How long will it take to fix bad books of a 7-year-old SaaS company?

Entrepreneurs love to do everything themselves when they start their business. Most entrepreneurs hire professionals once they grow beyond a certain size. Then there are those who continue doing things themselves. Even as business changes, they do not change their practices for one reason or another. What happens when a 7-year-old company wants to hire a bookkeeper and a CPA for the first time? How long will it take? How much should they expect to pay? Let's ask ChatGPT.

Here is my first question to ChatGPT:

I am a CPA. I recently received accounting books from a customer who has run a SaaS business for 7 years but never had
any professional bookkeepers. What details should I be looking for to find out how much bookkeeping work I must have to
do and whether I will need to amend past tax returns?

To that, ChatGPT responded with a really long and comprehensive response. I admit the question was very generic and the response was too. I probably should have started with the last question first and then provided specific issues to improve the estimates.

As a CPA, when you review the accounting books of a SaaS business that has been operating for seven years without professional bookkeeping, it’s crucial to take a systematic approach. The goal is to assess the quality of the existing records, identify potential gaps, and determine the level of effort required to bring the books up to date and ensure tax compliance. Here's a detailed breakdown of what to look for:

1. Review of Financial Statements

• Balance Sheet: Ensure all assets, liabilities, and equity are recorded correctly. Pay special attention to:
• Accounts Receivable: Check for uncollected amounts, aging reports, and the process for revenue recognition (important in SaaS).
• Accounts Payable: Ensure all expenses and vendor obligations are accounted for.
• Bank Reconciliations: Verify if bank statements have been reconciled regularly.
• Income Statement (Profit and Loss): Check if the revenue is recognized in line with the SaaS model (e.g., recurring subscription revenue). Look for:
• Revenue Recognition: SaaS revenue is typically recognized over time as services are rendered. Ensure that the books reflect this.
• Operating Expenses: Verify that expenses such as software development, hosting, customer support, marketing, etc., are accurately categorized and recorded.
• Cost of Goods Sold (COGS): SaaS businesses may have specific costs related to hosting or software development that need to be accurately tracked.
• Cash Flow Statement: Determine if the business is generating sufficient cash flow to support operations and investments.

2. Revenue Recognition

Since SaaS businesses often involve subscription-based models, revenue recognition can be tricky. You should:

• Check whether the revenue is recorded when earned, not when received (especially for prepaid subscriptions). SaaS companies often have monthly, quarterly, or annual contracts, so ensuring proper allocation over the service period is key.
• Identify if revenue is properly deferred and recognized according to ASC 606 or the IFRS 15 standard, which may affect how and when revenue is reported.
• Verify if customer deposits or advances have been accounted for correctly.

3. Customer Contracts and Subscription Terms

• Review the contracts with customers to confirm terms (monthly, annual, multi-year), payment frequency, and cancellation clauses.
• Ensure the books reflect the correct subscription lengths and any potential adjustments for discounts, refunds, or renewals.
• Assess whether deferred revenue and accounts receivable are recorded accurately for outstanding invoices or unearned income.

4. Tax Compliance and Deductions

• Sales Tax: Check if the company is registered for sales tax and collecting tax where applicable. SaaS businesses may have varying sales tax obligations depending on the jurisdiction (state, country, or other factors).
• Expense Deductions: Ensure that operating expenses are categorized properly for tax purposes. This includes technology, software subscriptions, cloud hosting services, employee wages, and contractor fees.
• Depreciation of Assets: Verify that capitalized assets (e.g., software development costs, servers) are being depreciated in accordance with tax rules (e.g., under Section 179, if applicable).
• Employee/Contractor Classification: Confirm that employees vs. contractors are properly classified and paid in accordance with tax laws. Misclassification could lead to significant penalties.

5. Audit for Errors, Omissions, and Gaps

• Consistency in Accounting Method: Check if the business has been consistently using an appropriate accounting method (cash vs. accrual) over the years. If there's been a switch, it might require restating prior financials.
• Missing or Unreconciled Transactions: Look for unrecorded income, unaccounted expenses, or transactions that have not been reconciled with external documents (bank statements, credit card statements, etc.).
• Unpaid Taxes or Liabilities: Look for outstanding tax obligations or penalties that might have accumulated over the years due to incorrect or incomplete reporting.

