Audit is the process of independently verifying the accuracy of an organisation’s financial statements. When a company’s accounts are required to be audited, it is typically because the company’s turnover exceeds £10.2m, has 50 employees or more, a balance sheet value of £5.1m or more, or operates within a regulated industry. Before setting up a limited liability partnership (LLP), our clients often ask what impact the new business structure will have on the audit process.
To explore this question further, we spoke to one of our clients who operates a holiday tour business that has to be audited for both statutory and regulatory reasons, namely as part of the CAA (Civil Aviation Authority) ATOL scheme, to share his experience about being audited while operating the LLP structure.
Our case study begins with an interview with our client, who explains how the tour operator industry works from a business and financial perspective, and his experience going through the audit process with the LLP model in place. We will finish the case study with some questions that you may expect from auditors in respect of your LLP model, and how to handle them.
Post the pandemic, in July 2021, you bought a tour operating business, what were the financials like?
“As you can imagine, the business was massively affected by the Covid pandemic, putting it in a very precarious position. Prior to the pandemic, the business had a regular turnover of £20m to £24m with an operating margin of about 10% or 11%.”
What was interesting, however, is that when we did a full review of all the figures, “in the past six years before Covid, it actually hadn’t made any money at all. The only reason it was alive was because it made money on deposit, which is when customers pay for the holidays and the company makes interest from that deposit.”
Why would the tour operator make money on the interest of the deposit rather than the sale?
The way the travel industry works is that, “you take a booking from a customer, 70% of the money has to go into escrow and we can’t access it until the customer has returned from holiday. Not gone on holiday but returned.”
“Hence, when Covid came around and they ran out of reserves, they needed someone like us to acquire the company, and apply new business methodologies, system processes, and the limited liability partnership model.”
Was it difficult to get the accountants to adjust to this shift?
“Given how the industry operates, where when you make a sale is not when you record it, I thought it would be best to switch the current provider and go with industry specialists. I had no reason to believe that the existing accountants and auditors weren’t good but just because of the earlier outlined oddities of the industry, I thought this was the better option.”
It does seem like a complicated way to record business sales, what was your experience finding accountants and auditors?
“The accountants I chose are very much industry specialists although they hadn’t heard of people operating a travel business in such a way before, however, they kept an open-mind.” When it came to the actual audit, the LLP model was already in place and following discussions with the team at OC, the auditors became “familiar with the implications and the structure.”
Therefore, in a way we were fortunate because as we were looking for new accountants, “we knew that the audit was a prerequisite, both from the size of the company and the CAA requirements. I think this contributed to how smooth the process went as we told them right from the start. That way if there were any questions, we can discuss them now, rather than somewhere down the line when we’ve got time limits.”
That sounds reasonable, I do feel like discussing the LLP model, and also being firm makes a big difference.
“Yes, it’s the best thing. Just say that you’re operating as an LLP. There’s no ifs, buts and maybes. That’s the structure. Find someone who understands the process or is willing to put in some work or be open to a conversation with people like you at Optimal Compliance to guide them through the process. This way it seemed to go very smoothly, which was quite refreshing.”
To conclude on our conversation above, an increasing number of our clients are audited and the question of whether an LLP will present a challenge to the auditing process does come up. However, in reality, provided you ensure that the OC team are able to brief the auditors on the correct operation of the LLP model, you should not expect any significant queries during the audit process. The following section explains the most common questions that you can expect from your auditor.
Questions that auditors will ask if you operate an LLP
Our standard LLP model uses a licence and undisclosed agency agreement which governs the relationship between the LTD company and the LLP. The auditors will need to verify that the transactions in the accounts correctly reflect the terms of the agreement, therefore you will need to provide:
- A copy of the Licence Agreement between the LTD and the LLP and any written variations
- A detailed schedule of all intercompany accruals in the financial year (revenue share, operating cost recharge, licence fees)
- A listing of all VAT invoices for the above charges in the financial year.
Part of our model involves securing the use of intellectual property (IP) from team members on a licence basis. The auditors will need to verify that the transactions in the accounts correctly reflect the terms of the licence agreements, and that the accounts have been prepared in accordance with the relevant accounting standards (IAS 38). Therefore, you will need to provide:
- A sample of the Intellectual Property agreements between the individuals and the LTD company.
- Clarification regarding the amortisation policy of the Intellectual Property within the LTD, and the reasons for choosing that policy.
- Details around the valuation of each individual’s Intellectual Property.
Accounting and bookkeeping
- Confirmation of the intercompany balances between the LTD and the LLP to ensure these match.
- Checking that payroll postings have been correctly reflected in the accounts.
OC will provide full support in answering any queries raised by accountants or auditors, and we can provide briefing documents providing background and responses to the most common technical queries.
To get in touch, click here.