’s management answers to, and what the plans are for the future. In its simplest form, an audit by a professional CPA can be looked upon as an annual physical exam for the company. Just like a checkup by the doctor, private company audits can uncover problems left unchecked and help management take corrective measures.

Also, having an auditor complete a final report on your company’s financial state using GAAS for private companies can keep you on your toes (because you know someone is watching), and give you an easy-to-read document for lenders or any other party who may be interested in your financial matters.

In the case of private companies with a small number of employees that isn’t growing very rapidly and with no shareholders, there isn’t really a reason to be audited as there are no private company disclosure requirements, other than regular tax obligations. From a cost-savings standpoint, it makes no sense. A professional audit by an independent CPA can cost over $100 per hour and take more than 100 hours, for a cost of more than $10,000.

For a larger private company with outside stakeholders or investors, a private company audit is essentially an assurance beyond a management assertion that a company’s financial statements can be relied on. It can be important for a private company to have disclosure requirements to provide to investors if they are large or hope to have continued investor commitment – and if they plan go public in the future, an audit is a requirement.

For most private businesses that are closely held and don’t have any public investors, a financial audit is generally not required, but it can be a good idea to provide peace of mind. Complete and quality financial records are a great tool to help run a business, and it’s always a good idea to make sure they are done properly and thoroughly.

By contrast, companies that require large amounts of bonding or financial assistance to do business are usually subject to financial audits because financial lenders and bonding companies require them as a requirement for securing funding.

As different companies and banks have different rates, private company disclosure requirements and standards it’s a good idea for a business to have accurate and thorough financial statements and disclosures so that quick decisions can be made.

While some financial lenders are liberal about those they approve, others require solid credit ratings for those they do business with, and in some cases, the lender will require a cash collateral as a requirement for the loan.

In that case, an audit helps provide accurate and assured financial information that can help evaluate financial risk to the lender – and can lead to lower finance charges to the borrowing company over the course of a loan.