The Ins and Outs of a First-Year Property Audit

By Erica Cohen, CPA, and Corey Ridlon

Preparing for the first audit of a property might be a daunting task if you’re unfamiliar with what to anticipate during the process. Regardless of the size of the property, auditors are required to obtain an understanding of the entity’s policies and procedures by performing walkthroughs of processes, followed by substantive testing procedures to gather an appropriate amount of evidence to provide an opinion on the entity’s financial statements. A clear understanding of the audit process paired with strong preparation will help greatly to ensure the audit is completed efficiently and effectively. In this article, we breakdown the audit process and provide you with valuable insights to help you prepare for your initial property-level audit.

Understanding your needs and establishing a timeline

Prior to beginning the audit process, it is important for the entity to understand their financial reporting needs. There are several key factors to consider before engaging an auditor including understanding the deadline for your financial reporting and the basis of accounting on which your financial statements are required to be reported. The most common basis includes the generally accepted accounting principles, such as (“GAAP”), and other comprehensive basis including income tax basis of accounting. This information can be found in governing documents of the entity, such as the operating or partnership agreements, or loan agreements if the reporting is required by a lender.

Understanding and managing the timeline of the deliverables to investors and lenders is an important aspect of the audit process. For calendar year audits, at the end of the third quarter or the beginning of the fourth quarter, an engagement letter outlining the scope of work will be executed with the auditors. Pertinent legal documents will be gathered, and the auditors will perform walkthroughs of the entity’s significant processes to obtain an understanding of the business, processes, and controls. In addition, the auditors will design the nature, timing and extent of the audit procedures, and will generally obtain audit evidence for transactions through an interim date. It is good practice to debrief with the auditors at this time to determine if any gaps exist in financial reporting or in the control environment that would need to be addressed timely before the calendar year-end.

The year-end audit process will commence immediately following the end of the property’s fiscal year and will continue until the issuance of the financial statements. Generally, the date of the financial statement issuance will depend on the date determined in the operating agreement, as well as when the entity’s books and records will be closed and available for auditors to commence audit procedures.

Benefits of a property audit

While a property audit can feel invasive initially, there are many benefits to having audit procedures performed on your property. Throughout this process, the auditor will take a deeper look into significant transactions and provide assurance that the financial statements are reasonably stated. The auditor will also be able to provide an outside perspective on how transactions are being recorded and if they appear to be correct. The Auditor must be independent in fact and appearance, and their unbiased view could be important throughout and at the end of the audit. In addition, by the completion of the audit, the auditor will have been through the details of the transactions occurring at the property, so they can better collaborate with the tax preparers in evaluating tax positions to ensure that you are getting the maximum benefit available. Furthermore, for those looking to launch a real estate fund in the future, having existing properties audited can be of significant benefit in being able to substantiate a track-record to potential fund investors.

How to prepare for a first property level audit to ensure a smooth process

To streamline the audit process, it is preferred to have one or two points of contact to support the audit. A secure method of transferring documents should also be established with the audit firm. While not all encompassing, find below a general list that you should expect to provide to the auditors for a first-year property audit:

• Permanent File items, which include:
  • Operating/limited partnership agreements
  • Organization charts
  • Loan agreements
  • Any other major agreements or amendments (including management, related party, major leases, etc.)
• Process narratives (explanations of how major transactions are ultimately recorded to the general ledger, such as the process for cash disbursements or cash receipts). Auditors will perform walkthroughs to corroborate that these processes are implemented. The auditors will also need to understand internal controls at the management company, which can be explicitly documented within process narratives or through an internal control matrix, taking into consideration the COSO framework. The auditors may also choose to test internal controls.
• Policies, including fixed assets, revenues and allowance/bad debt
• Trial balance and general ledger in excel for the period under audit
• Monthly / Quarterly / Annual reporting packages, if available
• The reporting packages should include supporting schedules that drive the amounts recorded in the general ledger and the trial balance, including but not limited to:
  • Bank statements and reconciliations
  • Fixed asset and depreciation roll forwards
  • Intangibles and amortization roll forwards
  • Tenant receivable aging schedule, as well as an assessment of allowance for doubtful accounts or bad debt write-offs
  • Accounts payable aging and accrued expense schedules
  • Loan roll forwards, including drawdowns and repayments
  • Equity / partner capital roll forward
  • Rent rolls and common area maintenance and real estate tax escalation schedules
  • Payroll reconciliation, if applicable
  • Interest expense recalculations, inclusive of interest from derivative instruments
  • Mortgage & Interest expense (including derivatives) summary schedules
• Other unusual or significant items, as applicable:
  • Contact information for lawyers handling any ongoing litigation and an explanation of the activity
  • Acquisition documents and workpapers used to record the purchase of the property
  • Understanding if the property is managed by an external property manager, and considering if they should be a point of contact for the audit team and to what extent they would be supporting the audit

Communication and Goals

• As you prepare for the audit, you may want to consider whether you’ve dedicated enough employee bandwidth to support auditor requests.
• In this initial audit stage, good communication with your audit firm is a priority. It is important to inform them so they know your timetable for providing them information and collaborate with the auditors to ensure they have sufficient time to perform their audit. This will also allow the auditors to prepare and schedule an audit team to begin work. Lastly, engage in continuous dialogue with the auditors, and make sure to ask questions early and often.
• Should any additional information have the potential to impact the financial statements, it is advisable to engage in a discussion with your auditors regarding the matter. It is important to gather the necessary information prior to meeting with your auditor as this will effectively help all parties adhere to the initial planned timeline to complete the audit in a stress-free and efficient manner.

For more information on what to expect from a first-year property audit, please contact Erica Cohen, Real Estate Audit Partner, or your Anchin Relationship Partner.