As companies look to close their books for 2024, they should be prepared for continued challenges throughout the audit process. Heightened scrutiny, increased skepticism, and greater regulatory expectations have become the norm. As stakeholders demand transparency and accountability, auditors are ramping up their focus on critical aspects of financial reporting.
For businesses, this means being more diligent in preparing for audits to avoid potential pitfalls and ensuring that their financial health is clearly and accurately presented. Key areas expected to face heightened scrutiny this year include the following:
1. Information Provided by the Entity (IPE)
Information provided by the entity (IPE), particularly when generated through a company’s IT systems, will face increased attention. For publicly traded companies this area is critical, especially in light of the U.S. Securities and Exchange Commission’s (SEC) focus on cybersecurity and the growing impact of artificial intelligence (AI) on financial processes.
The SEC’s concern stems from the need to ensure that the data companies use to drive financial reports is accurate, secure, and transparent. As companies continue integrating AI into their processes, the scale of consequences for manual errors increases, and audit firms will be more rigorous in assessing the controls companies have in place to mitigate these risks.
2. Supplemental Disclosures & Executive Compensation
Disclosures around executive compensation remain a top priority for regulators. This is particularly true concerning pay-versus-performance requirements. The SEC is expected to increase its scrutiny of these disclosures as part of the management discussion and analysis (MD&A) section of company filings. The use of accounting techniques that deviate from official standards in explaining performance are also likely to be closely examined. Companies must ensure that their supplemental disclosures are accurate, transparent, and properly contextualized in the broader financial landscape.
This focus is aligned with an ongoing push for companies to better explain how executive compensation ties into overall company performance. Inaccurate or incomplete disclosures can lead to reputational damage, legal issues, or even financial penalties.
3. Statement of Cash Flows
The statement of cash flows remains a leading area of restatements for many companies, and this year’s audits will likely amplify the focus on its accuracy. The SEC has issued recent statements highlighting the need for improved quality in cash flow information. Common issues include the misclassification of transactions, insufficient disclosure of noncash activities, and weaknesses in the internal controls over the preparation and presentation of cash flows.
For companies preparing for an audit, it is critical to ensure that their cash flow statements are not only correct but also robustly supported by documentation. Missteps in this area can raise red flags and lead to restatements, further damaging a company’s credibility with investors and regulatory bodies.
4. Revenue Recognition
Despite years of operating under the guidelines of ASC 606, the application of principal versus agent guidance under this standard remains a challenge for many companies. Determining whether to recognize revenue on a gross or net basis is a judgment call that auditors will scrutinize closely, especially as companies’ product and service offerings evolve.
Given that revenue is one of the most scrutinized areas in any financial statement, companies should revisit their revenue recognition policies regularly. Ensuring that these policies align with current business realities and meet the rigorous requirements of ASC 606 is essential to avoiding audit complications.
5. Prospective Financial Information (PFI)
Prospective financial information (PFI) plays a crucial role in many fair value measurements, making it a target for auditors. Because PFI often involves a high degree of subjectivity, it is vital that companies provide thorough documentation and support for the assumptions used in their forecasts. Auditors will likely examine how aggressive or conservative these assumptions are, particularly in light of economic uncertainty or market volatility.
Management teams should work closely with their valuation providers to ensure that the PFI used is reasonable and supportable. This step will help companies avoid disagreements with auditors and potential valuation-related restatements.
Preparing for Success
Given the continued scrutiny, upfront alignment with all stakeholders is crucial to a successful audit. Companies should proactively engage their audit firms throughout the year, leveraging their expertise during interim reviews to identify potential areas of concern. Early detection of issues, followed by timely resolution, can help companies stay ahead of potential pitfalls and ensure that their financial reporting is clear, accurate, and compliant.
Internally, companies should focus on bolstering their controls in high-risk areas, particularly those highlighted above. Collaboration between finance teams, IT departments, and external auditors can help ensure that all aspects of financial reporting are aligned with regulatory expectations.
By investing time and resources upfront, businesses can mitigate risks, enhance transparency, and ensure a smooth audit process that meets both regulatory requirements and stakeholder expectations.
