Audits & Auditors
HENRY VANIERSSEL, UNIVERSITY OF TORONTO PRESS, INC.
The concept of an independent external GAAP audit often strikes fear and trembling in the hearts of mere mortals, even at times in those of directors and chief financial officers. In addition, staff members often feel intimidated by the presence of auditors who seem to carry so many multicolored pencils to "tick" their working papers. Yet the reality is that an audit may be critical in helping a press.
Unfortunately, many not-for-profit organizations do not believe that an external audit is necessary. However, they can learn from the private sector what the benefits of an audit and Letter of Recommendation are.
The value of an audit is enhanced by the Letter of Recommendation, which is based on observations made during the audit. The two form the "report card" of an organization and provide a "comfort level" of assurance that the financial statements are materially correct, and that systems weaknesses not only have been identified but also will be corrected. Such a "report card" should be welcomed. It might save grief later and unpleasant surprises in the end.
Preparation of the audited financial statements and accompanying notes is the responsibility of management. The external auditor's responsibility is to express an opinion on these financial statements. Hence, the figures prepared by management should stand unless the financial statements are materially incorrect in the opinion of the auditor, resulting in a qualification of the financial statements in the Audit Report or in unacceptable notes to the financial statements.
In the commercial sector, most corporations have an independent external audit at year-end in which the auditor expresses an opinion on the financial statements for the fiscal year. Usually, the opinion is that "the financial statements present fairly, in all material respects, the financial position" of the company. Such an opinion requires that the audit is conducted in accordance with Generally Accepted Auditing Standards (GAAS). The purpose of the audit is manyfold, to comply with requirements from the SEC, lenders, banks, investors, IRS, state tax authorities, and other regulatory bodies.
Often, the chief executive officer, the audit committee, the finance committee, or the board of directors requests the auditor to prepare a Letter of Recommendation. Such a letter results from the auditor's review of internal control, and operational and valuation practices that may raise concerns about potential future material overstatements or understatements. A Letter of Recommendation typically might include such items as: concern about provisions for bad debts, inventory obsolescence, or returns; costing method of inventory; poor and unnecessary systems that cause problems in the processing of information; concern about the manner in which royalty information is entered in book master files that might result in an understatement of royalty expense and liability, or worse, antagonize authors; and many others.
Management reviews the draft Letter to ensure that the information supporting the recommendations is accurate, although managers may not necessarily agree with or appreciate some or all of the recommendations. Management then prepares written responses to each recommendation, which are incorporated in the final Letter.
Management subsequently reviews the Letter with the audit committee, finance committee, or board of directors together with a plan, where feasible, as to how and when to address each individual recommendation. Such a review ensures that management addresses each recommendation and reports back on its implementation. Of course, there is a cost for this Letter, which increases the audit fee.
The Audit Report and the Letter of Recommendation help the audit committee, finance committee, or board of directors to be better informed about the operations, strategic plan, and long-term goals of the company. Furthermore, they increase the level of understanding and commitment from board or committee members. Members also gain a better opportunity to determine how the company is managed. All of this makes for an active rather than a passive and uninformed committee or board.
Although university presses may be incorporated as not-for-profit, most are subject to the financial reporting requirements of their parent institutions. This is particularly the case if some or all of the accounting records are maintained by the institution. The nature of a press's audit is often determined by the nature of the institution's audit. As a result, few presses have a full-fledged external GAAP audit. This is further exacerbated by the fact that few presses have a complete balance sheet.
Press "audits" may be done by the university's external auditor, who ties in the press's accounts with those of the institution; or by the institution's internal audit department, a state auditor, no one at all, or any variation thereof. Under this scenario, the press's financial statements therefore generally do not fully comply with GAAP.
Although this type of institutional audit reviews the Income and Expense Statement, it tends to be oriented more toward proper recording of transactions and compliance with procedures than toward reporting on the substance of accounts such as accounts receivable, inventories, and fixed as sets. In some instances presses write off fixed assets because that is the institution's practice, which is permitted under its set of reporting rules. The significant inventory write-downs each year of several presses are a good illustration that audits have not been conducted in a manner that would have questioned substantively inventory valuation and write-down practice.
Some press boards and institution administrators do not fully understand scholarly publishing as a business operation, and therefore do not ask sufficiently hard-nosed questions about the financial results of the press, its operating ratios, operating policies, strategic plan, or long-term financial outlook, particularly as a contingency against possible cuts in subsidies, without necessarily cutting back its publishing program.
A GAAP external audit and Letter of Recommendation therefore help the director and the board, or the institution's administration, to ensure that they are as well informed as possible about the financial health and operations of the press. Ultimately, this benefits the press and its director, chief financial officer, other staff, and board, as well as the institution's administration. The ultimate cost of not having a Letter of Recommendation could be high.
Auditors conduct a number of examinations before they can issue a Letter of Recommendation or express an opinion on the financial statements. Following are some of the most common tests.
These examinations provide a general framework on the reliability of the financial statements. The auditors will:
- Test transactions during the year to ensure that adequate controls are in place.
- Examine minutes of the board of directors or its equivalent to determine whether any decisions were made that may impact on the presentation of the financial statements.
