Setting the Standards for Client Acceptance

“Reprinted with permission from Partner ADVANTAGE Advisory Copyright © Hudson Sawyer Professional Services Marketing, Inc. August Aquila, Editor. Martha H. Sawyer Publisher. Editorial and orders 800-945-6462”

June 2005

“Reprinted with permission from Partner ADVANTAGE Advisory

Copyright © Hudson Sawyer Professional Services Marketing, Inc.

August Aquila, Editor. Martha H. Sawyer Publisher.

Editorial and orders 800-945-6462”

Minimize Liability by Screening Clients

BY JOHN F. RASPANTE, CPA

Experienced professional liability claims specialists can almost lip sync the words they hear when CPA policyholders first contact them to discuss a new lawsuit: “I can’t believe this client is suing me. They were always slow to pay, and I had so much trouble getting the information I needed from them. It was never worth the aggravation. I should have gotten rid of them years ago. Where did I go wrong?”

CPAs err by accepting difficult clients in the first place. Even if a client starts out cooperatively and then becomes difficult over a period of time, it might not be too late to disengage. Clients can become difficult for various reasons. For example:

• They are not happy with the results of an engagement, even though there was nothing wrong with the services performed.

• They believe that the CPA rendered substandard services (especially when they are unhappy with the results).

• They don’t manage their own financial affairs responsibly and will blame

the CPA for their problems.

• They owe so much money to the CPA that they believe asserting malpractice will help them avoid or reduce the amount they owe.

Client screening has long been recommended as the crucial first step in an effective risk management program, and client screening procedures are now standard practice in the profession. AICPA Practice Alert 2003-03,“Acceptance and Continuance of Clients and Engagements,” describes in detail the rationale and elements of such procedures.

CPA firms should evaluate all potential new clients and re-evaluate all current clients at least annually. Their-evaluation of current clients enables firms to consider and monitor any changes that might affect the professional relationship or escalate into crises.

Clients should be screened regardless of the services being considered. The process should be completed before the preparation and signing of the engagement letter (the “pre-engagement” period), but firms can stipulate that the engagement is not binding until client acceptance procedures have been completed.

Three main considerations in the client acceptance process are:

1. Is the engagement a good fit for the firm’s expertise? The old saying, “practice what you preach,” might apply here. If your firm accepts an engagement for which it is not professionally staffed or qualified, it runs the risk of disappointing the client, or a third-party, and exposing itself to litigation and ethics violations. Due care demands that firms: a) are capable of performing the services required by the engagements they accept; and, b) are performing the services often enough to be competent at them. Claims experience shows that firms “dabbling” in services outside of their areas of expertise are not practicing them often enough to become proficient. Services that represent less than 15 percent of a firm’s service concentration produce disproportionately high losses for the firm.

Proficiency in any type of engagement includes the ability to identify risk stress points in the engagement. CPAs are expected to possess a thorough understanding of the client’s business and industry in order to identify those stress points.

Some CPAs make an annual ritual of redefining and understanding the scope of their own practice, going as far as to write out a clear statement of what they can do and what they cannot do. If they have clients who don’t fit into that scope, they disengage and refer the clients elsewhere. Establish a policy for what types of engagements your firm will avoid because of a lack of technical expertise.

2. Is the client the kind of client the firm would like to have? Once you’ve established the type of work you perform best, think about the type of clients you would really like to have. If you’re a new firm, you have the opportunity of selecting the clients you want. If you’ve been practicing for awhile, there’s nothing to stop you from changing your clientele.

CPAs err by accepting difficult clients in the first place.

A variety of factors need to be considered, including: the client’s reputation and integrity, competence and financial literacy, and their commitment to appropriate accounting practices and internal controls. CPAs should communicate with predecessor accountants and third parties to obtain as much information as possible about the client. Are the client’s expectations of CPAs reasonable? Does the client appropriately value CPAs’ services and advice?

