What an Auditor Actually Asks For in a First-Year Fund Audit

A first-year fund audit is rarely difficult because the accounting is hard. It's difficult because the fund is being asked, for the first time, to produce evidence for decisions it made months earlier — often decisions nobody wrote down at the time. The audit itself takes a few weeks. Reconstructing a year of undocumented judgment takes considerably longer.

What follows is the substance of a typical prepared-by-client request list for a first-year fund, and more usefully, what the auditor is actually trying to establish with each item. Understanding the second part is what lets you prepare for the audit rather than react to it.

The governing documents come first

The auditor will ask for the limited partnership agreement or operating agreement, the private placement memorandum, subscription documents, side letters, and any amendments. This is not administrative box-checking. Those documents are the authoritative source for how management fees are calculated, how the waterfall works, what expenses the fund is permitted to bear, and how income and gains are allocated among partners. The auditor reads them so they can test whether what the fund did matches what the fund agreed to do.

Side letters matter more than first-time managers expect. A single most-favored-nation clause or fee rebate to an anchor investor changes allocation mechanics for everyone else. If side letters aren't disclosed at the start, the allocation testing gets redone.

The financial statement package under ASC 946

Investment companies reporting under ASC 946 present a specific set of statements, and the auditor will expect all of them: the statement of assets and liabilities, the statement of operations, the statement of changes in net assets, the statement of cash flows where required, the schedule of investments, and the financial highlights. The schedule of investments and the financial highlights are the two that most commonly arrive incomplete, because they require disclosure detail — investment-by-investment fair value and percentage of net assets, expense and net investment income ratios, total return — that a general ledger doesn't produce on its own.

Existence and ownership of the investments

The auditor needs independent evidence that the fund owns what it says it owns. For positions held at a custodian, broker, or administrator, that generally means external confirmations sent directly to the third party rather than a screenshot supplied by management. For private positions, it means the executed purchase agreements, closing documents, share certificates or equivalent, and the capitalization table showing the fund's holding.

Digital assets are their own category. The auditor will want to reconcile on-chain balances to the fund's records, and will look for evidence of control over the wallets — which in practice means addresses, a demonstration of signing capability or a custodian's independent statement, and documentation of the custody arrangement itself. Self-custody is auditable, but it demands far more documentation than a qualified-custodian arrangement, and that gap is worth understanding before year-end rather than during fieldwork.

Valuation support, and why this is the hard part

For anything not trading in an active market, the auditor tests fair value under ASC 820: the inputs used, the classification within the hierarchy, and whether the methodology was applied consistently. For Level 3 positions the expectation is a valuation memo per position that documents the approach taken, the inputs and their sources, why the method suits the asset, and how the conclusion was reached.

The recurring problem in a first-year audit is that these memos are written in arrears. A valuation memo drafted in February for a March year-end mark is a reconstruction, and it will be treated with more skepticism than a memo dated contemporaneously with the valuation decision. The auditor may also request evidence of governance — that someone other than the person who set the mark reviewed and approved it.

Expect questions about calibration as well: if a position was acquired in a financing round and is still carried at that price, the auditor will ask what supports the conclusion that nothing has changed.

Capital activity and the allocation waterfall

The auditor will request the capital account roll-forward for each investor, tied to the trial balance and to the capital activity for the period: contributions, distributions, transfers, income and expense allocations, and any incentive allocation or carried interest. The test is arithmetic and legal at once — do the individual capital accounts sum to total partners' capital, and does each investor's allocation reflect the terms in the agreement, including any hurdle, catch-up, or loss carryforward.

Management fee and incentive allocation calculations are recomputed independently by the auditor. Where the calculation is done in a spreadsheet outside the accounting system, expect that spreadsheet to be requested in native form, formulas intact.

Expenses, offsets, and related parties

Expect a schedule of fund expenses with support, and specific attention to which costs sat with the fund versus the management company. Organizational and offering costs are treated differently from each other and from ongoing operating expenses, and getting that boundary wrong is one of the more common first-year restatement triggers. Any expense cap, waiver, or fee offset needs the underlying arrangement and the calculation.

Related-party transactions get separate treatment: transactions with the GP or affiliates, cross-fund transactions, GP commitments, and any co-investment arrangements. The auditor also needs a completeness representation — that they've been told about all of them.

The closing items

Toward the end you'll be asked for the management representation letter, a subsequent-events review through the report date, confirmation of legal and regulatory matters, and — for a first-year engagement — comfort around opening balances, since there's no prior audited period to rely on. Where the fund's first period includes activity before the auditor was engaged, that opening-balance work can be more involved than the current-period testing.

The three things that actually cause delays

• Valuation memos written after the fact — the mark may well be right, but reconstructed support invites additional procedures and, sometimes, a different conclusion.
• Capital accounts that don't tie to the trial balance — usually a side letter, a mid-period transfer, or an equalization adjustment that was never posted. Found in fieldwork, it stalls everything downstream.
• Expenses sitting in the wrong entity — costs paid personally or by the management company and never pushed down, or organizational costs commingled with offering costs.

What to do sixty days before year-end

Nearly all of the pain in a first audit is avoidable, and the window to avoid it closes at year-end. Sixty days out, the productive work is: reconcile every position to an independent third-party record; draft valuation memos for Level 3 positions now, at current information, and have someone independent review them; roll forward capital accounts and prove they tie to the trial balance; confirm every side letter is reflected in the allocation model; and settle which entity bears which expenses. Then assemble the schedule of investments and financial highlights in their disclosure form, because that's where the gaps become visible.

The goal isn't to do the auditor's work. It's to make sure every judgment the fund made during the year has contemporaneous support attached to it, so the audit tests documentation rather than memory.

The bottom line

Auditors aren't looking for perfection in a first-year fund. They're looking for evidence that the fund's numbers rest on something more durable than the manager's recollection. Funds that treat documentation as a monthly discipline rather than an annual scramble get through their first audit in weeks. Funds that don't spend the first quarter of the following year rebuilding a year of decisions — usually while trying to send LPs their statements.

Preparing for a first audit and unsure whether your documentation will hold up? Get in touch — I'll tell you honestly where the gaps are.

Related: how the fair value hierarchy works and ASC 946 reporting basics for emerging managers.