Self-audit Techniques for Government Contractor’s Financial Statement Audit

At a Glance:

• Self-auditing before a year-end financial statement audit can help identify potential issues and to improve the outcome before the audit even starts.
• Conducting a self-audit involves reviewing your financial records and processes to ensure accuracy and compliance.
• Evaluating the effectiveness of internal controls over financial reporting, including segregation of duties, approvals, and access to accounting data, can identify potential risk areas.

The Full Story:

A financial statement audit readiness assessment helps uncover control weaknesses, lack of documentation and other issues that should be corrected before the start of a year-end audit. Self-audit techniques also allow government contractors to assess their internal controls, evaluate compliance with policies and procedures required by the Federal Acquisition Regulation (FAR) and identify opportunities for process improvement. Keeping detailed records of your financial transactions throughout the year is key to a smooth and swift audit.

As you prepare for your audit, conducting a thorough internal review and applying self-audit techniques can help identify and rectify potential issues and prevent delays in the audit process. To help you effectively prepare, Aprio has compiled a few self-audit techniques below.

Financial Statement Self-Audit Steps

Focus Areas:

Trial Balance

Start the process with the prior year’s trial balance. If the preceding year’s financials were audited, compare the audited financial statements with your internally produced statements to make sure they match. Identify and resolve differences and record any missing audit or tax-adjusting journal entries.

Cash

Review the cash reconciliation process by sampling a completed month-end bank reconciliation and comparing the ending balances on bank statements to the corresponding balances in the general ledger. Old, outstanding checks or deposits need to be addressed. Look for any outstanding checks that may be reported as unclaimed property in compliance with State laws. Also, if any differences are noted, review outstanding checks and deposits for timing differences, errors, or possible fraudulent activity. Periodic reviews of bank reconciliations should be conducted regularly throughout the year to help detect errors early and prevent them from escalating.

Accounts Receivable

It is crucial to meticulously review the Accounts Receivable aging report once the month-end close has been finalized. This step is essential to maintain the accuracy of our financial reporting and to effectively manage potential collection risks. Compare the balance with the Billed AR balance in the general ledger, and promptly investigate and adjust any variances that may arise.

Analyze aged receivables in the 61-90 and over 90-day categories. Assess potential collection risks associated with aging balances and record allowance for doubtful accounts based on both known facts and your established policies. Document your decision factors for any reserves created.

Unbilled Account Receivable and Deferred Revenue

The Unbilled Accounts Receivable account represents revenue that has been recognized but not yet billed to the customer. Make sure reasons for the unbilled Accounts Receivable balance are documented for each project and that there is an expected bill date. Select a sample Unbilled Accounts receivable balance detail end-of-year and trace it to subsequent billing. Pay particular attention to any large, material amounts.

Deferred revenue represents payments that have been received from customers for goods or services that have not yet been delivered or performed. Select a sample from the deferred revenue detail and test compliance with Generally Accepted Accounting Principles (GAAP) accounting standards. This includes reviewing customer agreements, understanding contract terms and performance obligations, and checking if deferred revenue meets accounting standard ASC 606 requirements. Determine if the performance obligation has been fulfilled before the deferred revenue is reclassified. Make sure the management input and calculations for unbilled and deferred revenue are adequately documented and supported.   

Project Revenue and Costs

Annual project revenue summary to general ledger reconciliation ensures the accuracy and completeness of revenue data in financial statements. Self-audit steps include reconciling revenue, direct costs, and other direct costs from project summary reports to the general ledger. If differences exist, you must identify the root cause. Examine journal entries recorded for revenue, revenue accrual, deferred revenue and any other adjustments that would help reconcile. Use this opportunity to validate that you are billing customers in accordance with contract ceilings, performance dates or other special requirements. Document the results of reconciliation, any issues noted, and actions taken to address them.

Cash Disbursements

An audit cut-off test ensures that transactions are recorded in the correct accounting period, preventing misstatement of financial statements. To perform this test, select all cash disbursements 30 to 45 days after year-end and gather supporting documents for these disbursements, including vendor invoices, purchase orders and payment records. Inspect vendor invoice details to determine if the services were performed in the prior or current year and if the cost is recorded in the correct accounting period. If the start of your audit is delayed, be sure to revisit this process up to the date your auditors begin work.

Leases

New lease standard ASC 842 (effective 1/1/2022) compliance requires accurately reflecting lease obligations and Right of Use Asset in the financial statements. Be sure to review lease agreements and current-year financial transactions to identify all operating and finance leases. Validate that all lease agreements are reflected in the lease obligations and right-of-use assets in the financial statement. Implement controls to ensure any new lease identification, classification, measurement, and disclosure for the financial statements are included.

Journal Entries

Controls over recording and approving journal entries reduce the risk of errors or fraud by ensuring no one has complete authority over the process. Select a few journal entry samples during the year to review if different individuals performed key tasks such as initiation, approval, and recording. Documentation is required, and, where possible, supporting documents for the journal entry in the accounting system are attached. Explanations should be added for each journal entry.

Material Amounts or New Activities

Take a moment to consider anything new that was added this year. Perhaps the company added an employee equity incentive plan benefit which, depending on the attributes of the plan, can have specialized accounting needs. Determine where you have very material balances or expenses and focus your activities accordingly to get the most benefit from time spent.

A Final Thought

A self-audit is a proactive measure to assess and improve internal controls and processes and ensure compliance with GAAP and FAR. Various areas of an organization, including financial management, compliance, operations, human resources, IT Systems, and environmental practices, are all included in the process. Self-audit assists in identifying and assessing risk within an organization and prepares for successful external audits by identifying and addressing potential issues.

Financial audits are becoming more complex due to new accounting standards and emerging needs in the accounting industry. Aprio accounting experts and advisors are happy to assist with the accounting and compliance challenges of your company. For additional guidance on audit readiness, reach out to Aprio’s government contracting team.