Professional Liability

Published in: JOURNAL OF ACCOUNTANCY

S P O T L I G H T

July 2013

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A contentious divorce. Clients who want to file delinquent tax returns. The new client who represented himself as an upstanding businessman but has been indicted—for the third time.

After malpractice claims are resolved, CPAs often say, “I never should have taken this client.” But there is a way to help prevent this type of regret.

By establishing sound client acceptance procedures, CPAs often can identify problem clients before they cause trouble. That helps firms of all sizes better manage potential professional liability risks. A disciplined approach to client acceptance also contributes to a firm's sustainable growth and a firm’s long-term profitability.

BASIC STEPS FOR ALL CLIENTS AND ENGAGEMENTS Practitioners should exercise due diligence in accepting all clients and engagements. Basic steps include:

Evaluate prospective client integrity.

• Personally meet with prospective clients (senior management, owners, and/or directors for business clients).

• Ask for and follow up with references, including attorneys, bankers, other business consultants, and major vendors or customers. Verify that relationships were not terminated due to disagreements regarding business operations or outstanding invoices.

• For key executives of business clients (especially those not known by the CPA firm), ask for and follow up with personal references, including previous employers and business associates.

• Consider obtaining a credit history for individual tax and financial planning clients.

• If the prospective client is changing CPA firms, request permission to contact the predecessor firm to investigate issues such as the client’s consideration of advice provided, integrity, ethics, reasonableness of expectations, experience and qualifications of the staff, and business policies and procedures including cooperation, timing of the engagement, and whether the client pays bills on time. The previous CPA firm can provide only limited information unless it obtains an Internal Revenue Code Sec. 7216 disclosure statement from the client. Even so, the prospective client’s reaction to this request (and the response of the predecessor firm) may be indicative of the client’s relationship with professional service providers.

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• Determine how the prospective client found the CPA firm. A referral from a long-term client may require a different degree of professional skepticism than someone who found the firm over the internet.

Perform engagements with professional competence. Before agreeing to propose on or accept an engagement, consider whether the requested service can be competently provided in accordance with applicable professional standards. This includes considering whether:

• The service is within the experience and expertise of the CPA firm;

• The engagement is consistent with the CPA firm’s vision or business plan;

• The service requires specialized skills or industry expertise;

• The CPA firm’s resources, including personnel, are sufficient to meet the needs of the engagement (e.g., timing, report delivery date, etc.); and

• The services requested pose independence or conflict-of-interest issues, such as those covered in the AICPA Code of Professional Conduct (including ET Section 100-1, along with Rules 101, Independence, and 102, Integrity and Objectivity). For instance, fees from a prospective client that would represent a significant percentage of overall firm revenue could be perceived as a threat to independence. Additionally, Interpretation 101-3, Performance of Nonattest Services, is particularly relevant when both attest and nonattest services may be performed.

Consider risks related to the particular engagement. This is a broad and imprecise activity and requires the attention of an experienced member of the CPA firm. It may include the evaluation of factors relevant to a specific engagement and prospective client, such as:

• The company’s financial condition/status;

• The company’s current and future economic and regulatory environment;

• The business acumen of company management;

• Turnover in company management and staff;

• The intended use of the CPA firm’s work product;

• The company’s proclivity to litigate as a means of resolving disputes; and

• Additional criteria that should be developed related to the profitability and realization for the engagement.

Is this client the right fit for your firm? by Deborah K. Rood, CPA

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being litigated against CPAs,” said Alvin Fennell, vice president of underwriting at Aon Affinity, “the CPA firm’s failure to use an engagement letter was a contributing factor in the filing of the lawsuit. Getting into the practice of having an engagement letter signed beforehand is a good way to protect yourself.”

CONTINUING CLIENTS A similar evaluation should be conducted annually with continuing clients. Even a great client should be reevaluated, especially when management or the financial environment changes or when services are requested in connection with a planned or prospective business transaction.

IT'S GOOD BUSINESS Prudent risk management requires that a CPA firm know as much as possible about a prospective client before the engagement is accepted. Forgoing client acceptance procedures can lead to unwanted surprises, including staff frustration and write-offs of billable hours or unpaid fees as well as professional liability concerns. Performing this analysis before the prospective client is accepted allows the CPA firm to weigh the risks and rewards of the engagement.

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HIGHER-RISK ENGAGEMENTS Going beyond the basic steps described above may be warranted based on the results of performing these steps and other relevant factors pertaining to the type of client, service requested, and other identified risks.

For higher-risk engagements, consider:

• Performing a background check on key members of the company’s management. This might include a survey of bankruptcy proceedings, judgments, tax liens, credit records, regulatory and licensing actions, and civil and criminal records; and verification of prior employment history, credentials, and current and past business ownership.

• A review of the entity’s public records, including financial ratings, for an audit or attest engagement;

• Interviews of selected employees performing tax and accounting functions to assess their perception of the company’s control environment and the entity’s recordkeeping practices;

• A detailed review of previous financial statements, including the reasons for any delays in issuance or restatements;

• For prospective clients that are publicly held, have expanded rapidly, or are in rapidly changing or regulated industries, their history of changes in CPA firms. Depending on the results of this investigation, consider contacting more than one predecessor firm for additional information.

• A detailed review of previous tax returns, recent tax return audit results, and other pending tax issues.

FORMALIZE THE PROCESS Firms should develop a new client acceptance checklist to document the decision-making process. The checklist should identify what the firm deems important and provide a written record of representations made by prospective clients and why the firm accepted them.

Larger firms may want to establish a new client acceptance committee that includes senior members of management and the accounting department. The committee meets with the relationship partner to provide a more objective evaluation of prospective clients and has the authority to reject them on behalf of the CPA firm.

Firms also should consider developing an ideal client prototype. The prototype can be compared to the prospective client to determine whether it is a good fit for the firm. While few prospective clients may be “ideal,” deviations from the ideal should be documented and justified before the prospect is accepted. This process is especially important for prospective clients who present increased risks.

Finally, when the decision is made to accept a new engagement, an engagement letter should be drafted and, for high-risk engagements, reviewed by the committee before it is sent to the client. No services should commence until the client has signed the engagement letter. “In three out of every five tax claims currently

Deborah K. Rood (deborah.rood@cna.com) is a risk control consulting director at CNA. Continental Casualty Co., one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available at 800-221-3023 or visit cpai.com. This article provides information, rather than advice or opinion. It is accurate to the best of the author’s knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations. Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured.