The CPA firm of Granger, Edwards, McDonald, & Solo (GEMS) had audited Benjamin County Sanitation Agency (BCSA) for 10 years when GEMS purchased local practitioner Charles “Skip” Towne’s solo practice. Skip was assigned BCSA because it was of no interest to the other partners for two reasons: BCSA was perceived as a “no growth” client, and the static nature of BCSA’s activities resulted in unchallenging audits that hadn’t required the attention of the firm’s more seasoned audit personnel.
The other partners had little or no relationship with Skip, the “acquired” partner, so he received minimal help or counsel when servicing his clients. As such, the BCSA audit was all but “invisible” to GEMS management. Skip personally performed most of the field work and had nearly all contact with BCSA.
The year Skip was assigned the account, the BCSA staff shrank to just one person. Skip warned BCSA’s board about the inadequacy of the organization’s internal controls and how those weaknesses would severely hinder the system’s ability to prevent and detect errors and theft.
During his initial audit, Skip sought evidence supporting the staff person’s expenditures, but he wasn’t given the requested documentation and never followed up. After his first year, Skip shared mild warnings about internal controls and indicated that he had frequently experienced difficulty obtaining timely documentation.
Similar issues were present during Skip’s second year auditing BCSA’s financial statements. After the second year’s management letter comments elicited no improvement, Skip again warned a BCSA board member about his concerns during a lengthy conversation.
The BCSA board was rubber-stamping the disbursement checks without considering any supporting documentation. This made it easy and safe for the staff person to pay personal expenses with a BCSA credit card without fear of being caught. This routine continued for 10 years.
The BCSA’s annual budget was approximately $10 million, with most of the funds received from the federal government earmarked for local agencies. The embezzled amounts were less than $30,000 annually, minor amounts compared to the BCSA budget, but about $270,000 over 10 years.
The embezzlements were discovered when the BCSA staff person was vacationing and a board member with accounting experience volunteered to fill the void. The board member noted expenditures unrelated to the organization’s purpose and determined they were the fraudster’s personal expenditures. After quantifying the amount of the loss, the BCSA demanded $540,000 (the amount embezzled, the cost of quantifying the loss, and interest on the loss).
GEMS partners were stunned by the allegations. GEMS argued that the firm had repeatedly communicated their concerns regarding inadequate segregation of duties and had even met with a board member to discuss the concerns. Unfortunately, the board member didn’t recall the discussions, and the firm had no documentation of those conversations. Board members testified that they assumed the lack of adequate segregation of duties described in the early years’ management letters had been resolved since the comments ceased.
After an independent investigation by the state, and a mediation session, BCSA reduced its demand to $300,000.
Which of the following responses is representative of the one best practice that would have been most beneficial in minimizing the likelihood of a claim?
- Integrate the solo practitioner into the firm.
- Continue to address the lack of segregation of duties issue in management letters despite the BCSA board repeatedly ignoring the problem.
- Disengage from the BCSA because of the client repeatedly ignoring the firm’s management letter advice.
- Memorialize the discussions with the board member detailing the internal control concerns involving the lack of adequate segregation of duties.
- Implement all of the above.
A. Correct. More information is available on the CAMICO Members-only Site under Knowledge Tree, Risk Management, Mergers and Acquisitions.
Before considering a merger or acquisition, firms should assess the other firm’s clients and personnel to determine if culturally the two are a good fit. If the other firm’s owners or staff culture differs dramatically from their own, it may not be just personnel that are lost – clients may not feel comfortable with the new relationship. Remember, any acquisition is only as good as the clients and personnel retained. To ease the transition for staff and owners, many successful firms invest considerable time and resources to assimilate the new personnel into the acquiring firm. Also, more senior personnel benefit by being assigned mentors to further smooth the transition. The investment pays dividends in both personnel and client satisfaction and retention. Skip wasn’t given this treatment, and GEMS paid the price.
B. Valid but not the best answer. Communicating Internal Control Related Matters Identified in an Audit
AU-C Section 265
requires CPAs to communicate significant deficiencies and material weaknesses if remedial action hasn’t been taken to address issues
C. Valid but not the best answer.
When a client does not provide the information you need, carefully consider the problem. Is the problem sloppy record keeping, or is the client deliberately withholding information? If it looks deliberate, be cautious, especially if you are urged by the client to proceed with work without appropriate documentation. Client behavior such as this is a red flag, and repeated delays could be the result of unethical or illegal activity. (See the article on “Risk Factors and Warning Signs of Fraud” in this issue of IMPACT.)
D. Valid but not the best answer.
CAMICO’s claims experience has shown that jurors expect CPAs to retain comprehensive documentation on all facets of an engagement, including conversations about CPA services, advice and decisions. Memories of critical events fade over time, and the client’s memory may differ significantly from the CPA’s, especially if the client’s expectations aren’t met and the client is disappointed. Jurors will generally take the view that the CPA had a duty to document, and in the absence of documentation, jurors tend to give clients the benefit of the doubt.
E. Valid but not the best answer. Communicating Internal Control Related Matters Identified in an Audit).
The firm had to settle this case, had made multiple mistakes, and was fortunate that the amount stolen by the client’s staff member wasn’t more. The firm hadn’t integrated the new partner into the firm and should have disengaged from a client that repeatedly ignored their advice to strengthen their internal controls – advice the client could easily afford to implement. The firm didn’t memorialize significant client interactions, and repeatedly failed to communicate the lack of adequate segregation of duties (called for by AU-C Section 265
Each of the preceding responses is valid, but we were looking for the one best practice. “All of the above” is more than one practice. If you picked this one … we tricked you!