What changes in your first audit after raising?

Before the round, the statutory audit was a formality. The accountant prepared the financial statements, the auditor asked a few questions, signed, and the accounts were filed. Nobody outside the founders read them.

The first audit after raising feels different, and it is. Investors now have a right to audited accounts, often within a set number of days after the year ends. The auditor knows those investors will read the financial statements, and that a future investor will read them again in diligence. And the money the company raised has quietly changed which reporting rules apply to it.

None of this is a reason for anxiety. It's a reason to start earlier and prepare differently. This article covers companies following Indian accounting standards, which is where most startups sit. Your auditor and CA should confirm what applies to yours.

Why the first audit after a round is different

Every company in India has to have its accounts audited every year, whatever its size. What changes after a round is who depends on those accounts and how much scrutiny follows.

• ·Investors rely on the audited accounts, and the shareholders' agreement usually specifies when they must be delivered.
• ·The next investor will read them closely, and any qualification or emphasis in the audit report will need explaining.
• ·The company has more transactions, more people, ESOPs, and possibly foreign investment, each with its own accounting and disclosure.
• ·The balance sheet now holds a large amount of share capital and securities premium, which can bring the company into reporting requirements it was previously exempt from.
• ·Some investors ask for a change of auditor to a larger firm, which means a new auditor learning the company from scratch.

CARO reporting probably applies now

This is the change founders most often don't see coming. The Companies (Auditor's Report) Order, known as CARO, requires auditors to report on a long list of specific matters in their audit report: records of fixed assets, inventory verification, loans and guarantees, deposit of statutory dues, disputed tax, use of funds raised, fraud, related party transactions, cash losses and more.

Small private companies are exempt if they meet all of a set of conditions, which include not being a holding or subsidiary company of a public company, paid-up capital plus reserves and surplus of not more than ₹1 crore at the balance sheet date, borrowings from banks or financial institutions of not more than ₹1 crore at any time in the year, and total revenue of not more than ₹10 crore. Securities premium from a funding round counts within reserves. So a company that raised a few crore at a premium will often cross the ₹1 crore threshold in the year of the round, even if revenue is modest and the company is making losses.

In practice, that means the auditor now has to say, publicly and in writing, whether statutory dues like GST, TDS, PF and ESIC have been deposited regularly, whether any are outstanding for more than six months, whether the company has incurred cash losses, and whether funds raised were used for the purposes they were raised for. Delays that nobody noticed in a small company's audit become lines in a report investors will read.

ESOPs get accounted for properly

Many early-stage companies grant ESOPs and record nothing in the accounts until someone exercises. After a round, auditors are much more likely to expect the cost of employee share-based payments to be recognised over the vesting period, following ICAI's guidance on employee share-based payments, which usually needs a valuation of the options at grant.

That creates an expense in the P&L, sometimes a large one, even though no cash moves. It also exposes gaps in records: grants promised in offer letters but never approved by the board, grant letters that don't match the ESOP scheme, vesting schedules nobody tracked, and leavers whose unvested options were never cancelled. Reconstructing all of that in April is much harder than keeping it right as grants happen.

Provisions that were ignored become visible

Gratuity is the most common. Employees become entitled to gratuity after a period of service, and the accounting standards require the liability to be provided for as it builds up, usually based on an actuarial valuation. Plenty of young companies have never booked it. With a growing team and a more careful auditor, it will be expected, and the first year's catch-up can be meaningful.

Leave encashment works the same way where the leave policy allows unused leave to be paid out. Bonuses and incentives earned in the year but paid after it need accruing. So do expenses for services received before year end but invoiced after it. Under the labour codes, the definition of wages also affects how gratuity is calculated, which is worth raising with whoever does the valuation.

Revenue recognition gets examined

Auditors look harder at revenue once investors are relying on it, because it's the number investors care most about. The questions are the familiar ones. Is revenue recognised when the service is delivered or the goods are transferred, rather than when invoiced? Are annual prepaid plans spread across the months they cover? Are milestone contracts recognised as work is completed? Are refunds, credit notes and discounts reflected? Does revenue in the books agree with GST returns, and where it doesn't, why?

If revenue has been recognised on invoice, the audit adjustment can move revenue between years and reduce the figure investors were shown in the monthly MIS. That's a difficult conversation after the fact, and an easy one to avoid by setting the policy right in the first month after the round.

