What steps should a smart IT manager take to prepare for an audit?

The only way to be successful in achieving a low-risk state is to build appropriate processes and procedures into your daily business operations. It needs to be part of procurement, part of IT operations, part of document retention and accounting operations.
You have to comply with good business practices, and implement the tools you need to do internal auditing, so you can constantly manage what you have.
If you don’t have in place a program for software management that can provide internal audits with accurate, predictable and consistent results, you need to get one.
ComputerWorld - June 12, 2008

BSA Piracy cases:

BSA settles largest piracy case to date

An example of the pain a license audit can cause.  "During the investigation the organization had its premises raided by the police and its assets frozen."
VUnet - September 18, 2007

BSA settles for 110k

Miller Automotive Group Pays Software Watchdog Nearly $108,000.
Business Software Alliance - April 10, 2008

Acceptable documentation:

Can I See Your Receipt?

The Importance of Serial Numbers

Proof of License

Under pressure from the BSA, companies have no choice but to make license compliance part of their business process.
From CFO Magazine.

Software Audits:

Not if but WHEN

"There are two types of companies: those that have been audited [for software violations] and those that will be."
So says Robert J Scott, managing partner of legal and technology services firm Scott & Scott.
From Computerworld

Beware of the License Police

Forty percent of businesses can expect an audit; less than 25% have a mature asset management process.
From Law Technology News

What Attorneys Are Advising Their Clients

Scott & Scott's software license best practice white paper for clients.  Common Mistakes that Lead to Legal Liability:  "Poor document management."