Audit. The very mention of the word causes most people to sweat. I, for one, envision a panel of IRS agents sitting at a long table in a conference room, peering at me over the tops of their reading glasses – looking for any sign that one of the receipts I used as a write-off wasn’t a legitimate business expense after all…

Relax. It’s not an IRS audit that I’m talking about here, but rather, your annual Investment Club Audit – or the one that your club should be conducting each year. You should only be sweating if you currently do not conduct an annual audit. And even if that’s the case, it doesn’t have to be for long, as I’m about to take you on a step-by-step journey into the not-so-scary world of investment club audits.

But don’t take my word for it. Take it from someone who’s been there, done that. “I’ve been involved in a number of club audits, for all three of my clubs,” says Herb Barnett, who currently serves as one of ICLUBcentral's volunteer club accounting advisers and a member of the beta test team for Club Accounting 3 and myiclub.com. “It’s not as ominous a process as the term ‘audit’ suggests. Basically it is a matter of the treasurer collecting particular standard reports, the official bank and brokerage statements, and organizing a couple of the club’s members to cross-check the records. You don’t have to have a sophisticated knowledge of accounting to do this, and the entire process usually takes only a couple of hours.”

There. Feel a little better? Now, let’s get down to business.

Do We Have To?
Yes, to answer your question, a club audit is a necessity. In fact, it could spell big trouble for your club down the road if your members choose to ignore this important annual check of the books, says Gene Rooks, who took over as club treasurer of the Southern Women Investing Money Club in Orlando, Fla., in 2003. “The clubs that do not conduct annual audits are usually the ones that end up with the grossest errors – compounded over the years,” she says. Gene has also served as an Accounting Instructor for the BetterInvesting, Inc.’s Space Coast Chapter and, like Herb, currently serves as one of ICLUBcentral's volunteer club accounting advisers and a member of the beta test team for Club Accounting 3 and myiclub.com.

Why, then, do some clubs avoid the task all together? One of the biggest reasons is the fear of offending the club treasurer. “There are many clubs where the members are ostriches, afraid to even question or touch the records or even suggest to their ‘for life’ treasurer that an audit would be advisable,” Gene points out. Other clubs simply aren’t aware that they should be conducting such audits, or they aren’t sure how.

For the club members who fear that bringing up the topic of an audit will insult the treasurer – keep in mind that we’re talking about your money. As for those who are ready to stand up and say bring it on, I’m going to try to do just that – with the guidance of experts Gene Rooks and Herb Barnett.

When, Who and What
An annual audit can be conducted at any point during the year – preferably after the club has received and reconciled all of its 1099s, but before the 1065 and K-1s are prepared for the IRS and club members. If your club rotates the office of treasurer, the audit should be completed before the new treasurer takes over.

The audit should be scheduled as a separate meeting outside of the club’s regular meeting. Typically, a few of the club’s members and/or officers will suffice – and your club may choose to rotate each year so that everyone has a chance at some point to go through the audit process. Although the club’s treasurer and assistant treasurer should be available to answer questions, they should not participate in the audit.

Just as you need to have all of the pieces of the puzzle before you can complete your personal tax return each year, you must have certain documents ready in order to conduct your club’s audit, including:

• Valuation Statement and Member Status Report
• Copies of Individual Valuation Unit Ledgers for each member for the year
• Copies of the Individual Security Ledgers for the year
• The Transaction Summary Report for the full year
• The Cash Journal Report
• Allocation of Income and Expenses

Note also that each member of the Audit Committee (Yes, I know that sounds very official, but again, no need to sweat it. We have to call it something!) will need his or her own copies of these statements. “The members of the Audit Committee need to have their own copies so that they can take the time to review each document individually,” Gene says. “Making just one set of copies and passing them from member to member just doesn’t cut it in this case.”

How to Conduct an Audit
The audit is a thorough, careful step-by-step process. In fact, it might be a good idea to provide a checklist for the Audit Committee meeting, to keep everyone on the same page and so that the Committee’s members know what they should be looking for. Step by step, your audit should proceed around this sample framework:

Step 1: Reconcile and Verify the Club’s Cash on Hand and Number of Shares

·         Reconcile the club’s actual cash on hand in cash accounts with both your bank and broker against the corresponding accounting reports.

·         Reconcile the number of shares that the club is reporting with the brokerage report. If there are discrepancies, determine where, and correct the necessary entries.

Step 2: Review Individual Unit Ledgers

·         Are all members current on required contributions? If not, are the exceptions noted?  There should not be any fractions of units remaining for any member who withdrew during the year.

·         Does the monthly unit value and number of units purchased with the same contribution change from month to month?  If not, this is evidence that valuations have not been done as specified in most club Partnership Agreements. If that is the case, the missing valuations need to be done, which will of course alter somewhat previously distributed reports.

Step 3: Review the Transactions Summary Report and Individual Security Ledgers

·         On the Transactions Summary, stock dividends should only be listed in the Cash and Reinvested Distribution section, and money market dividends or interest listed only in the Cash Income and Expense section. Money market income can be either dividend or interest, depending on what your institution deems it to be, but shouldn’t vacillate back and forth.

·         On the Individual Security Ledgers, are dividends on stocks that pay them recorded regularly? If they aren’t paid quarterly, or, on occasion, annually, this might indicate they were misapplied as income, and could also account for some discrepancies in the shares held. In addition, there shouldn’t be any fractions of shares left on any securities sold during the year.

·         Are the expense items in accordance with what the club has approved? 

·         Check for unusually large “income” and “expense” items that should have been transfers between accounts, rather than recorded as income or expenses. (For a more detailed explanation, refer back to my column, Expert Tips for Club Treasurers, Part II.)

Step 4: Review the Allocation of Income and Expenses

·         Any members who withdrew prior to the past year should not be listed. The members who withdrew during the year should be listed at the top.

·         The Allocation is the basis for the club’s tax filing and K-1 information. If adjustments are made as a result of the audit, the treasurer will need to generate a new Allocation before the tax program is run.                   

And You’re Done!
You’re almost done (that wasn’t so bad, was it?). Once the Audit Committee has completed the steps, each member should initial his or her individual copies of the club statements. Next, one member should prepare an Audit Committee Report, signed by all of the committee members, which either confirms that all records were complete and correct, or details any discrepancies and the action that was taken. Finally, if the committee has any recommendations for improving club procedures, that should also be noted in the report. And don’t forget to congratulate yourselves for stepping up to the plate!

Be sure to download a copy of the "Investment Club Annual Audit Checklist" from StockCentral's Learning Library.  You'll find the Learning Library here.