Hidden consequences of audit season failures

According to Audit Analytics, there are 489 firms conducting audits of 59,664 private funds in the US alone, with the top 10 auditing firms owning 81.3% of the market.  But with multiple versions of generally accepted accounting practice (GAAP), and each firm having their own interpretation of generally accepted auditing standards (GAAS), the challenges facing a fund administrator tasked with preparing the draft financial statements, and supporting the audit, should not be underestimated. Any failures in the process can have serious downstream effects for the fund managers’ reputation with investors and regulators.

Every year, Opus participates in hundreds of fund audits with a goal of being a key party in the process to get audited financial statements to interested parties, in a timely way.   This is what we have learnt from 15 years supporting our clients through the audit process.

When does the audit need to be completed by?

The timelines are typically driven in one of two ways:

a.       Regulatory reasons: In looking at the largest domicile, Cayman Islands, where funds are regulated under the Mutual Funds Law, the audit needs to be completed, signed off and filed within 6 months of the fund’s financial year-end (with the exception of funds which meet the criteria set out in section 4(4) of the Mutual Funds Law, which are exempt). 

b.       Investor reasons: In recent years, many funds have set audit completion dates of 30, 60- or 90-days post year-end. This may be to satisfy key investors or to ensure the financial statements are on a similar timescale to tax reporting requirements.

On paper, this seems like enough time to ensure all is completed with time to spare, yet many funds struggle to meet deadlines for a multitude of reasons. The shorter the timescales are, the higher the challenge is for timely completion in an unplanned hedge fund audit process.

What typically goes wrong?

Below are some practical recommendations to ensure timelines are kept and to avoid unnecessary issues and stress:

Problem	Reason	Solution
Planning/Timetabling Too many times, the audit process is an afterthought that suddenly rears its head 1-3 months after the year ends—typically between January and March. The fund manager hasn’t focused on it. The auditor hasn’t planned for it. The administrator is focused on daily/monthly work that they haven’t considered year end requirements. Ultimately, everybody is waiting for another party to take control of the process.	Now, it’s panic stations. The audit needs to be completed in weeks, not months. Nobody has scheduled time or allocated resources to get it done. It’s now a tense situation. The auditor starts blaming the administrator. The administrator starts blaming the auditor. The fund manager starts blaming everybody.	The parties should commence planning discussions, including agreeing on an audit timetable as soon as possible, preferably no later than 90 days before the year end. The timetable should factor in fixed dates such as filing deadlines.  The audit timetable should be agreed by all parties in advance. A strong timetable should include agreed dates for each step of the process, including delivery of draft financial statements.
Interim audit work Auditors call the first 4 months of a year ‘busy season’ and it’s for very good reason. Due to the seasonal nature of the demand for their services, audit firms expect their teams to work long hours at the start of the year and are compensated by much shorter hours for the remainder.	Spreading work out over the course of the year means that the audit firms have available people power to get ahead. Work can be done during the quiet times, rather than when busy. Also, interim work allows issues to be identified earlier, and buys everyone time to put remediation steps in place.	Ideally, auditors should complete interim work approximately 12 weeks prior to year-end. This process should include an initial review of draft the financial statements and provision of feedback on any changes in accounting and auditing standards that might impact the final deliverables.
Agree on the format of the Financial Statements early Almost every stress at sign off time relates to the financial statements.	The financials pass through many hands and each provides feedback and recommended changes. Processing last minute changes is never straightforward and causes delays.	Incorporate the preparation of pro forma drafts during the interim audit process. OK, the year end numbers will not yet be known. But it gives the many hands ample opportunity to make the changes to the format and disclosure wording well ahead of time.
Communication Failure for the parties to continue communications in a timely manner may cause the audit process to awry. Things will go wrong, and silence prevents the parties from identifying remedies.	Changes happen. The auditor may have staffing issues or identify additional information needed to do their job. The administrator may not be able to juggle resources to meet the revised demands. The manager may have new expectations that are being pushed upon them.	It is critical that communication is always maintained. The typical method used is to schedule regular catch-up calls between the relevant parties.  All queries should be scheduled, maintained and discussed on each call.
Debrief Witnessing a completely smooth audit process is like a chance meeting with a unicorn. It never happens. Things will go wrong – and if they are not discussed, then they could go wrong again next year.	The relief of getting your hands on the signed audited financials is palpable for all concerned. It can cause the parties to jump straight onto their next fire drills. However, there will be learning opportunities for all parties—a chance to discuss what went right, what went wrong, and recommended changes for future years.	Schedule a debrief call now and put it into the initial timetable. The call will be to discuss how all parties can make the process better next year. It might be uncomfortable for those listening, but the goal is to prevent future issues and stress.

What does the interim process involve?

A typical interim-audit checklist might cover the following:

Provided by Administrator	Provided by Auditor
Fund’s NAV packs for the year to date	List of reporting standards in issue for year under review but not yet effective
Copies of bank, broker and custodian statements for year to date	List of reporting standards which have come into effect for year under review
Trades report detailing all investor transactions for year to date	Draft Audit Confirmation Letters to banks/brokers/custodian and legal advisors
Copy of the Administrator’s current year SSAE18 Report	Audit Timetable
General ledgers for the year to date

Ultimately, advanced and comprehensive planning allows the multiple parties: manager, administrator, auditor; all come together, ensuring that one of the most stressful times of the year runs as smoothly as possible. Effective management of the audit process helps ensure time and costs incurred by the administrator and auditor are controlled, whilst the manager can deliver audited financials to its investors and regulators in a timely way.

The Opus financial statement and audit support team have decades of experience and are committed to ensuring that this process runs as seamlessly as possible and each milestone is tracked with full transparency via our client portal, keeping all parties on track and giving Opus’ clients comfort that all is in hand.