5 of the Most Common Audit Challenges We See with Tech Startups

As technology startups prepare for their first audits, it’s common to see a number of accounting issues that can potentially increase the time and cost required to complete the audit successfully.

In most instances, these issues result from causes such as the finance team balancing various financial and operational roles, not understanding complex technical accounting guidance, or not having proper systems to account for transactions properly.

Technology firms are often unsure how to account for transactions such as the beneficial conversion features on convertible notes or simple agreements for future equity (SAFEs), warrants, and stock options. Because non-cash equity activity won’t appear on bank statements, those transactions are often not recorded (or are recorded improperly).

Similarly, issuance costs for a series of stocks are often recorded improperly as legal expenses, instead of being capitalized as stock issuance costs on the balance sheet.

A common challenge for tech startups is failing to recognize revenue in line with the often-complex provisions within the GAAP standards. Startups may struggle to understand, for instance, precisely what’s being sold within a customer contract or the accounting implications of non-cash measures.

Similarly, startups often lack a policy for recording revenue properly, or there’s inconsistency with different team members recording similar transactions differently. In these situations, the accounting must be adjusted to complete the audit successfully.

Intercompany accounts are often not reconciled, so the auditors may request that a company unwind historic transactions to determine if intercompany balances are appropriate and in line with intercompany cost-plus agreements in place. If a startup has an international entity, such as an offshore development subsidiary, the company needs to be sure any foreign currency translations or remeasurements are calculated properly.

Technology startups face the specific issue that GAAP accounting for software development costs includes complex guidance. Many companies mistakenly expense the costs associated with software development to payroll, but there are fairly complicated rules dictating whether or not you’re allowed to expense those costs or whether you need to capitalize a portion of those costs.

Similarly, many companies lack documentation of the nature of their software development costs, making adjusting the accounting challenging.

If reconciliations aren’t done on a consistent and timely basis, there’s a risk that expense or revenue cutoff dates are missed. As a result, transactions can be recorded in the wrong period, which causes an inaccurate accounting of the organization’s performance in a given period. Common causes for this issue include a lack of proper accounting policies or inconsistent practices among different team members.

While most of these startup challenges can be resolved fairly easily, a consultation with your external auditor as you’re setting up systems, developing accounting policies, and creating the financial infrastructure before a financing round or potential transaction can save time and money while helping you achieve your business goals sooner.

If any of these scenarios sound familiar, don’t hesitate to reach out. Our technology accounting team has helped hundreds of technology startups navigate similar situations, and we look forward to assisting you.