An acquisition is an exciting and stressful time for private equity firms and portfolio companies, when management is pulled in every direction as the firm prepares to invest, and the target company organizes itself for purchase.
Amid the shuffle, one crucial step can be overlooked: first-year audit readiness.
“The acquisition transaction has now closed; the focus shifts to numerous post-acquisition matters, and the upcoming audit is often an afterthought,” said Steve Koltun, RSM audit partner. “If the audit is not prioritized, you elevate the risk of late reporting and likely end up with an inefficient audit. To be proactive against that, as you buy a company, work with a partner to help ensure a smart and efficient audit experience.”
A well-prepared audit is an efficient audit
Audit readiness from the private equity group (PEG) perspective means setting a tone at the top that preparation is important.
It’s to be expected that the year of acquisition audit is the hardest, and management is often not quite as prepared. This can cause a strain on time and company resources. Being well prepared will minimize the risk of missing a reporting deadline.
“An efficient audit will enable management to focus on more relevant, key operational matters such as the 100-day integration plan, and other matters that drive EBITDA (earnings before interest, taxes, depreciation and amortization) generation,” Koltun said.
“For target firms or portfolio companies, having a knowledgeable audit readiness team means being able to handle issues that arise in the year of acquisition,” according to Craig Cross, partner with RSM Canada. Purchase price accounting, for example, requires involvement with a valuation team, along with accounting for the flow of funds.
“Having resources with valuation and business combination expertise helps everyone get through to the end result, which is meeting critical deadlines—whether it’s with the bank—or other internal deadlines that have been imposed for other reasons such as group consolidation,” Cross said.
Key steps for audit preparedness
A critical part of audit readiness is allocating the responsibilities internally in regard to handling the audit. This includes scoping level of resources and level of expertise required for the audit, and setting a timeline for project management.
In an acquisition, the responsibility normally falls to the portfolio company; however, the purchasing group might have a certain approach or go-to firm it uses, and should communicate with the portfolio company’s management accordingly.
Firms also need to get the valuation completed ahead of the audit.
“I’ve often seen that go sideways, where the purchase accounting or valuation matters are delayed, and now you’re in a time crunch during year-end audit fieldwork,” Koltun said.
By way of example, Cross indicated a current client misunderstood or misinterpreted what the valuation was going to look like, and now is scrambling, at the last minute, to finalize aspects of the acquisition accounting. The result is a potential delay in finalizing the audit for the bank and restrictions on available refinancing.
What to look for in an audit readiness team
An effective audit readiness team should have experience with the industry that the acquisition was done in, as well as expertise in purchase accounting.
If an audit adjustment that affects EBITDA is uncovered in the opening balance sheet audit or through purchase accounting exercises, that can be an unwelcome surprise for companies—and a key goal is to always avoid surprises, Koltun said.
“An external technical accounting consultant can be helpful if the company doesn’t have the resources or expert staff to handle it internally,” Koltun said.
When preparing for an audit, it’s also helpful when a team can point out regulations and standards that apply to the company. For example, external advisors can help a company determine which accounting framework might work best, or assist in building a bridge between different countries’ accounting standards, such as the generally accepted accounting principles (GAAP) in the United States, and the accounting standards for private enterprises (ASPE) in Canada.
An external advisor can look at a statement of earnings or quality of earnings report, and identify potential areas of concern. Or perhaps it’s a revenue recognition issue, or a U.S. GAAP potential reconciling item that the company needs to address.
“Otherwise, the audit teams can help them get through it within the independence framework, but it’s easier when they have that extra set of hands dedicated to supporting organizations through a transaction,” Cross said.
Cross said if the U.S. Securities and Exchange Commission or Canadian reporting issuer independence level is required for a respective company, it limits the technical accounting consulting (TAC) services the audit firm can provide. However, under the American Institute of Certified Public Accountants and Canadian nonreporting issuer independence levels, TAC can provide substantial assistance.
“Some companies may need to assess whether to adopt Private Company Council Standards,” Koltun added. “It’s not a one-size-fits-all, but certain companies have saved a lot of time and money adopting these standards, and they are the right fit for certain companies.”
How to spot an unprepared audit readiness team
Steven Heyendal, RSM senior manager, said one way to tell if a team hasn’t properly scoped an auditing project is if a proposal isn’t provided that walks a company from the audit beginning to end.
“What I’ve seen in audit readiness projects that don’t go well is there’s not a contemplation of the financial statements, creation thereof, or auditor comments on that back end,” Heyendal said. “If there isn’t a discussion around project management, that’s a red flag as well. Because a lot of it is around communication, updates, meeting frequently, things of that nature.”
Another red flag is if the audit readiness team does not provide support and answers to questions on workpapers or back-end items. “Where these things go awry is when proper attention has not been put on communication with the client, roles and responsibilities, how to communicate challenges with getting proper data, delays on the auditor side, among other things,” Heyendal said.
Even if there’s an eleventh-hour problem, Cross added, a reliable advisor would not shy away from difficult conversations, triaging extensions or waivers, nor setting a more realistic timeframe that meets legal requirements.
- Don’t treat an audit as an afterthought. Being well prepared will minimize risks of missed reporting deadlines, added costs, and strain on company management’s time.
- Scope the audit and conduct relevant valuations.
- An effective audit readiness team should have experience in the industry of the acquisition.
- Accounting and independence standards are nuanced and they vary among countries.
- There are some requirements that legally must be met. Ensure that your company and advisor hone in on key complexities when a company is under the pressure of a deadline.
- Have a discussion about project management. A lack of communication is a red flag.