Preparing for a financial audit is an important part of every wastewater (and water) utility’s operation. Not only is it good financial practice to run your business with the prospect of an audit on your mind, but some level of regular financial audit is typically required by states. Additionally, access to public funding for infrastructure improvements, such as state revolving fund loans, grants, and capital outlay funding often hinges on a system being current with financial audit requirements.
Although a blog post is far too short a format to cover everything a utility needs to do to prepare for an audit (and those requirements vary by jurisdiction) there are several keys to successful audit process.
Know Your State Reporting Requirements and Level of Scrutiny
Understanding your specific state’s audit requirements is the foundation of successful preparation. Every state has different thresholds that determine the type and scope of audit your utility will need to undergo. Some utilities may only require a compilation or review, while others need a full audit with additional compliance testing.
Start by consulting your state’s public utilities commission, department of environmental quality, or similar regulatory body to understand exactly what’s required for utilities of your size and type. Many states have tiered requirements based on factors like annual revenue, number of customers served, or total assets. For example, smaller utilities might only need a financial review every few years, while larger systems require annual audits with federal compliance components.
Additionally, consider whether your utility has received state funding such as state revolving fund (SRF) loans or grants, as these may trigger specific audit and compliance requirements beyond basic financial statement audits.
Understand Factors That Can Impact Your Reporting Requirements Year-to-Year
Keep track of key thresholds in your state because state audit requirements are not static. They can change based on a utility’s revenue growth, funding sources, or even operational changes such as a service area expansion. If you are approaching a revenue or other key threshold that would require a more comprehensive audit, it’s wise to start preparing early rather than scrambling when you cross that line.
Using New Mexico as an example:
New Mexico’s Office of the State Auditor (NM OSA) uses a six-tiered reporting requirement system for utilities and other local public bodies with less than $500,000 in annual revenue. A utility generating $49,999 in annual revenue that had no capital outlay expenditure would fall into Tier 2, which only requires an online certification to the Office of the State Auditor (OSA). But a one dollar increase in annual revenue would shift that system to Tier 4 and trigger a more stringent “agreed upon procedures engagement” (AUP) requirement. (Similarly, monitor any state funding you receive and its expenditures carefully, as accepting state revolving fund loans, capital outlay, or other grants may also trigger unfamiliar audit requirements.)
- A New Mexico utility with less than $10,000 in annual revenue typically must only provide an annual online certification to the NM OSA. But if the same entity expends 50% of a capital outlay award in a year, an AUP with an independent public accountant is required.
- New Mexico utilities that receive State Revolving Fund (SRF) loans must typically provide annual audited financial statements and maintain compliance with specific financial ratio requirements and reserve fund provisions.
Changes in ownership structure, such as forming a joint venture or creating an authority, can also impact audit requirements. Major infrastructure projects funded through bonds or special assessments may require additional financial reporting. Stay in regular communication with your auditor and regulatory bodies to anticipate these changes before they become compliance issues.
Know Who Can Perform Required Audit Procedures in Your State
Not all CPAs are qualified to perform government audits, and finding the right auditor is crucial for both compliance and cost management. Government audits often require specific expertise in governmental accounting standards, and some types of state-required audits have additional credentialing requirements.
Some states maintain lists of pre-qualified auditors for government entities or SRF borrowers, which can be a helpful starting point for your search. Check with your state’s revolving fund programs to see if they have specific auditor requirements or recommendations.
Make sure you are aware of required auditor contracting processes and timelines. There may be a limited number of qualified auditors in your area, so it is best to start looking early, lest you miss a critical deadline because the available auditors are all booked.
When selecting an auditor, consider their experience with utilities specifically. Utilities have unique accounting considerations around infrastructure assets, connection fees, and regulatory requirements. An auditor familiar with your industry will work more efficiently and provide more valuable insights. Don’t just shop on price, consider the total cost of working with an inexperienced auditor who might require extensive education about your operations or miss important issues.
Establish Adequate Financial Controls and Accurate Reporting
Strong internal controls aren’t just good business practice, they’re essential for audit success and often required by regulation. Your control environment should ensure accurate financial reporting, prevent fraud, and demonstrate proper stewardship of public resources.
Key control areas for utilities include segregation of duties in cash handling and bill processing, proper authorization levels for expenditures, regular bank reconciliations, and documented procedures for major accounting processes. Even small utilities can implement effective controls through periodic supervisory review, cross-training staff, and establishing clear policies for financial transactions.
Your controls should also address utility-specific risks like revenue recognition for connection fees, proper classification of infrastructure improvements versus maintenance, and compliance with rate-setting requirements. Document your procedures clearly and train staff consistently. Auditors will test whether financial controls are actually followed, not just whether they exist on paper.
Consider implementing monthly financial close procedures that mirror your year-end process. Doing so helps identify and resolve issues throughout the year rather than leaving them all to be discovering right before, or worse during, the audit. Regular internal reviews of your financial statements will help you catch errors early and demonstrate management’s commitment to accurate reporting.
Maintain Well-Compiled Financial Records
Organized, complete financial records are the backbone of any successful audit procedure. Your documentation should clearly support all transactions and demonstrate compliance with applicable accounting standards, including both generally accepted accounting principles (GAAP) and any state-specific uniform financial accounting and reporting standards (UFARS) requirements. Consider the auditor’s perspective, they need to be able to trace transactions from source documents through your accounting system to the financial statements.
Invoices, contracts, board minutes, and other supporting documents should be easily accessible and clearly tied to accounting entries so the auditor can follow the money. Establish a consistent filing system for supporting documentation, either physical, electronic or better yet both. Redundancy in financial records is never a bad idea.
Pay particular attention to areas that are likely to be scrutinized, such as capital asset records, debt agreements, restricted fund compliance, and revenue recognition. Keep detailed fixed asset registers that track acquisitions, improvements, and disposals throughout the year. Keep copies of all debt instruments, grant agreements, and other legal documents that affect financial reporting. Make sure that you can trace expenditures from authorization through reconciliation.
Don’t overlook the importance of board minutes and resolutions. These documents often contain crucial information about major contract approvals, rate changes, debt issuance, and other decisions that impact financial reporting. Ensure minutes clearly document financial decisions and maintain complete sets organized by date.
Final Thoughts
Successful audit preparation is really about building strong financial management practices that serve your utility year-round. While the specific requirements may seem overwhelming, remember that you don’t have to navigate this alone. Engage with your auditor early in the process, maintain open communication with regulatory bodies, and consider working with other utilities in your area to share knowledge and resources.
The investment in proper preparation pays dividends beyond just meeting compliance requirements. Strong financial controls and clear reporting help you make better management decisions, build credibility with lenders and grantors, and demonstrate accountability to the communities you serve. When audit time comes, you’ll be ready not just to meet requirements, but to showcase the professional management of your vital public infrastructure.
Need guidance on your audit preparation? The EFCN can help! Click the “Get Help” button in the top bar of this page.