Audit trail, controls and records

Since April 2023, companies have been required to keep their books in accounting software with an audit trail feature that records every change and can't be disabled, and auditors report on whether that's been done. A company still keeping part of its accounts in spreadsheets, or using software with the edit log switched off, has a reporting problem.

Reporting on internal financial controls is a separate requirement. Private companies below certain turnover and borrowing thresholds have been exempted from it, so many startups won't be affected yet. But the underlying expectations, like approval limits, reconciliations and segregation of duties, are exactly what a diligence team will look at anyway.

The round itself gets audited

The share issue is a transaction the auditor will check. Were shares allotted within the required time after the money arrived, and were the funds kept in a separate account until then? Was the return of allotment filed? Was a valuation report obtained where the rules required one? If investors are foreign, was the investment reported under the foreign exchange rules? Were issue expenses, like legal and advisory fees for the round, accounted for correctly?

Related parties also get closer attention: founders, their relatives and their other companies, and investors with board seats. Transactions with any of them need proper approval and disclosure. Your company secretary will have much of this on file, and the auditor will want to see it.

A timeline that avoids the scramble

For a financial year ending 31 March, the annual general meeting generally has to be held within six months, so by 30 September, and the accounts need to be approved by the board before then. Many shareholders' agreements ask for audited accounts sooner. A timeline that works:

1. 01January: agree the audit plan and timetable with the auditor, including any new requirements like CARO. Commission the ESOP and gratuity valuations.
2. 02February and March: clean up reconciliations, ESOP records, fixed asset registers and statutory dues while there's still time to fix things within the year.
3. 03Early April: close March, including all year-end accruals and provisions.
4. 04Late April and May: prepare financial statements and supporting schedules, and give the auditor a complete set.
5. 05May and June: audit fieldwork, questions and adjustments.
6. 06June or July: board approval of audited accounts, delivery to investors within the agreed deadline.
7. 07By September: AGM, followed by filing with the Registrar within the prescribed period.

Companies that start in April tend to finish in September. Companies that start in January tend to finish in June, and they spend far less founder time on it.

What to hand the auditor

• ·Trial balance and ledgers for the year, with every bank account reconciled at year end.
• ·Revenue schedule by customer, reconciled to invoices, GST returns and receipts.
• ·Receivables and payables ageing, with confirmations for the largest balances where the auditor wants them.
• ·Fixed asset register with additions and supporting invoices.
• ·Payroll summary, statutory dues schedule with payment dates, and TDS reconciliation.
• ·ESOP register, grant approvals, valuation report and the expense calculation.
• ·Gratuity and leave valuations.
• ·Share allotment records, filings and any valuation reports for the round.
• ·Related party list and transactions, with approvals.
• ·Board and shareholder minutes for the year, and key contracts.

An auditor given all of that in the first week of fieldwork can work efficiently. An auditor who requests it piece by piece will take much longer and ask many more questions.

Losses, going concern and deferred tax

Most funded startups make losses in their early years, and that raises two accounting questions auditors will want to discuss.

The first is going concern. The auditor has to consider whether the company can meet its obligations for the foreseeable future. A company that has just raised money with a credible plan is usually comfortable here, but the auditor may ask for the cash flow forecast and the board-approved budget as evidence. Having both ready, and consistent with each other, makes the conversation short.

The second is deferred tax. A company with accumulated tax losses may be tempted to show a deferred tax asset for the future tax those losses could save. Under Indian accounting standards, recognising such an asset on unabsorbed losses needs a high level of certainty about future taxable profits, which a loss-making startup rarely has. Expect the auditor to be cautious, and don't build that asset into the numbers you show investors.

Choosing or changing the auditor

Investors sometimes ask for an auditor with more experience of venture-backed companies. That can be sensible, particularly ahead of a larger round. But changing auditors has its own process under company law, and a new auditor in the first year after a round means more questions, not fewer. If a change is coming, make it early in the financial year, and give the new firm access to the previous year's working papers and the reasoning behind any judgement calls.

The benefit that outlasts the audit

A clean first audit after a round is useful beyond the audit itself. The schedules, reconciliations and records it needs are almost exactly what a Series A or B diligence team will ask for. Companies that treat the audit as a year-end compliance task do the work twice. Companies that use it to put their records in order do it once, and walk into the next data room with most of it already done.

Who wrote this

Shafneed is the founder of Simplify, a finance clarity and investment readiness practice working with founders across India. He writes about the questions founders bring before a decision, not after it.