Documentation is everything in the world of accounting, particularly when it comes to accounting audits. Whether the audit is internal to test controls around financial statement accuracy, an IRS tax audit, or a state tax audit, having the right paperwork and documentation on hand simplifies the process, speeds up audit closure, and facilitates a successful outcome.
One reason why audit trails are so important can be attributed to the Sarbanes-Oxley (SOX) Act. Audit trails provide proof to the auditor that a company has implemented and followed strict internal control measures as required under SOX. SOX is intended to establish who did what and when -- and ensuring that they had the right permissions to do so -- by requiring companies to provide verifiable security controls. It is the verifiable security controls that auditors will be examining.
How does this relate to fixed assets accounting audits? In capital-intensive companies, fixed assets are frequently the largest item on the balance sheet. As a result, having strong SOX controls around fixed assets becomes paramount to a successful audit.
When to Create Audit Trails
An audit trail should be created every time a fixed asset transaction takes place. Anytime a fixed asset is bought, sold, transferred, or repaired, there should be a verifiable audit trail entry. The goal is to record relevant details that answer the following questions that an auditor is sure to ask:
- Who was involved in the transaction?
- Did the person who entered the data have permission to do so?
- When did the transaction take place?
- What was the nature of the transaction? (Was it a transfer, repair, purchase, or sale?)
- What impact did the transaction have on depreciation of the asset?
This evidence is so important to fixed assets accounting audits that, without them, the audit trails are considered incomplete. Incomplete audit trails are red flags for an auditor and he or she may order a deeper audit, costing the organization time and money. Think those costs are insignificant? Consider this: the
Financial Executives Research Foundation (FERF) reports audit fees of approximately $1.8 million paid by 6,490 unique company filers for their 2015 external audits. The median cost of these audits? $522,205.
Audit Trails Protect Against Material Weakness
When companies cannot produce the documentation requested by an auditor, are unable to provide more details about specific transactions, or provide details that don’t make sense, the risk of failing the audit due to “material weakness” rises.
Material weaknesses have deep repercussions that have the potential to affect a company’s bottom line. Stock prices can drop and impact shareholder values. Furthermore, the company may incur tax penalties and fines.
In just one example, a Fortune 500 company had to restate their financial statements for three years to correct more $45 million in errors. These errors were specifically related to the capitalization of fixed assets and timing of depreciation. An audit uncovered poor accounting controls and errors stemming from spreadsheets, even though a Big 4 CPA firm had given the company a clean audit covering those years. The impact of this announcement was staggering: The CFO and several key professionals within the tax department were fired, investors lost confidence in the company, and stock values plunged to the point where shares fell almost 70% in the course of a year.
Understandably, it is a daunting task to think about creating an audit trail for businesses that have millions of dollars in fixed assets, but the risk of not doing so can be far greater.
Finding a Better Way to Manage Fixed Assets
A Bloomberg BNA survey unveiled that nearly three-quarters of respondents have 6 to 25 professional employees dedicated to fixed asset data entry, and management specifically for tax and accounting purposes.
Despite the tools and technology available, nearly 75% of mid-market and enterprise companies are relying on a mix of ERP systems and manual spreadsheets. Even if the goal of such undertakings is to establish and maintain satisfactory audit trails, the time and effort it takes to do so is time-consuming, error-prone, and downright painful, not to mention a waste of professional employees’ skills that could be better used elsewhere.
The right software solution can change all of that. Creating fixed assets audit controls does not have to be so onerous and fraught with challenges. Consider Illinois Tool Works (ITW). ITW is one of the world’s leading diversified manufacturers of specialized industrial equipment. ITW started using a specialized fixed assets solution and saw a noticeable change in their audit trails; they became more streamlined and accurate.
Where the previous system made it difficult to create audit trails for the transferring of assets from one business to another, the fixed assets solution eased this process. This was a huge improvement for ITW, which frequently transfers assets between business units.
Brandon April is the federal tax manager at ITW. He explained, “when we had transfers, the numbers never seemed to match up. The pain our company used to go through managing fixed assets was ridiculous, but since we started using technology to streamline the process, everyone is extremely happy.”
Asset additions were another challenge for ITW to manage for a simple reason: many of the business units’ accounting staff knew more about GAAP rules than tax rules. That slowed down processes, and required ITW’s accounting staff to proceed slowly and cautiously to double-check everything against the tax books.
“Technology lets our business units add and transfer assets easily and accurately,” says Mr. April. “It’s all automated so that the GAAP-oriented folks in the business units no longer have to look at the tax books.”
The ITW example demonstrates that establishing sound audit controls doesn’t have to be an enormous undertaking. What it does demonstrate is a need to pair the right processes with the right technology. Once in place, this approach can help companies establish strong audit controls, and create the audit trails necessary to stand up under the scrutiny of both internal and external audits.
Diane Tinney is the Director of Product Management, Bloomberg BNA, Software.