Financial Statement Tie out is an audit process.
It’s a completeness check to confirm if all the numbers in the financials are either tested in the current year or the prior year.
The auditor provides assurance for stakeholders with respect to balances within the financials. This assurance is provided only after performing thorough audit procedures.
Considering the nature of the balances within the financial statements, these balances are tested at each GL account level.
The auditor’s start point is the Trial Balance.
They perform risk assessment (finding the level of risk) and substantive audit procedures (testing of balances).
Management prepares the financials as per the Trial balance, which is adjusted for topsides, accruals, closing entries, etc.
Auditors and Management have the same starting point.
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But why is there a need for a financial statement tie-out?
The balance sheet is presented in a condensed manner compared to the trial balance. For example, Management presents the bank balance as Cash and Cash Equivalents in the Balance sheet. However, the Audit team performs testing at a granular level.
In Other words, testing is performed at disaggregated levels for Cash and Cash Equivalents Financial Statement line items – Cash in hand (Petty Cash), Cash at the bank, and Marketable Securities (Liquid-able assets within three months).
Are there any exceptions to the completeness check?
Yes, there are some.
In Other words, there can be some numbers or text on which the auditor doesn’t express his opinion.
For instance, the numbers within the Management Discussion and Analysis will be verified by auditors to ensure consistency with the testing results. However, the audit team still needs to provide its opinion on it.
What does the MD&A Section comprise?
The MD&A Section discusses the company’s operations, results, and future steps, such as expanding or extending business plans.
Sounds Interesting?
The keyword for checking completeness is to vouch for the consistency of audited sections with unaudited ones.
In other words, the text within the MD&A section should be consistent with the Balance Sheet, Income Statement, Cash Flow Statement, Equity Statement and Notes.
How about an example here?
Company “False Positive” Revenue balance per the Income statement is $40 Million vs the amounts per the MD&A section, which is $140 Million.
The inconsistency shouldn’t be present in the text format either.
Suppose the company is experiencing severe losses in the current year, which amounts to $100 million. However, the 10-K reads as if it’s expanding the business front in new countries and aiming to hit a profit of $1000 Million.
It sounds unrealistic for a company to move to profit in a year, which equals ten times its losses.
How to perform the Financial Statement Tie out?
The word ties-out itself clarifies that there will be an agreement of numbers.
Balances within the Financial Statement will be agreed upon with the auditor’s workings.
These two numbers needn’t be the same.
Confused?
There can be a slight difference between the financials and auditor work papers due to
- Rounding off
- Manual errors
- Adjustments/Top Side entries
- Difference in the Financials presentation
- Change in the Trial balance vs financial statement grouping
Tie-out Example
Let’s take an example of an Audit of Accounts receivable, whose balance is $30,000 per the Trial balance. The balance sheet presentation has a different number – $30,400.
The difference is due to the recording of accrual adjustment entries after year-end.
Considering the immaterial balance, the auditor is fine with the difference and passes on further testing of the $400.
The audit team decides upon a threshold, and any differences within such threshold do pose any risk of material misstatement for them. So, this threshold is decided after consideration of the entity’s nature, misstatements in the current year and prior year, risk assessment, etc. Refer to the Materiality article for further understanding of this threshold, commonly referred to as Clearly Trivial Threshold.
What’s the Accrual Adjustment?
Accrual Adjustment is a year-end process for any business receiving invoices after year-end. So, Management performs accrual analysis and records adjustments for all the invoices relating to the current year received after the end of the year. These are the expenses incurred in the current year, but invoices are received after the end of the year. The best example is a utility bill, where the costs are incurred throughout the period, and bills are received after the period ends.
Methods of performing the Tie-out
Manual Process
Tie-out is performed on a hard copy.
Balances made through audit procedures are acknowledged by manual tick and tie. Think of it as how we start a to-do list once a task is done.
Let’s Say the audit team is performing a tie-out for the balance sheet. A reference to the workings will be added against each financial statement line-item balance, or a tick mark will be placed for the already tested balances.
These balances, which are left over after tick and tie, indicate that these are not through audit testing.
Ideally, there shall not be any balances that have not been tested.
However, some balances can be considered as having no risk of a material misstatement by the audit team. So, the auditor shall ensure to explain the reasons for not testing them, which can be done through a memo. All the applicable risk factors are evaluated and elaborated on in the memo.
Electronic Process
Tie-out is performed in a pdf document.
The process of tick and tie remains the same in any method of financial statement tie out. However, the medium will differ.
All the Manual references will change to electronic references (Shapes option in pdf such as boxes for adding the work paper reference, lines to link the balance and testing references etc.)
Do we need to perform a tie-out through both approaches?
Well, it’s a No.
Any one of the approaches is fine.
What’s the best of these two methods?
Electronic tie-out will be more time-consuming than the manual process. However, if we have a prior year tie-out, then all the Shapes and references can be copied for all the pages of tie-out from the previous year to the current year with the click of a button.
Tie out Software
Some audit teams went ahead and developed custom software to improve efficiency. This application provides various checks, such as
- Identifies the unreferenced numbers in the tie-out with ease
- Improves efficiency as the application itself identifies all the numbers which need to be agreed with workings
- Helps with cross-checking balances. Some GL account balances will be further elaborated on and discussed with Foot Notes, MD&A Section, etc. For example, the cash ending balance in the balance sheet, Footnotes, and Management Analysis section shall all agree. These applications directly agree on the first number with other numbers, with due consideration of their nature. Further, any discrepancies between the different sections within tie out.
Conclusion
Financial Statement tie out is a final check to verify if all the numbers within the financials are covered under testing or assessed as no risk. All those numbers the audit team is comfortable with are referred to the respective working papers through tick and tie.
If there are any discrepancies, then they will be brought to the notice of the management/client reporting team so they can be fixed.