One of the best ways for small and midsize businesses (SMBs) and nonprofits to prepare for an audit is to incorporate commonly requested audit schedules into their regular closing and financial management processes. Most schedules requested by auditors will fall into five major categories:
- Reconciliations
- Rollforwards
- Recalculations
- Subledgers
- Variance Analysis
In this article, we’ll introduce you to these common schedules and their uses for both the auditors and your internal financial management.
Reconciliations
Reconciliations are a method of vouching a balance on the general ledger with a third party. The most common reconciliations are for bank accounts, but you can perform them on any balance sheet account related to a third-party custodian, such as credit cards, investments, debt, and beneficial interests in trusts. If you receive a statement from another entity, you should be tying that balance and activity to the activity and balance in your general ledger, and you do that through a reconciliation.
The basic format is:
General Ledger Balance +/- Reconciling Items = Third-Party Statement Balance
The act of reconciling an account is an important control, as you can identify errors and differences between your records and those of the third party.
Reconciling items are usually the result of a timing difference. Those that are not the result of a timing difference should be corrected in the general ledger before closing is finalized.
When your auditors are looking at your reconciliations, they aren’t just looking to make sure the balances match and you have identified all the reconciling items. They also are looking at the reconciling items to ensure that material errors have been corrected and that the differences are valid timing differences. Performing reconciliations on a regular basis is a recommended control, as it can help identify transaction errors and system issues.
Rollforwards
A rollforward is very much what it sounds like—a schedule that rolls a balance forward from one period to another. Common rollforwards prepared for audit purposes include investments, fixed assets, debt, prepaid expenses, and net assets/equity. The basic formula of the schedule is:
Beginning Balance + Additions – Reductions = Ending Balance
While a reconciliation is focused on vouching a balance against an independent verification, the focus of a rollforward is identifying the activities that happen between the beginning and ending balances of an asset or liability and tying those totals to revenues, expenses, or changes in other assets. This type of schedule is about testing the activity rather than the balance.
For example, a prepaid expense rollforward may break down activity as:
Beginning Balance + New Prepayments – Amounts Expensed = Ending Balance
From this, the auditors can vouch the beginning balance to the prior period and evaluate prepayments and amounts expensed for recognition in the proper period.
Similarly, a fixed asset rollforward may break down activity as:
Beginning Historical Cost + Capital Additions – Disposals (Net) = Ending Fixed Assets at Historical Cost
And
Beginning Accumulated Depreciation + Depreciation Expense – Depreciation on Disposals = Ending Accumulated Depreciation
From this, the auditors can isolate additions and disposals for testing and test depreciation expense through recalculation or other analytical methods.
Recalculations
Recalculations are used to test the reasonableness of a balance, generally a revenue or expense. Recalculations are commonly used to help test sales, tuition income, membership income, special event revenues, and payroll expenses. In essence, the recalculation leverages data regarding the volume of a type of transaction—reported by a nonfinancial unit—to formulate an expected balance.
For associations, this may look like:
Number of Memberships per the Membership Database
X Published Membership Price
= Expected Balance for Membership Revenue
For payroll, it could be:
Number of Full-Time Equivalent Employees per HR
X PY Average Wages per Full-Time Equivalent Employee
X Average Raise (as reported by HR or in the board minutes)
= Expected Wage Expense
Recalculations help auditors evaluate the reasonableness of a balance, as they can verify the independent parts of the calculation. They also can help you in periodic management, as recalculations are great ways to identify systemic issues and errors. The concept of materiality is very much at play when evaluating recalculations, especially those using mean averages, so you may not need to spend an inordinate amount of time identifying detailed differences. If you can recalculate the balance within a percentage point, it’s time to stop.
Subledgers
If your auditors ask you for a subledger and/or an aging, what they’re looking for is a detailed subdivision of the balance of an asset or liability into individual amounts by customer, vendor, asset type, or other classification. The most common subledgers are receivables, payables, and fixed assets.
Subledgers for receivables and payables generally list the following information that is useful when evaluating future cash flows:
- Vendor/customer name
- Invoice date
- Due date
- Amount of outstanding invoice(s)
- Number of days past due
Auditors may request a detailed subledger, meaning one line per invoice, or a summarized subledger, meaning one line per vendor/customer. They generally also want to see it aged, which means that there are columns showing the balances that are past due and what is due in each subsequent fiscal period.
Subledgers for fixed assets generally include the name and location of the asset, date purchased, date placed in service, date of disposition, accumulated depreciation, and expected depreciation in future periods.
A subledger gives the auditors information they can use to test transactions and balances, and an aged subledger helps them evaluate collectability and red flags for fraud. Monitoring subledgers on a regular basis can help your organization identify potential cash flow issues and transaction errors.
Variance Analysis
Variance analyses are the comparison of a current period balance to a prior period balance or another expected balance, like a budget. They can be useful to identify high-risk areas and understand the financial activity that took place during the period under audit.
The auditor will generally set a threshold for the magnitude of variance that they want you to explain. It may be “$50,000 or 5%” or something stated similarly, based on their risk assessment. What they are asking for is identification of those material variances and as detailed an explanation as possible for what caused the variance.
The detail provided in a variance analysis can be tested through recalculation, tied to board minutes or budgets, or vouched to other third-party documentation, so it is important to explain as thoroughly as possible and provide the documentation that supports your explanation.
We suggest our clients keep a running list during the year of major events or items that could cause variances, so it’s easier to remember at year-end. In addition, we recommend clients perform a budget-to-actual analysis at regular intervals during the year and maintain that documentation. It’s a great financial control that can help identify errors, and the documentation will already be prepared when it’s time for audit.
As always, communication with your auditor is the best way to help ensure a smooth audit process, and you can prepare throughout the year by incorporating these types of schedules into your monthly close process. If you have questions regarding their requests, ask early and often. Clarify expectations and ask for templates, if necessary. A well-prepared organization is an auditor’s dream, and you can help make their dreams come true!
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