Steve McCarty, CPA, CMA, Jeff Solis, CPA, and Brian Wolfbauer, CPAAn audit is an examination of the information reported in a com-pany’s financial statements, conducted by an independent certifiedpublic accountant (cPA). the cPA and members of the auditteam apply the applicable accounting principles, evaluate signifi-cant estimates used by management, and assess the risk of a ma-terial misstatement. the amount of testing required depends onauditor judgment and the level of risk associated with the PEO’sgeneral ledger accounts. When the audit team determines thatenough documentation and evidence has been obtained to pro-vide a reasonable basis that the financial statements are fairlystated in all material respects, an unqualified audit report is is-sued.

Because an unqualified audit report is the highest level of as-surance issued by an independent cPA, users of audited financialstatements may place greater reliance on the reported informationwhen evaluating the state of the company. Having audited finan-cial statements can lead to better interest rates on credit arrange-ments and increased finance opportunities, or it may eliminatethe need for personal guarantees on loans. in addition, if you areplanning to sell your PEO, having audited financial statementsmay lead to higher multiples and a more efficient sales transac-tion. Audited financial statements are not only beneficial for fi-nancing and selling opportunities, but are also required to dobusiness in certain states. currently, more than 30 states requirelicensing or registration of the PEO to conduct business in thosestates. Many of these states require audited financials to become alicensed or registered PEO, and it appears that even more stateswill adopt this requirement in the near future.

PrEPAring YOur PEO fOr An AuditWhen you determine your PEO needs an audit, consider variouscriteria during the auditor selection process, such as experience inthe PEO industry, client references, firm size, and fees. Althoughaudit procedures are similar for many different industries, it is im-portant to engage an auditing firm that has experience in the in-tricacies of financial reporting for PEOs.

After selecting the best candidate, management should havea detailed discussion with the audit team about what will be

needed for the audit. the auditors will most likely send a year-end request letter detailing all the required documents andbackup needed to complete the audit of your PEO. Managementshould understand exactly what theauditors are requesting, deter-mine the desired format forthe documentation, andhave everything com-piled prior to

the date of field-work. Auditors are thereto audit, not to gather doc-uments. Having everythingorganized and ready for the auditteam will allow for an efficient audit, andcan possibly result in reduced fees.

A systematic approach to financial statement maintenanceand audit documentation preparation is the most efficient. Whilea PEO is making the necessary period-ending adjustments, thenecessary work papers, schedules, and documentation should becreated and compiled at the same time. the asset side of the bal-ance sheet is a great place to start. start on cash and work yourway down.

Prepare bank reconciliations for all significant cash accountsand investigate any significant differences. if there are legitimatedifferences, post adjustments to the cash general ledger accountsto reconcile them. An auditor will almost always request bankreconciliations and bank statements for all significant cash ac-counts. Analyze cash accounts for cut-off issues to make sure re-ceipts and disbursements near year-end are posted to the properperiod.

Accounts receivable is usually the next significant account inthe balance sheet and one auditors commonly test. Prepare anaging schedule by customer balance and reconcile it to the generalledger account balance. if the amounts do not agree, investigatethe difference and post the necessary adjustment. in addition toreconciling the schedule, complete general maintenance, such as

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“cleaning up” old immaterial balances or insignificant credit bal-ances, before making any adjustments. in conjunction with theaccounts receivable analysis, review recent sales transactions toverify they are posted to the correct period and post adjustmentsif necessary.

PEOs may have some unique accounts receivable and rev-enue situations. it is common for a PEO to receive cash fromclients in advance of the actual payroll date. if cash is receivedprior to year-end, but the payroll date is subsequent to year-end,report these cash receipts as a liability. Payroll periods often over-lap accounting periods, so PEOs need to calculate and book un-billed revenue as well as the related payroll liabilities, revenues,and expenses. these calculations can sometimes be difficult; itmight be necessary to discuss them with your auditor.

depending on the significance of the remaining assets re-ported in your balance sheet, maintenance and documentationprocedures can vary. Other common asset accounts that requiremaintenance include prepaid expenses and fixed assets. Prepare aschedule of prepaid expenses and adjust the general ledger ac-counts to properly report the expense in the income statement. ifsignificant additions are posted to the prepaid accounts, make thepurchase documentation available for review. similarly, prepare alapse schedule for all fixed assets detailing the total assets at thebeginning and ending of the year. the schedule should also in-clude the current year additions and disposals, current year depre-ciation, and accumulated depreciation. reconcile the generalledger fixed asset accounts and depreciation expense to agree withthis schedule.

After completing these procedures on the asset accounts, thenext area that usually requires maintenance is current liabilities.

Auditors often examine accounts payable and accrued payroll ex-penses. Prepare an accounts payable aging schedule by vendor andclean up any old, insignificant balances. After scrubbing theschedule, reconcile the general ledger accounts to agree with theaccounts payable aging report. common accrued expense ac-counts include accrued wages and related withholdings, workers’compensation, and other benefit deductions. Prepare schedulesfor the significant accrual accounts and base them on subsequentpayments. After the schedules are completed, adjust the generalledger accounts to agree. Because payroll taxes are a significantaccrual for PEOs, we recommend these accounts be reconciled tothe payroll tax returns filed in the subsequent period. in conjunc-tion with the current liabilities maintenance, review expenses re-lated to these accounts for proper cutoff and expenseclassification. review transactions near the year-end to verify thatthey are posted to the proper period.

