Inside an SMSF audit: What auditors look for

What actually happens in an SMSF audit and what are auditors looking for?

Yeah, that’s interesting because, you know, so how long’s a piece of string as to what we do behind the scenes? But the reality is we are checking that the assets actually exist and that they’re worth what the accountant or the trustee claims they’re worth, which is really easy. If it’s listed shares and managed funds, property’s a little more challenging. It’s easy to figure out if you own it. But then what is a property worth? And we all know that a property’s worth what someone’s willing to pay for it. And that may vary from one day to the next.

In terms of what we’re looking for, when we go through the records, we’re also looking for errors. You know, we will be given a bucket load of source documents and we’ll be going through those to make sure that creditors are fairly stated, that the tax calculations are correct. And auditors, even though the accountant might use a software package that’s dedicated to SMSF accounts prep, they still glitch, so we’ll be still looking for errors. And, you know, I was chatting yesterday to a colleague, I said, there’s a really common one we’re finding in one of the software packages at the moment, but it’s understating the franking credits for BHP dividends, which is a really simple but really common investment.

And so if you’re not checking, then, you know, for my clients where I found this error, they’ve had some significant franking credits not being claimed. And so we can just pick up those little anomalies and software glitches. So that’s kind of the role. And then of course there’s the compliance side of things. You’re looking for mischief, you’re looking for direct contraventions, and you’ll find both when you look for them.

When an SMSF audit has a poor outcome, where does responsibility typically lie?

Yeah, that’s a good question because it depends on what the issue is that’s been found. So if there’s a poor quality audit, in the majority of instances, that will impact the auditor, because as we talked about yesterday, there’s ATO reviews, there’s peer reviews, there’s referrals to ASIC. So if you’re doing a poor quality audit and you get an ATO audit, they will look at your file and say you’re a bit substandard. And if there’s significant number of deficiencies that warrant a referral to ASIC. You’ll get referred to ASIC with an ATO recommendation that you’re disqualified so you lose your job. There might be conditions placed on your registration, all of those professionally embarrassing. But then again, you might have situations like the Melissa Caddick case where you’ve got a poor quality audit, but it’s the trustees that are really feeling the pain. The auditors in those instances, some of them didn’t even have insurance. The ones that did are like, well, I’ve got insurance so there’s really no skin off my nose, which is to me a really unprofessional approach to your obligations. And you’ve got trustees that are really suffering because they’ve lost, you know, the bulk, if not all of their retirement savings, which wouldn’t matter.

Where in your retirement journey you are, whether you’re at the start or you’re towards the end, that is a horrible outcome that you have to start over. So you do get situations where it’s the trustees that are the ones that bear the brunt of a poor quality audit in terms of the accountants. The way that I manage my business is I like to manage everybody’s risks. Firstly, predominantly I want to manage my own because I’m the one that obviously bears the brunt of that. But by doing that I make sure the trustees risks are all managed. I’m picking up the problems and pointing out better outcomes. And for the accountant, by doing all of that means their risks have managed. Because if I’m picking up a tax problem or saying, hey, this is going to turn into a tax problem and the accountant can then act, it protects them as well.

What documentation gaps most often cause problems for SMSF trustees?

Yeah, so in terms of documentation gaps, most trustees are really good at keeping the documentation because it’s not like the old days where we just get the shoebox and everything is thrown in. You know, most copies of documents are soft copies these days or they at least know to scan it up and they’ll have that folder that they then take to their accountant and it’s all there ready to go. So it’s actually quite unusual these days to go, oh, I need to see the rates notice for your property expenses to make sure it’s the right property and it’s the correct figure. It’s rare to have the trustee go, I can’t find it. So the documentation gaps from the trustee’s perspective are almost non existent from the auditor’s perspective. Documentation gaps is where we run into problems with quality or poor quality audits because you might have the client give you the information, but if you then haven’t done something with it in your audit files, what have you actually audited? So the documentation gaps in audit files, for example, is if you’ve got a super fund that’s got a limited recourse borrowing arrangement, that’s a significant activity for the funds.

So where is your loan documentation to prove that it complies with the requirements? Where’s your bare trust documentation to show that it’s in the assets in the right name, whereas you guarantee documentation to make sure that all complies? So it might sound like it’s a, you know, big documentation gap versus the little one that you ask, but that’s the sort of stuff that’s missing in audit files regularly. And even, you know, some auditors that are really low quality, they won’t even be doing title searches or getting evidence that the property’s owned by the fund. And, you know, those documentation gaps are pretty significant for the regulators, and rightly so.