Background investigations are recommended for all significant engagements, especially when the client company is considering a public stock offering, seeking to acquire another company, becoming the target of an acquisition effort by another company or anticipating involvement in other significant transactions. Carefully consider all of the parties who will be relying on the firm’s services. Who will be damaged if the business fails? Remember that the unsuccessful result is usually what Are the business and accounting CPA in order to compensate the causes the disappointed party to sue.

There are high-risk clients and high-risk engagements. High-risk engagements tend to come from real estate, construction and financial industries, or any limited partnerships, public offerings, buy/sell transactions, and deals that look too good to be true. Is the engagement risky? If so, are the rewards of the engagement worth the risk?

Some CPAs rank their clients according to how cooperative, knowledgeable, reasonable, difficult, or time-consuming they are. Engagements can be ranked as well by the complexity of the work. Generally, difficult clients with complex work pose the highest risk to the CPA firm.

For some engagements, the CPA firm will need to consider potential or actual conflicts of interest, and whether the firm’s independence and objectivity are impaired in appearance or in fact, especially when considering nonattest services for attest clients. (See information on Interpretation 101-3, “Performance of Nonattest Services,” at www.aicpa.org.)

3. Is the client financially viable? The answer to this question is critical, especially in avoiding fee collection problems and disputes. Much of the information you need can be obtained by:

• Interviewing the client and their key personnel, banker, attorney, predecessor accountants and auditors;

• Running a credit check;

• Examining prior CPA management letters; and

• Examining the past three years of financial statements and tax returns for inconsistencies and other problems.

• Why did the client leave?

• Did the client pay bills on time? Meet deadlines? Keep good records?

• Are the business and accounting records adequate and in order, or disorganized?

• What is the client’s financial track record (e.g., bankruptcies, business failures)?

• What is the client’s level of financial sophistication (especially the accounting staff’s)?

• Is the client of a litigious nature?

The questions the CPA firm should ask the prospective client include:

• Why was our firm selected for this engagement?

• What was the source of the referral?

• Is there a high staff turnover?

• Is a key partner or employee leaving?

Much of the information can be obtained at the client interview and verified later through other interviews. The more information you get, the better you can assess the risk of the engagement or the client. In a CPA partnership or professional corporation, it is a common practice for another partner or committee to review the client-screening details and to pass judgment on the acceptability of the client or engagement.

JURY STANDARDS

“Jury standards” are established by juries who render decisions in trials over CPA services. Such standards tend to be much broader and higher than professional standards, especially since the recent financial reporting scandals have sensitized the public toward CPA responsibilities.

For example, the percentage of the public expecting an accountant to uncover fraud in a review engagement has gone up from about 40 percent to 70 percent since the scandals. Such expectations can have major implications for a CPA facing litigation.

Juries generally expect the CPAto produce a successful result, “to get it right. ”In the event a CPA does not get it right, a disappointed client or third party may find a sympathetic jury willing to punish the CPA in order to compensate the disappointed party for its losses.

Communicating the nature of the services in a way the client will understand, and documenting those communications with the client, are essential risk management practices.

DISENGAGING

It’s a little ironic, but effective disengagements actually begin with the engagement letter, which should include language regarding the CPA’s right to stop work or disengage in the event the client does not meet the responsibilities set forth in the letter. If you encounter a problem during the engagement, an initial warning letter will serve to notify the client that the problem may result in termination. A final warning letter should also be sent before deciding to disengage.

Disengaging while in process can cause potentially negative effects, especially for clients in tax preparation or attestation engagements (when financing or loan covenants are at stake). If the CPA disengages before completion, a successor CPA may be unable to finish the work by a deadline, causing missed opportunities or damage to the client’s business. CPAs should be aware of this exposure and not wait until the last minute to disengage.

By heeding the warning signs that develop from the client-screening process,

CPAs can save a lot of stress, time, energy and money that may have otherwise been spent dealing with litigation and controlling damage to the firm’s reputation.