Auditing Newly Created for MTL License Entities Without Recorded Activities
Auditing entities created for MTL license applications presents unique challenges. This post outlines key considerations for auditors working with crypto payment businesses in the United States.
Crypto payment businesses frequently operate within a regulatory framework governed by U.S. state money transmission laws. These laws require companies to obtain a money transmitter license (MTL) in every state in which they operate. To fulfill this requirement, businesses often establish new legal entities solely to apply for and hold these licenses. In many jurisdictions, financial statements for these newly created entities must be audited as part of the MTL application process.
These entities may initially have just one or two journal entries, creating the illusion that minimal audit work is necessary. However, this perception can be misleading. Auditors must remain diligent and consider several important factors when auditing such entities.
Going concern
A newly formed entity might not be able to continue as a going concern without financial backing from its parent company. Auditors should refer to AU-C Section 570, "The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern." Key considerations include:
The entity's ability to obtain a surety bond from a provider and the associated premiums.
Whether the entity can pay state application and licensing fees, especially in the absence of a bank account.
The level of financial support anticipated from the parent company and the parent's capacity to provide it.
If the auditor concludes that the going concern assumption is not appropriate, and management's plans do not alleviate substantial doubt, this must be disclosed prominently in both the audit opinion and the financial statements. Such disclosure could adversely affect the entity's MTL application.
Net worth requirements
Even when the entity is determined to be a going concern, it may still fail to meet the net worth thresholds required by certain states.
Expenses paid by others on behalf of the entity.
Often, expenses related to these newly created entities are paid by the parent company or an affiliated entity. According to PwC guidance:
“If a principal stockholder settles an obligation on behalf of the entity, it should be reflected as an expense in the company's financial statements with a corresponding credit to contributed (paid-in) capital, unless the stockholder's action is caused by a relationship or obligation completely unrelated to their position as a stockholder or such action does not benefit the company.” [PwC Guide]
To properly account for such transactions, the parent should rebill the expenses to the entity:
DEBIT Expenses
CREDIT Accounts payable to affiliates
Then, ideally, the parent should issue a credit memo indicating that payment is not required, resulting in:
DEBIT Accounts payable to affiliates
CREDIT Additional paid-in capital
In practice, however, we frequently encounter cases where these entries are absent. Parents often do not rebill such expenses, which is a common issue among U.S.-based business groups.
Engagement Scope Recommendations
Given the complexities and risks, we recommend against direct standalone audit engagements for entities created solely for MTL applications. Instead, auditors should engage with the parent company to audit a set of carve-out financial statements for the future MTL-licensed subsidiary.