Mastering the Annual Digital Asset Funds Audit for a Smoother Process
The annual funds audit can be a stressful time of year for all parties involved, and the introduction of digital assets and the fast pace of evolution in this sector has created new layers of complexity when it comes to the audit process. However, undue pressure need not necessarily be the case.
A clear schedule of work that needs to be done, with allocated responsibilities, is the foundation to a smooth running of the audit process for any fund, whether or not it invests in digital assets. However, there are also specific details, peculiar to digital asset funds, particularly in terms of record-keeping, net asset valuation and accounting treatment for crypto assets, where specialist knowledge is invaluable.
There are key principles to adhere to throughout the audit, and indeed throughout the financial year itself, that will simplify the process significantly and reduce the possibility of hitting any roadblocks. Knowing this, it is important that the fund has internal processes and a focused and knowledgeable team to ensure that it can achieve the relevant requirements. This is especially because the fund has its own obligations towards the applicable regulator and its investors, and the administrator would be running this process with multiple clients at the same time.
Below are the fundamentals that should be taken into consideration to ensure a smooth and efficient audit process that will benefit all the relevant parties.
Specific planning for your audit is the first and essential step for a smooth process and timely conclusion. The administrator, the fund manager, and the auditor (collectively the “parties”) should all be aware of the regulatory deadlines that the fund has to meet in applicable jurisdictions. A meeting between all parties should be held 2-3 months before the financial year-end of the fund so that a timeline is laid down and agreed upon. As a result of the meeting, each party involved should have roles and responsibilities assigned and deadlines to be met. Some funds might also agree to do an interim audit so that they pre-empt any issues that may arise at a more pressing time during the audit. It is up to all parties to decide and agree whether to go down this route.
An important matter to consider during planning for the audit is not just the deadline for the fund, but also for its investors and investment manager. Although the fund will have its own regulatory deadlines (typically 6 months after the financial year-end), the investors and investment manager might have their own personal tax reporting and regulatory deadlines respectively. These deadlines might fall earlier than that of the fund, and the planning meeting must take this into consideration when setting the timeline, roles, and responsibilities.
A plan which is not followed up by ongoing communication between all parties during the audit will become irrelevant and present a high risk of not meeting deadlines. The parties will need to keep open communication lines throughout the audit process and each responsible party must be responsive to requests for information and additional questions.
The administrator should assign team members (more than one to ensure continuity) with the relevant expertise on the fund and who have ample time to dedicate for the audit so that they are responsive and able to communicate effectively with the auditors. Typically, the auditors will give access to their online portal so that they can communicate with the administrator through one channel and will also have a designated team member assigned to the fund. This will help ensure that the request for information and relevant replies are communicated smoothly and efficiently.
Expertise and Ongoing Training
A few years ago when crypto funds were still in their infancy, all players in the industry were still learning about the digital assets world from each other, especially when it came to accounting. The industry has evolved significantly since then. There is now an expectation that all parties involved are more knowledgeable and have gained the necessary expertise to conduct a smooth audit. Expertise needs to be gained not only in the subject matter, i.e., digital assets, but also very importantly in the preparation of the financial statements and the accounting standards relating to digital assets. The administrator needs to keep continuously abreast of updates in the International Accounting Standards and other regulations that apply to holdings of cryptocurrencies and other related digital assets. Particular attention and training must be given to updates on recognition, classification, and fair value measurement of digital currencies.
Whether the fund is being audited in accordance with auditing standards generally accepted in the United States (US GAAP) or International Financial Reporting Standards (IFRS), the administrator needs to regularly invest time in staying abreast of the developments in these accounting standards in relation to digital assets to ensure that they remain specialised in the asset class, so that the financial statements presented to the auditor are in good order from the very start. This will save precious time in exchanging emails and calls between the auditor and the administrator during the audit to ensure the financial statements are compliant with the current standards.
Proper record-keeping carried out throughout the year by the administrator is essential in ensuring that the calculation of the Net Asset Value (NAV) during the audit process is accurate and efficient. It is important that the accounting system of the administrator can handle the specific characteristics of trading in digital assets. A table of accounts and trial balance should be flexible enough to cover accounting for several components, for example, derivative margins, staking, rewards, airdrops, and liquidity pools. A “traditional” financial trial balance might not have the flexibility to cover these, and the administrator might post everything in one account, making it difficult to retrieve and separate data from previous months at the audit stage, thus slowing the audit process.
Furthermore, the administrator should record and appropriately save all trading data and reconciliations on its servers, especially because some crypto exchanges do not allow you to go back in time to retrieve data via API. Thus, record-keeping and accounting should be easily retrievable and done with the auditor’s requests in mind.
There is a special consideration for funds trading in non-vested and/or pre-ICO tokens to bear in mind as well. In most cases, funds would have entered into a Simple Agreement for Future Tokens (SAFT). It is important that the administrator has a record of the SAFT and be fully aware of its contents from an accounting point–of-view. This will ensure proper accounting and record-keeping in the fund’s trial balance.
Technology plays a key role in fund accounting for digital assets. Independently retrieving or pulling data for digital asset funds will in most cases involve advanced technology, which will enable the administrator to calculate the NAV smoothly and in a timely manner. This role is even more enhanced for quantitative and high-frequency trading funds. Unless the administrator has the appropriate technology, which will provide them with full information on the fund’s trading, holdings, and pricing, issues will arise during the critical NAV calculation and eventually during the audit process itself.
The administrator you work with should have invested in technology that will ultimately ensure a smooth NAV calculation and audit process. Likewise, auditors should be independently able to pull data to audit the information provided to them by the administrator and/or the fund. This will enable the parties to rely on their own data rather than relying on, and waiting for data coming from third parties, with the possibility of slowing down the audit process.
Once the audit process is closed, all parties should meet to review the audit process and discuss what went well and what can be improved for the next audit process. This will give ample time to all the parties concerned to take that feedback and address it accordingly.
The above best practices will not only help the audit process itself but will also help build the relationship between all parties involved, ultimately making a possibly painful process much smoother and putting the team in a position where every party is prepared and aware of its role and responsibility in advance.