What valuation mistakes do SMSF trustees most commonly make, especially with complex assets?

Probably the biggest challenge we find with trustees when it comes to property valuations is that they don’t fully understand the subtle changes that have occurred over the past couple of years with ATO expectations. So, you know, 10 years ago, trustees would have just organised a real estate agent appraisal. And as an auditor, great, you’ve got some external documentation that says the property’s worth X dollars, will report it at that, and I’m okay to sign my audit report.

Then a few years ago, the ATO came out and said, look, we actually need a little bit more, you know, we want an agent appraisal that’s got comparable sales information. So now as the auditor, I now need to look at the appraisal cheque that there’s comparables cheque that the comparables are actually comparable, and then evaluate the dollar values that the agent appraisal has in it. And we find that trustees don’t fully understand it. Like, yeah, but you accepted just the agent appraisal previously. What’s changed? Or they’re the experts, I don’t know. So that’s probably the biggest challenge trustees have with the agent appraisals. Also, the big challenge is the timeliness of them. So if we’re doing the 30 June financials, giving me an agent appraisal from December last year is too old.

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And I know we all think it’s not very old, but the ATO say three months either side of year end is really the window that you’ve got for your appraisals to be appropriate audit evidence. So our evidence has to be in the correct format, cover the correct things, but also has to be timely. So we can’t be looking at old appraisals. Or even what we get is, I might be doing 30 June 2024 and I get an appraisal today, like that’s too new. I need you to backtrack. And that look, that’s probably an easier problem to deal with because you can discount it by CPI or take the average from your 23 to now and work your way back to 24 balances. But the timeliness and the content is probably the biggest challenges that trustees seem to face with those kinds of assets.

How can trustees ensure related party transactions stand up to scrutiny?

Yeah, that’s a really good question because a lot of clients trip up on that. I can appreciate that. If your super fund owns a property and you lease it to a related party, you set the rent, you put your direct deposits in place and you literally set and forget. And a lot of time can go by without you revisiting those lease agreements and the lease terms. So what trustees really should be doing is proactively looking at when their leases were put in place. If there’s a renewal that has a CPI increase, make sure the increase goes on at the time it should not. Oh, three months late. When the accountant tells me that I really should have increased my rent a couple months ago or 18 months ago. And the big problem area for auditors is those lease arrangements need to be at arm’s length. So cheque with your accountant or even better still with your auditor. So, hey, I’m putting a new lease in place. Do the terms look arm’s length to you? So, for example, we get some clients who might put in a 15 year lease with no increases that’s not arm’s length because you would never have that with an unrelated party.

So a really good check for trustees is like, if I was leasing this to someone else, what terms would I want? And then just mirror that with the terms you have with yourself and your super fund. And if you’re having that almost external approach to it, odds are on you’re going to withstand the scrutiny come audit time.

Do you have any practical advice for making SMSF audits smoother?

Well, look, I did do a session yesterday about audit quality and I did have a bit to say about accountants and advisers. And how sometimes they run interference with the audit process. You know, they’re the ones that seem to be driving trustee attitudes about the audit and it’s unfair and it’s unnecessary. So if trustees have got an accountant that understands the audit process and respects the audit process, we have a job to do. And the more that they give us that they know we need, the easier the process is. So again, it comes back to the trustee selecting the right adviser for the SMSF. Somebody that’s not super negative about the audit. Like if you go and have a meet and greet with a prospective accountant and they roll their eyes and groan about the audit, well, then they’re actually going to be difficult to deal with and you’re probably not going to get a good quality audit.

Looking ahead, where are the ATO and ASIC likely to focus and how should trustees prepare?

I don’t think trustees have to be overly concerned with ATO activity. The average trustee will have a very, you know, low risk kind of SMSF. The bigger problem is the ones that are lending money to themselves, you know, leasing assets not at market value. And the ATO will be aware of those activities. It surprises me every time how much they know about all of us. And certainly when I see the funds that the ATO select for other auditor reviews, I’m like, wow, how did they know to pick those three? They are the most problematic funds this, this auditor has got, but they just know. So trustees that have low risk, you know, portfolios, like they’ve got listed shares, they’ve got cash at bank, and there’s no mischief going on. I don’t know that they really have to trouble themselves too much with risk or ATO assessments.