As a technology startup prepares for its first audit, there are a few common accounting issues that can increase the time and cost required to complete the audit.
These issues often result from the accounting/finance team balancing competing priorities, not having certain technical accounting knowledge, or not having proper systems in place to account for transactions properly.
The most common accounting challenges we see for technology companies include:
#1 Non-Cash Equity Activity
Technology companies are often unsure how to account for various non-cash, equity related transactions. This includes accounting for equity instruments such as restricted stock, warrants, and stock options. Because non-cash equity activity won’t appear on bank statements, these transactions are often overlooked from a financial reporting perspective and are not recorded (or are recorded improperly).
Similarly, legal or other costs incurred in the issuance of preferred stock are often recorded improperly as legal expenses, rather than being properly capitalized on the balance sheet as stock issuance costs.
#2 Revenue Recognition
A common challenge for tech startups is failing to recognize revenue in line with the often-complex provisions within the GAAP requirements under ASC 606. Startups may struggle to understand, for instance, precisely what’s being sold within a customer contract, the complexities of subscription revenue accounting, or the accounting implications of non-cash items.
Startups often lack a robust revenue recognition policy or may have inconsistencies in recording similar kinds of transactions. In many situations, the accounting for revenue must be adjusted to complete the audit successfully.
#3 Intercompany Accounts
For startups that operate through multiple entities/subsidiaries, 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 any intercompany cost-plus agreements. If a startup has international entities, such as an offshore development subsidiary, the company needs to be sure any foreign currency translations or remeasurements are assessed and calculated properly.
#4 Software Development Costs
Technology startups face the specific, complex issue of accounting for software development costs in accordance with GAAP. Many companies mistakenly expense the costs associated with software development as they are incurred, but there are complicated rules dictating whether these costs should be capitalized or expensed.
Many companies also lack the necessary documentation regarding the nature of their software development costs, making the accounting determinations increasingly difficult.
#5 Improper Cutoff for Accruals and Payables
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 each period. Common causes for this issue include a lack of proper accounting policies or inconsistent practices among different team members.
Enlist Help Early to Avoid Future Accounting Issues
While most of these startup challenges can be resolved, a consultation with your external auditor early in the audit process to identify and resolve potential roadblocks is extremely beneficial. Consulting with your auditors as you’re setting up systems, developing accounting policies, and creating your financial infrastructure 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.