Getting Audit-Ready: Key Accounting Considerations for Technology Firms and Other Growing Businesses

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As your company grows beyond the founder capital stage and has additional capital requirements, you will likely face increased scrutiny from investors and lenders. A first-time financial statement audit will typically become part of the process. To ensure a successful audit, equity (including equity-based awards), revenue and internally developed software must be accounted for properly and the documentation of such technical accounting positions must withstand investor and auditor review.

This article highlights some of the more common accounting considerations for technology companies and other growing businesses that have significant tech components.

409A Valuation and Equity-Based Award Valuation

Audit red flags often arise with issuing equity-based awards (e.g., stock options, restricted stock, warrants) “in the money”, lack of 409A valuation(s), unreconciled equity-based award ledgers and not having valuation(s) of equity-based awards. Here’s how to stay ahead:

• 409A Valuation
  • Make sure you have a current, independent valuation of common stock to ensure that options are granted with strike prices at or below market value (i.e., not “in the money”).
  • Refresh the valuation annually and after material events (e.g., fundraising, acquisitions, major contracts) as they occur.

• Equity-Based Awards
  • Keep a record of board minutes and approvals for equity-based awards at each issuance.
  • Retain ledgers and reconcile to board approvals and against stock plan limits.
  • Obtain proper approvals and amend organization documents for increases in available common stock to issue under equity award plans.

• Accounting under Accounting Standards Codification (ASC) 718
  • Use an appropriate option pricing model (e.g., Black-Scholes) to value stock options.
  • Document all key assumptions, including volatility, expected life and risk-free rate.
  • Remember, a 409A is not a stock option valuation. The 409A supports the value of the underlying stock at the issuance date of the option; the fair value of the option will be calculated using the appropriate option valuation model.
  • Consider utilizing an external service to handle both 409A and option valuations.

Internally Developed Software

Accounting for internally developed software costs are a common source of audit challenges, including issues with improper capitalization and potential impairment. To stay compliant:

• Capitalization Rules (ASC 350-40)
  • Only capitalize costs incurred after the project passes the “technological feasibility” stage.
  • Track time and costs by project phase (research versus development).
  • Maintain detailed time-tracking, invoices and payroll allocations.
  • Remember, costs capitalized must be recoverable.

• Impairment Testing
  • Review software assets annually for impairment triggers, such as if the software that was developed and capitalized is no longer being used or is obsolete.

Revenue Recognition (ASC 606)

Common issues include improper recording of revenue primarily related to bundled hardware and software and deferral of revenue and related costs. To avoid these pitfalls:

• Five-Step Model
  • Follow the five-step model under ASC 606. This includes ensuring identified customer contracts are reviewed for distinct performance obligations, that consideration or the transaction price is allocated to the performance obligations and determining whether revenue recognition for services and/or products should occur over time or at a point in time.

• For Bundled Arrangements
  
  • Determine the performance obligations under the contract.
  • Document standalone selling prices (SSPs) for hardware, software, support and services, as applicable.
  • Ensure contract revenue is allocated to performance obligations using SSPs.
  • Determine if the software or hardware has standalone use or if they can only be used together. This determination will impact the timing of revenue recognition for both software and hardware.

• Long-Term Contracts
  • Determine if long-term contracts have revenues that should be deferred and recognized over the contract term and if there are associated costs to fulfill that should be capitalized and amortized over the contract term.

Equity

Incorrect or inadequate disclosure of equity-related rights and preferences can delay audits and weaken investor trust. To stay ahead:

• Cap Table Integrity
  • Reconcile your equity records (common and preferred stock, options, simple agreements for future equity (SAFEs), convertible notes, etc.) to legal documents and board approval and to your general ledger.
    
    
• Preferred Stock
  • Review key terms of preferred stock for mandatory redemption, conversion features and liquidation preferences to ensure proper accounting, disclosure and balance sheet classification.

Deferred Taxes

Deferred tax assets may be overstated when accumulated net operating losses and other deferred tax attributes aren’t tracked correctly or updated based on current tax law. To help reduce risk:

• Section 382 Analysis
  • If control of the company has changed, it might be necessary to have a Section 382 analysis performed to understand the extent that net operating losses can be carried forward and used to offset future taxable income.
    
    
• Deferred Tax Attributes
  • Ensure that records are retained that capture both book and tax expense items, a common example being deprecation and amortization of depreciable assets. Such differences will need to be captured in your deferred income tax footnote disclosure.

Key Takeaways

• Perform timely 409A and equity award valuations — these are common audit roadblocks.
• Establish clear capitalization policies for software and enforce project tracking.
• Prepare contract reviews and revenue recognition memos.
• Clean up your cap table now, not mid-audit.

By tackling these areas proactively, your company will not only reduce audit risk but also signal readiness for institutional investment.

Contact Us

Our Technology Company Accounting and Consulting team welcomes the opportunity to help you navigate these challenges, minimize audit risk and position your company for institutional investment. Please contact your PKF O’Connor Davies client service team or either of the following:

Michael Ruggiero, CPA
Technology Practice Lead Partner
mruggiero@pkfod.com | 203.705.4127

Jonathan Zuckerman, CPA
Partner
jzuckerman@pkfod.com | 646.699.2842