Although long-term debt may not be a significant area for allPEOs, it is important to reconcile the general ledger accounts tothe amortization schedules or bank debt statements. it is also agood idea to reclassify the current portion due on debt not onlyfor the auditors but also for internal analysis in determiningshort-term cash flow needs. PEOs commonly have multiple re-lated entities; therefore, PEOs should prepare a schedule of re-lated-party notes payable and notes receivable for all related partygeneral ledger accounts, and reconcile them to agree with eachother.

the remaining area on the balance sheet to maintain and re-view is the equity section. the components of equity can vary de-pending on the type of business structure, but the review processis similar for all businesses. determine if retained earnings (capi-tal accounts for partnerships) roll forward properly. if not, lookfor entry posting errors or previous year adjustments improperlyposted to the current period. Be sure to verify that dividends (dis-tributions), stock transactions, and capital contributions are prop-erly posted and classified in the general ledger. Auditors will oftenrequest documentation such as stock certificates, bank statements,and AcH confirmations to verify these types of transactions.

Another item for PEOs to consider during financial state-ment maintenance is reporting revenues using the net revenue re-porting method, which is a nAPEO-recommended best practice.the net method generally reports gross receipts net of direct pay-roll costs. Publicly traded PEOs must report using this methodand we suggest all PEOs use this reporting procedure.

BEst PrActicEs: OPErAtiOnAlAnd finAnciAl EfficiEnciEsAlthough it is common for financial statements to be issued onlyonce a year, we suggest internal review procedures be completedmonthly. develop an accounting procedures and policy manual

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that dictates these periodic interim processes. Prepare weekly ormonthly “dashboard reports” on significant areas, reviewed bymanagement. this will alert management to any financial issuesthat can be immediately addressed prior to the closing of the pe-riod. Prepare monthly schedules for significant accounts and postclosing monthly entries in a timely manner to reconcile the gen-eral ledger accounts. Variance or exception reports are also usefultools. Analyzing variations in balance sheet and income statementaccounts can uncover possible accounting errors and profitabilityissues. implementing these types of procedures will improve theefficiency of your PEO’s financial statement maintenance andmay uncover operational issues that require attention.

the end of the year is not only a great time to evaluate thestatus of your PEO’s accounting processes, but also an opportunetime to investigate operational areas that have room for improve-ment and ways to increase profitability. One of the most impor-tant factors for proper evaluation is having accurate and usefulinformation. PEOs have unique accounting and reporting needsthat require sophisticated accounting software to efficiently com-bine payroll, general ledger maintenance, and financial reporting.it is appropriate to assess your current software and consider pos-sible software upgrades during year-end planning.

Because current year data is usually the starting point forbudgeting procedures, having accurate and timely information isalso essential for budget and forecast preparation. Preparing abudget for the upcoming year is an excellent tool for determiningareas for gross margin improvements, other expense reductions,and cash flow needs. Properly estimating the amount of cash re-quired for operations can prevent short-term liquidity issues anddecrease interest expense by paying down debt if your PEO has acash surplus. Budgets and projections are also crucial for tax plan-ning and minimizing your income tax liability. As previouslymentioned, it is common for PEOs to have multiple related partyentities. use budgets to determine the optimal amount of man-agement fees and other interrelated expenses that should be allo-cated amongst the related parties to manage earnings andpossibly minimize income taxes.

PEO revenues and expenses for the upcoming year are di-rectly related to long-term contracts and other agreements, so thePEO should examine these types of documents annually. care-fully review client service agreements to determine if the billingstructure could be revised; that may benefit your bottom linewithout negatively affecting the client relationship. consider re-vising agreements that expose your PEO to these types of liabili-ties. reevaluating these and other types of revenue and expenseagreements can reveal areas that require attention and can in-crease overall profitability.

Another area to focus on at year-end is the internal structureof your PEO. Have you closed on a new client during the yearthat dramatically affected the size of your business? Have your in-ternal employees been working a lot of overtime during the pastyear? As your PEO continues to grow, consider the need to hireadditional employees or obtain more office space to suit yourneeds. this can be done parallel to the budgeting and forecastingprocess.

As more and more states continue to recognize PEOs andhave requirements to obtain and maintain licenses, always keep inmind that these statutes are constantly changing. near year-end,you should evaluate which states your PEO operates in and makesure you’re up to date on the state licensing requirements. statessuch as (but not limited to) new Jersey, tennessee, Oklahoma,and texas require your PEO to get quarterly payroll tax assertionsonce you meet a certain amount of payroll or number of worksiteemployees in that state. the last thing you want is your PEO li-cense renewal process getting delayed because you were not awareof these reporting requirements.

Whether or not you are preparing for an audit, implementingsome of these best practices will help ensure your PEO is operat-ing efficiently and effectively.

Steve McCarty, CPA, CMA is partner and Jeff Solis, CPA and

Brian Wolfbauer, CPA are senior accountants with UHY LLP, Ster-

ling Heights, Michigan.

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