What is Accounting Due Diligence?
Table of contents
- What is Accounting Due Diligence?
- Purpose of Accounting Due Diligence
- Scope of Accounting Due Diligence Services
- Firms Offering Accounting Due Diligence Services
What is Accounting Due Diligence?
Accounting due diligence is an important phase of the overall due diligence process in M&A. Accounting due diligence (also called “Financial Due Diligence”) involves the evaluation of the financial statements and accounting practices of a target company. The goal is to ensure the accuracy and reliability of financial information, identify potential risks and liabilities, understand how various accounting policies impact earnings, evaluate the financial performance of the business, and assess the quality of the target company’s financial position. Accounting due diligence is typically performed by specialized accounting and consulting firms that offer financial advisory / due diligence services. Let’s explore the details of accounting due diligence and some of the firms that provide these services.
Accounting due diligence typically involves three key work products: quality of earnings analysis, net working capital analysis, and debt and debt-like analysis.
Purpose of Accounting Due Diligence
The primary objectives of accounting due diligence is to assist in the evaluation of a target company that is being contemplated as an acquisition or investment. It’s important to perform accounting due diligence in order to confirm that the financial performance presented by the sellers is accurate and reliable. Accounting due diligence also helps investors analyze the target company at an even deeper level including profitability by service line, earnings by location, etc.
- Verifying the accuracy and completeness of financial records and statements.
- Assessing the quality and sustainability of earnings and cash flows (i.e., quality of earnings)
- Identifying any potential financial risks, such as undisclosed liabilities or contingencies.
- Evaluating the adequacy of accounting policies and practices.
- Assessing the target company’s compliance with relevant accounting standards and regulations.
- Understanding the historical and projected financial performance of the target company.
Scope of Accounting Due Diligence Services
The scope of an accounting due diligence project can vary depending on the specific needs of the buyer and the nature of the transaction. The scope is typically agreed to before accounting due diligence professionals start their work. They prepare a “scope of work” that is approved by the buyer (or client). The scope of work typically includes the following areas:
- Review of income statement, balance sheet, and cash flow statement
- Review the audited financial statements and audit workpapers
- Examine the target companies accounting policies to ensure they comply with GAAP (Generally Accepted Accounting Principles)
- Analyze the company’s revenue recognition methodology to ensure revenue is accurately presented
- Review of the target company’s historical expense recognition and balance sheet accruals to identify any potential overstated or understated expenses.
- Analyze the various line items within the income statement to understand reasons for large fluctuations
- Analyze the various line items of the balance sheet to understand each type of asset and liability as well as potential fixed asset capital expenditure needs
- Identify potential debt-like items, such as litigation claims, warranties, pending lawsuits, or regulatory compliance issues.
- Performa an analysis of net working capital to assist in setting the net working capital peg
Firms Offering Accounting Due Diligence Services
There are several small and large professional services/consulting firms that provide accounting due diligence. Here are some well-known firms in this space:
Deloitte: Not only does Deloitte offer accounting due diligence, but they also offer a range of financial advisory services, including tax due diligence, commercial due diligence, and more.
Alvarez and Marsal (A&M): Alvarez and Marsal is a well-known consulting firm that specializes in restructuring, M&A, and operational improvements. They also have a team of over 300 professionals offering accounting and tax due diligence services.
PricewaterhouseCoopers (PwC): PwC provides comprehensive accounting due diligence services to help clients identify and understand potential financial risks and opportunities in M&A deals. Their team focuses on evaluating financial statements, accounting policies, and internal controls.
Ernst & Young (EY): EY offers accounting due diligence services to support clients in assessing financial and accounting aspects of potential transactions. Their team conducts detailed analyses of financial records, statements, and relevant accounting practices.
KPMG: KPMG provides accounting due diligence services to assist clients in evaluating the financial condition, risks, and opportunities associated with M&A transactions. Their team focuses on assessing financial statements, accounting policies, and controls.
Grant Thornton: Grant Thornton offers accounting due diligence services to help clients in M&A transactions by providing insights into the target company’s financial position, quality of earnings, and potential risks.
Interviewing for Accounting / Financial Due Diligence Jobs?
Practice makes perfect. The best way to prepare for an FDD interview is to practice. First, you will need to nail down your understanding of the process and goals of financial due diligence. Next, you will need to learn how to analyze a business with an eye toward identifying red flags and potential quality of earnings adjustments. Finally, you will need to work on your ability to present your findings in a clear, concise, and confident manner.
Leverage our free resources or complete financial due diligence interview guide to help you prepare for all of these items
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