6. Payroll and Benefits

• Employee Wages and Payroll Taxes: Verify that payroll has been processed correctly, with all appropriate payroll taxes being withheld and remitted. Review any equity compensation (stock options, RSUs) if applicable.
• 401(k), Health Insurance, and Other Benefits: Check whether benefits and deductions are being correctly handled.

7. General Ledger (GL) and Chart of Accounts

• Chart of Accounts (COA): Ensure the COA is properly structured for the SaaS business and reflects industry-specific categories. Misclassified accounts could distort financial reporting.
• Journal Entries: Review any journal entries for unusual or large amounts that could indicate errors or intentional manipulation.

8. Check for Prior-Year Adjustments or Amended Returns

• Tax Filings: If tax filings were done internally, assess whether the correct tax treatment was applied to deferred revenue, R&D tax credits, or other unique SaaS-related deductions.
• Prior-Year Tax Returns: You may need to amend prior-year tax returns if discrepancies are identified, especially with revenue recognition or expense misclassifications. Check for issues such as:
• Missed deductions.
• Incorrect application of revenue recognition.
• Unreported income or liabilities.
• Accounting Restatements: If there are significant errors in past accounting, you may need to restate financial statements and potentially amend prior tax returns.

9. Systems and Tools Review

• Accounting Software: Check the software or system being used to track transactions (QuickBooks, Xero, custom solutions, etc.). Ensure it’s capable of handling SaaS-specific needs, such as recurring billing and revenue recognition.
• Automation and Integration: Verify if any automation (invoices, payments, financial reports) is in place. This is especially important in SaaS, where transactions can happen frequently.

10. Internal Controls and Documentation

• Documentation of Transactions: Ensure that there’s adequate supporting documentation for all transactions, particularly for large expenses, revenue recognition, and significant contracts.
• Internal Controls: Review whether there are any internal controls in place to ensure accuracy, consistency, and prevention of errors.

Conclusion

After reviewing these areas, you will be able to assess the level of work needed. In many cases, you may have to:

• Restate prior financials.
• Correct misclassifications or errors in revenue recognition.
• Amended tax returns may be necessary if past filings were based on incorrect or incomplete financials.
• Reconcile records with bank statements, credit card accounts, and other third-party documents.

Depending on the state of the accounting books, you may also need to establish better ongoing accounting practices for your client to prevent future issues.

I knew that this customer used Quickbooks and Intuit Payroll. They were a small(ish) company using Accrual method. Hence, I was not too concerned about the payroll, systems and controls issues. I decided to dive into cost of goods and revenue recognition.

I asked.

Can you dig deeper into cost of goods sold? This client has mixed cost of servicing clients with cost of marketing. What
are the key questions to ask to determine how to separate these costs? Please list the questions briefly in less than
250 words.

To which ChatGPT responded.

To properly separate Cost of Goods Sold (COGS) from marketing expenses in a SaaS business, you need to ask the following key questions:

1. What direct costs are associated with delivering the SaaS product or service?

• Ask for a breakdown of costs related to infrastructure, servers, software development, and customer support. These should be considered COGS.

2. Are there any direct personnel costs involved in servicing customers?

• Inquire about employee salaries or contractor fees directly involved in customer support, onboarding, or technical service. These costs should be included in COGS.

3. How do you define marketing and sales expenses?

• Clarify if costs related to advertising, content creation, and campaigns should be categorized as marketing. These should not be included in COGS.

4. Do you have specific costs for acquiring customers (e.g., sales commissions)?

• Sales commissions tied directly to customer acquisition might be categorized as part of COGS if they are directly linked to onboarding customers.

5. Are there costs related to maintaining existing customers (e.g., renewals or retention programs)?

• Costs related to customer retention or renewals (e.g., customer success team, email marketing) might be split, with some classified as COGS and others as sales/marketing.

6. Do any costs overlap or require more detailed tracking?

• Review any ambiguous costs that may be incorrectly categorized and suggest better tracking mechanisms moving forward.

These questions help distinguish direct service delivery costs (COGS) from indirect customer acquisition and retention costs (marketing).

Then, I asked about revenue recognition.

Great! Now, can you dig deeper into revenue recognition? Most of their sales are an year long subscription. Sometimes,
they offer promotions at the beginning to get new customers or in the middle of the year to retain them. What are the
key questions to ask here? Answer within 250 words?

To which ChatGPT responded.