- Request a Letter of Representation from management stating that, to the best of their knowledge, the financial statements reflect all management decisions and that all transactions are recorded in conformity with Generally Accepted Accounting Principles.
- Review events subsequent to year-end, including minutes, to ensure that no events or transactions have taken place that should have been recorded or mentioned in the notes to the financial statements.
- Review bank reconciliation for unusual items, unreconciled differences, and checks that are out standing for an unusual period of time, say, more than six months.
- Reconcile the detailed accounts receivable trial balance with the general ledger; examine individual accounts for unreconciled charge-backs and overdue accounts to determine the adequacy of the provision for bad debts; determine the need for a general provision for bad debts to reflect unanticipated losses on accounts in the future; review credit balance accounts to determine whether they should be written off or refunded; reclassify legitimate credit balance accounts to accounts payable; send out confirmation requests to customers to verify outstanding balances; review shipping documents of the last day of the year and the first day of the following year for cut-off of shipments and inclusion in sales and accounts receivable.
- Review royalty advances to check whether publication can be reasonably expected or should be written off.
- Reconcile the detailed inventory listing with the general ledger; test unit cost for consistency of application and accuracy of calculation and, where estimates are used for late deliveries, test that subsequent invoices attest to the unit cost's accuracy; test unit quantities against past sales for obsolete or slow-moving stock; review inventory turnover for reasonableness; review inventory write-down policy for consistency, accurate application, and adequacy of provision for inventory write-down; review work in process to ensure that titles are indeed in process and no balances represent discontinued publications that should be written off; review receiving reports at year-end to ensure proper inclusion in inventory. The above reviews apply to any paper stock held by printers or unbound stock.
- Review deferred publication cost to ensure consistent accounting practices and determine whether these practices are reasonable in terms of matching revenue and cost.
- Review fixed asset capitalization policy to ensure consistency; check additions to fixed assets to ensure that they should not have been expensed; reconcile the detailed fixed assets ledger, if one exists, with the general ledger, and test some recorded assets to ensure that they have not been disposed of and hence should have been removed together with the accumulated depreciation; test depreciation expense calculation, consistent application by class or type, and reasonableness of the period over which fixed assets are depreciated.
- Reconcile the detailed accounts payable ledger with the general ledger; send out confirmation requests to suppliers to verify balances owing; investigate differences to determine whether liabilities should be set up; review debit balance accounts and reclassify to accounts receivable if collectible, if no further purchases from the supplier are contemplated, or if written off as uncollectible (in the worst case scenario).
- Review accrued charges to determine their accuracy and review expenses that are generally billed late, such as telephone charges or printing bills, and ensure that they have been accrued and expensed.
- Review royalties payable and proceeds on commission books by testing sales against contracts for terms and rates; ensure that payments due during the year were made and properly charged against royalties payable.
- Review deferred grants and prepaid production advances to determine that amounts are for future deliveries; confirm the larger grants or prepayments with donors to ensure that they comply with the contract.
- Reconcile and confirm the due-to-related-parties account that represents the liability to the parent institution or another closely affiliated organization.
- Obtain confirmation of the indebtedness, short- or long-term, with a financial organization.
Income and expense statement:
- Test year-end cut-off of sales to ensure that all product shipped up to year-end has been billed and included in sales; review the need for a possible reserve for returns.
- Check unit costs to ensure that cost of sales are recorded appropriately.
- Refer royalty liabilities to author contracts.
- Analyze and cross-reference other income to contracts.
- Examine inventory write-down practice in conjunction with inventory valuation to ensure that write-down expense is recorded properly; calculate the impact of changes in practice so it can be reported in the notes to the financial statements.
- Analyze overhead expenses by reference to previous years and budget.
- Review operating ratios for reasonableness and unusual variations from previous years.
- Review unusual and nonstandard journal vouchers for unusual entries that may have resulted from an undue number of corrections, inconsistencies with prior years recording, or unusual postings.
- Review notes to the financial statements; check figures and reference to the financial statements; ensure that changes in consistency of recording are reported and the impact quantified, if known; report on events subsequent to end of the audit, if they materially affect the financial results.
Although a press will rarely be allowed to appoint its own external auditor, it is still a good practice to negotiate the audit fee at the planning stage and then request information from the auditor on what can be done to reduce the fee. There are several ways in which a press can assist the auditor to achieve such a reduction. The easiest one is to prepare detailed schedules of each balance sheet account and some revenue and expense accounts such as sales groupings, other income, other expense, schedules of groupings of general ledger accounts on the financial statements, other unusual accounts, or other detailed schedules that the auditor may request at the audit planning stage. If the press itself prepares the audited financial statements and accompanying notes, this will also reduce the audit fee. Sometimes the institution's internal audit department is prepared to lend staff to the external auditor at no cost to the press, thereby reducing further the time spent on the audit. If possible, a press should prepare a balance sheet, and request an external GAAP audit and a Letter of Recommendation. It is well worth the effort, particularly for the Letter of Recommendation. Together, the audit and the Letter of Recommendation boost the confidence with which the director, the audit committee, the finance committee, the board of directors, and the institution's administration view the financial statements, the press's internal control, and its operating efficiencies.