Preparing for Your Initial Financial Statement Audit: What Should You Expect?

An initial financial statement audit usually begins with someone else's requirement: a lender, an investor, a surety, or a board.

Your initial audit will take more time than subsequent audits, because your auditor has to learn your business, document your control processes and test beginning and ending balances no one has audited before. Starting three to six months ahead makes the process faster and less disruptive.

Audited statements that arrive late can put you out of compliance with a loan covenant, delay deal closings, or limit your ability to work with customers or vendors. Adjustments found during the audit, often related to cash to accrual conversions, timing errors and implementations of accounting principles not previously included in the financial statements, can change the earnings your lender or investors see.

Why Do Companies Need an Audit?

Most initial audits are triggered by growth. As a company takes on more debt, brings in outside capital, or bids on larger work, the people extending money or credit want to know that a qualified independent accountant has put their opinion on the financial statements.

Common triggers include a bank loan, a surety increasing bonding capacity, private equity or other outside investors, preparation for a sale, and grant or contract requirements. Contractors, distributors, and nonprofits with federal funding often have financial reporting requirements that can include financial statement audit but also additional audit requirements.

How Is an Audit Different From a Review or a Compilation?

An audit provides the highest level of assurance that your financial statements are fairly presented, and it relies more on risk assessments and substantive testing. The auditor tests transactions and balances, confirms accounts directly with banks and customers, observes inventory counts, and evaluates your internal controls over financial reporting.

A review provides limited assurance, based mainly on analytics and inquiries to management. A compilation provides no assurance: the accountant presents your financial information in proper format without verifying it. If your lender currently accepts a review, read the agreement closely, since moving to an audit is a significant step up in scope and cost.

What Happens During a First-Year Audit?

Most audits move through four stages: planning, risk assessment, fieldwork, and reporting. The first year adds work at each stage.

• Planning. You sign an engagement letter that sets the scope, timeline, and fee, and the auditor learns how your business and accounting systems work.
• Risk assessment. The auditor identifies the accounts and processes with the most risk of error and decides where to focus testing.
• Fieldwork. The audit team tests balances and transactions, sends confirmations, reviews contracts, and asks for supporting documents.
• Reporting. The auditor issues an opinion on the financial statements and communicates any significant control issues identified.

The biggest first-year difference is opening balances. If your prior-year statements were not audited, the auditor tests whether the balances you started the year with are reasonable and reported under the appropriate basis of accounting. Accounts receivable, inventory and fixed assets usually require higher levels of effort, which is one reason to engage your auditor before year-end. If the auditor can observe your year-end inventory count, the work is far simpler than trying to reconstruct it afterward.

For inventory intensive businesses a first year audit may be elected in the form of a balance sheet only audit so that by the end of the next year you would have both beginning and ending balances that observation procedures were able to be performed, limiting the potential for a qualified or adverse opinion.

How Should You Get Your Books Ready?

Your auditor will provide a list of requested documents, often called a PBC list (short for "provided by client"). The earlier you can deliver these requested items complete and on time, the faster the audit moves.

• Reconcile significant balance sheet accounts monthly, not just at year-end.
• Document how you calculate significant estimates, such as bad debt allowances, inventory reserves, and accrued expenses. Be consistent.
• Keep a fixed asset schedule that ties to the general ledger, with invoices for major additions.
• Gather loan agreements, leases, major customer and vendor contracts, and board minutes.
• Confirm your revenue recognition and lease accounting follow current accounting standards.

What Should You Look for in an Audit Firm?

Look for independence and quality first, then fit.

Your auditor's opinion only carries weight if lenders and investors trust the firm behind it.

• Peer review results. CPA firms that perform audits undergo an independent peer review of their quality control. Ask for the firm's most recent report.
• Industry experience. A team that already audits companies like yours will understand your accounting issues and ask better questions.
• Team continuity. Ask who will work on your audit and whether the same people will be there next year.
• Independence. If the firm also prepares your tax returns or helps with your books, ask how it maintains independence under professional standards.
• A realistic timeline and fee. A clear schedule tied to your reporting deadline is worth more than the lowest quote.
  
  
  

What Should You Do Next?

1. Read the agreement that requires the audit and confirm the deadline, the reporting framework, and whether an audit or a review is required.

2. Engage an audit firm before your fiscal year ends so it can plan the work and observe your inventory count, if applicable.

3. Clean up your balance sheet and strengthen your monthly close. Document your internal control processes.

4. Name one person on your team to own the PBC list and serve as the auditor's main contact.

5. After the audit, meet with your auditor to review what went well and what to change next year.

Frequently Asked Questions

How long does an initial audit take?

It depends on the size of the company and how prepared your records are. Lenders and investors commonly require audited statements 90 to 120 days after year-end, so plan your timeline backward from that date. Often in the initial year you can request a 150-day deadline to provide more time, especially if the audit requirement is the result of an acquisition.

Will the auditor find mistakes?

Proposed adjustments are common in an initial audit and are not a sign of failure. Your auditor will review them with you, and management decides how to record them in the financial statements.

Will we receive feedback on our internal controls?

Yes. Auditors are required to communicate significant deficiencies and material weaknesses in internal control in writing. Many also share other control deficiencies and their observations that can help strengthen your processes.

Can we hire an auditor after our fiscal year has ended?

Yes, but it often adds cost and time, especially if your company carries inventory. Engaging an auditor before year-end gives you more time to plan and prepare.

The Bottom Line

An initial audit is a milestone that usually means your company is growing. Starting early, cleaning up your books, and choosing a firm with a strong quality record and a consistent team will make the first year smoother. At LGT, our audit practice has participated in AICPA peer review since 1978, with a consistent record of clean peer review reports.

If you have questions about preparing for your initial audit, our assurance team can help.

To learn more about LGT and how we can serve you, contact us here.