To properly assess revenue recognition for a SaaS business with annual subscriptions and promotions, ask the following key questions:

1. How are you recognizing revenue from annual subscriptions?

• Verify if revenue is being recognized over the subscription period (i.e., monthly, quarterly) rather than at the point of sale. This aligns with ASC 606 or IFRS 15 principles for SaaS businesses.

2. Are there any discounts or promotional offers tied to subscription terms?

• Ask how promotional discounts or offers (e.g., 20% off the first year) are handled. Discounts should be prorated over the subscription period and should not be fully recognized upfront.

3. Do you track deferred revenue?

• Confirm if deferred revenue is used for upfront payments, as it must be recognized over time as services are delivered, not all at once when the payment is received.

4. How are mid-year promotions or renewal incentives recorded?

• Determine if promotions given to existing customers (e.g., discounts for renewal) are being handled correctly. If a discount is applied partway through the year, it may require adjustment to the revenue recognition process.

5. Are there any performance obligations associated with promotions?

• For promotional offers, ensure the revenue recognition is tied to the satisfaction of performance obligations (e.g., ongoing access to the software). If the offer is conditional, it should only be recognized once conditions are met.

6. How do you handle churn or cancellations?

• Understand the process for handling refunds, cancellations, or customer churn. Make sure adjustments to recognized revenue are properly accounted for when customers cancel or downgrade.

These questions help ensure revenue is recognized in compliance with accounting standards and accurately reflects the timing of service delivery.

Then, I asked how long will it take an average skilled bookkeeper to analyze books.

How long in hours do you think a bookkeeper of average skills take to analyze the last 7 years of this company's books?

To which, again ChatGPT responded in an itemized list with a range of estimates.

The time it would take a bookkeeper with average skills to analyze the last 7 years of a SaaS company's books depends on several factors, such as the complexity of the records, the quality of the existing data, and the level of detail required. However, a rough estimate for a thorough analysis could be broken down as follows:

Key Steps in the Analysis:

1. Initial Review of the Books (10-15 hours)

• Checking the overall structure of the financial records, ensuring accounts are properly classified, and identifying any glaring errors or discrepancies.

2. Revenue Recognition Review (15-20 hours)

• Verifying if the SaaS revenue is being recognized properly, especially for long-term contracts, deferred revenue, and promotions.

3. Cost of Goods Sold (COGS) and Expense Review (10-15 hours)

• Assessing if COGS is accurately recorded and distinguishing between direct service costs and marketing or other operational expenses.

4. Bank and Credit Card Reconciliation (15-25 hours)

• Reconciling the company's bank statements and credit card accounts to the general ledger to ensure all transactions are accounted for.

5. Tax Compliance and Adjustments (10-15 hours)

• Reviewing prior tax filings and determining if any adjustments are needed, especially if there were errors in categorizing revenue or expenses.

6. Promotions and Discount Analysis (10-15 hours)

• Evaluating how promotions, discounts, and customer incentives have been recorded and ensuring revenue is recognized correctly for these transactions.

7. General Adjustments and Cleanup (15-25 hours)

• Identifying any errors, misclassifications, or missing information, and making necessary adjustments.

Total Estimate: 75-110 hours

This estimate is based on the assumption that the books are somewhat disorganized or have some level of missing or incorrect data. If the records are in good shape, the time could be at the lower end of this range.

This is looking good even if to broad. The last thing I asked ChatGPT was to tabulate this.

Can you put these 7 work items and the hours in an excel spreadsheet please?

To which, surprisingly, ChatGPT said it could not do excel files, but gave me a table.

I can't create and export Excel files directly, but I can provide the structure in a way that you can easily copy into an Excel file.

Here’s how you can structure it:

Work Item	Estimated Hours
Initial Review of the Books	10 - 15
Revenue Recognition Review	15 - 20
Cost of Goods Sold (COGS) and Expense Review	10 - 15
Bank and Credit Card Reconciliation	15 - 25
Tax Compliance and Adjustments	10 - 15
Promotions and Discount Analysis	10 - 15
General Adjustments and Cleanup	15 - 25
Total Estimated Hours	75 - 110

You can now copy this table directly into an Excel sheet. If you want to further break down or adjust the hours, you can easily modify the data in the spreadsheet as needed.

I think this is a great response from ChatGPT. I realize that the question here was too broad. I should have asked more specific questions to get better answers. Even then, I am impressed at how it understood a CPA and bookkeeper's work and applied that to make an estimate. What do you think? Would you need more or less time than these estimates?