Important Considerations in Documentation and Record Retention
by Ric Rosario, CPA, CFE
CAMICO Executive Vice President - Risk Management
CAMICO has long advocated that accounting firms establish a written record retention policy that is applied consistently to all engagements. When developing a record retention and destruction policy, the firm should consider the level of service it provides as well as what is best for its clients. For example:
- Should different record retention periods be allocated for different types of clients and different scopes of service? A policy for tax services versus one for audit services may depend on statutory requirements as well as on what works best for the CPA firm and the client.
- Should a shorter record retention period be allocated for former clients (at least seven years for audit services) and a longer one for current clients? Incidentally, the likelihood of having a claim filed against a CPA firm is not affected by whether the claimant is a current or former client. The firm will also want to consider the potential impact of its record retention policy on storage costs and space limitations.
- Don’t forget to factor in the impact of potential litigation. For instance, not keeping records long enough can negatively impact a claim’s defense, and keeping them for too long can increase litigation costs.
Saving Records is Your Best Defense
When a client leaves the firm, the firm’s records become the only physical evidence for supporting the reports, opinions and other services that were provided. In the event of litigation, work papers provide evidence that services were in compliance with professional standards. CAMICO claims experience shows that good documentation is one of the best defenses against a client lawsuit. We recommend retaining records for at least five years for tax engagements and at least seven years for all other engagements, unless longer periods are specified by law.
By the same token, work papers that fall short can be used by potential claimants to attempt to prove that the firm acted in some inappropriate manner, or that the engagement was not in compliance with standards.
High Documentation Standards
Documentation can come back to haunt the firm if it doesn’t meet certain standards. Consider the following documentation guidelines:
- Documentation should be factual and professional. Avoid personal comments about an employee or client’s performance. These may be considered inappropriate and could damage the integrity of the documentation.
- Only maintain the final version of a work product (e.g., tax return, financial statements, letter) and not all of the prior drafts.
- Do not keep review notes in your work papers past the time they have some value. Destroy them when you are finished with them, as they can come back to haunt you.
- Think about the documents in your client files (hard copy or electronic) and ask yourself whether or not you would be harmed if the documentation was presented to the “ladies and gentlemen of the jury.” If your answer is yes or maybe, you may have a problem with the adequacy and appropriateness of your documentation.
It’s Not There? It Wasn’t Done
Some firms have chosen to destroy documents after one or two years, thinking that this would reduce the chances of litigation and costly claims. However, most courts allow a jury to infer from a firm’s destruction of work papers that those papers would have demonstrated malfeasance.
Liability experts continue to see stricter documentation standards for CPAs under regulatory and legal requirements and professional standards, especially in public company audits where the burden of proof has shifted over to the CPA. For instance, if observations, interviews and various ‘other means’ used in an audit are not documented, it will be presumed that the CPA did not do the work that was needed for the audit.
CPAs will need to be more aware of and in tune to the myriad of regulatory, legal and professional requirements and exercise greater professional skepticism, especially when it comes to significant transactions and whether those transactions are reflected accurately in the books.
Record retention policies should include an exception to destroying documents that are, or are likely to be, the subject of litigation or other inquiry. If your client has been sued with regard to a material misstatement in financial statements, the work papers related to your client’s engagement should be kept indefinitely. This holds true even if your firm has not been named in the suit.
CPAs are known for having detailed documentation in their work papers to meet the standards required for audit work. However, for many other services, such as consulting engagements, CPAs often fail to keep detailed records to support their work. As a general rule, any advice or practice area that can result in adverse tax or financial consequences is at high risk. In some instances where client confidentiality is an issue, documentation may be inappropriate and considered unprofessional conduct.
Train your employees to prepare documentation beyond the minimum work paper requirements established by professional standards. Don’t forget, the potential for liability exposures is great when failing to adhere to juror perceptions of CPAs as documentation experts.
Claims experience and jury research show that juries expect CPAs to retain comprehensive documentation on all facets of an engagement, including conversations about CPA services, advice and decisions. Juries will generally take the view that the CPA had a duty to document, and in the absence of documentation they will usually give the benefit of the doubt to the client.
Always document significant communications and follow up. Every client contact can be used against a CPA, so it’s essential that all contacts are documented in a detailed and professional manner. It’s especially important to follow up with written communication in the following circumstances:
- Changes in the scope of an engagement;
- Negative information (e.g., tax return is already late);
- Judgment calls (e.g., former CPA took an aggressive position that the client is aware of and has consented to); and
- Client is to take material action on a discussion.
Make documentation a habit. Top management needs to set an example by initiating all documentation procedures required of staff. All staff members need to learn and use effective documentation skills.
Seek legal counsel if documentation alone is not sufficient. For example, if you advise a client on a complex exchange, you may want to have your legal counsel review the documentation before passing it on to your client. CAMICO encourages CPAs to consider communicating their record retention policy in writing to clients as part of the engagement letter. When in doubt, consult your risk adviser or legal counsel.
Ric Rosario, CPA, CFE, is executive vice president - risk management with CAMICO Mutual Insurance Company (www.camico.com). A Certified Fraud Examiner with experience in public accounting and private industry, he advises CAMICO’s member-owners and other CPAs on loss prevention principles and techniques. His duties at CAMICO also include executive oversight of underwriting, program development, and marketing and communication operations for the company’s 7,332 policyholders.
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