Accepting High Quality Clients...or Not!

The first time I developed a CPA practice years ago, client quality had little affect on my decisions to accept new clients. A local banker sent me new clients regularly and, to keep the stream flowing, I served them all. Because I was young, smart and well-trained (and not the least bit prideful!), I believed I could whip any unethical or dishonest client into shape!

Several of my banker’s referrals proved me wrong. One sued me! I’ll spare you the sad story only to say this client was a liar and built his success at the expense of his employees. At the trial he lied and I paid, well, actually my insurance company paid.
br/>Two other clients referred by my banker friend later went to jail! One for skimming and perpetrating sales tax fraud (I don’t know if the IRS ever found him). The other client I thought I could handle owned a lot of nursing homes; he was eventually convicted of Medicaid fraud (family members on many payrolls). These clients contributed to my revenue growth but I spent more time trying to catch these clients in their illegal acts than I did serving my good clients! And guess the character of other clients these criminals referred to me!

Most CPA firms’ client portfolios represent clients developed over many years. Time, especially hard economic times, affects the behavior of our clients. People change, some for good and some for bad. A participant in one of my CPE seminars said it this way: “Desperate times cause desperate people to do desperate things!” Thorough, annual client acceptance and retention evaluations are crucial to the success of a CPA firm, now more than ever before!

IFRS Are Coming

I recently attended the NASBA CPE Expo 2009. Held in San Antonio, Texas this conference had some outstanding programs given by some of the most knowledgeable speakers in the CPE world. Several of these speakers emphasized that IFRS are coming.

As you are aware, the FASB and the IASB have been working on a joint project designed to converge US GAAP, and international accounting standards. The SEC now permits issurers to file with the SEC using IFRS. The AICPA Council has voted to update Rule 203 of the Code of Professional Conduct to recognize the IASB as an international accounting standards setter, so private companies and not-for-profit organizations have an option to decide if following IFRS makes sense in their situations.

Another indication that IFRS is coming is a call from the AICPA Examination Team for volunteers to develop or review questions on IFRS for the CPA exam.

A perusal of IFRS will show you that in some ways, these standards are not all that different from US GAAP. Of course there are some differences. For instance, there is no such thing as LIFO in IFRS. And while US GAAP has a great many standards (now codified in one section of the FASB Codification™) on revenue recognition, IFRS has only two.

If you are not familiar with the FASB and IASB convergence project or IFRS, there's a couple of websites that will help bring you up to speed on this important subject. The AICPA has www.ifrs.com containing various courses on IFRS as well as news clips on the subject. The International Accounting Standards Board (IASB) website is www.iasb.org. On their website you'll be able to access IFRS.


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Client Acceptance and Retention Evaluations--the Good, Bad and the Ugly

Over the past year or so, the AICPA has alerted CPA firms to the importance of client acceptance and retention evaluation. As a defense for preventing association with less-than reputable clients and potentially erroneous or fraudulent financial statements, these evaluations are an integral part of the financial statement audit process.

One of the first quality standards formulated by the AICPA, these evaluations were treated as a compliance function by many CPA firms. Practice aids were filled out and signed as a matter of routine, only to be initialed and carried forward for many years simply to comply with the quality control standards. Intended to help CPA firms cull their client portfolio to separate out the bad and the ugly, the process resulted in little more than a few extra pieces of paper in working paper files.

One of my business partners decades ago, Don Istvan, was a practice management consultant for hundreds of smaller CPA firms. The starting place for most of his consulting engagements was a required evaluation of a CPA firm’s clients. After completing a questionnaire evaluating client quality, CPA firm partners and managers assigned points to favorable attributes of each of their clients. The point awards were placed on a spreadsheet in descending order to help identify the bad and the ugly. One of Don’s first recommendations was to terminate 10% of the clients ranking the lowest. His second recommendation was usually to complete a similar evaluation for prospective clients and to accept only those with point awards higher than the previous year’s terminations. The results of this process over the years produced client portfolios of the highest quality for Don’s clients.

AICPA quality control standards were intended to accomplish the same end. In our current unstable economic environment, the client acceptance and retention evaluation is still the key to producing a high-quality client portfolio. It may also be the key to our survival!

What do you think about these required evaluations? Are they serving their purpose in your CPA firm or do they simply add more paper to engagements? Please post your comments.

ASB Issues Three Exposure Drafts

The AICPA Auditing Standards Board has issued three new proposed statements on auditing standards:

• Related Parties (Redrafted)
• Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures (Redrafted)
• Audits of Group Financial Statements (Including the Work of Component Auditors)
  Proposed Statement on Auditing Standards, Related Parties (Redrafted)

Proposed Statement on Auditing Standards, Related Parties (Redrafted)

The Proposed Statement on Auditing Standards, Related Parties (Redrafted) is one of the SASs being redrafted under the ASB’s Clarity Project. It is also part of the ASB’s project converging SASs with International Standards on Auditing (ISAs). It has been drafted using ISA 550, Related Parties, as a base. It would supersede the “Related Parties” section of SAS No. 45, Omnibus Statement on Auditing Standards—1983 (AICPA, Professional Standards, vol. 1, AU sec. 334). It also represents the redrafting of the “Related Parties” section of SAS No. 45.

Issued September 11, 2009, the comment period ends December 15, 2009. It would be effective for would be effective for audits of financial statements for periods beginning on or after December 15, 2010. This effective date is provisional but will not be earlier than December 15, 2010.

Changes From Existing Standards

Since this proposed SAS is a redrafting of an existing SAS you should be aware that there are changes to existing standards. The current AU section 334 is based on the related party requirements in FAS No. 57, Related Party Disclosures, so it’s focus is on auditing the amounts and disclosures pursuant to accounting principles generally accepted in the United States.

The proposed SAS is framework neutral, so the proposed SAS would include financial reporting frameworks, such as U.S. GAAP and International Financial Reporting Standards as promulgated by the International Accounting Standards Board, as well as special purpose frameworks described in the proposed SAS Special Considerations—Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks. The applicability of the objectives, requirements, and definitions in the proposed SAS are irrespective of whether the framework establishes such requirements.

Proposed Statement on Auditing Standards, Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures (Redrafted)

Supersedes SAS No. 57, Auditing Accounting Estimates and Auditing Fair Value Measurements and Disclosures and SAS No. 101, Auditing Fair Value Measurements and Disclosures (AICPA, Professional Standards, vol. 1, AU sec. 342 and 328). It represents the redrafting of SAS Nos. 57 and 101 to apply the Auditing Standards Board’s (ASB’s) clarity drafting conventions and to converge with International Standards on Auditing (ISAs).

Issued September 4, 2009 with a comment period ending November 30, 2009, the proposed SAS would be effective for audits of financial statements for periods beginning on or after December 15, 2010. This effective date is provisional but will not be earlier than December 15, 2010.

Changes From Existing Standards

The proposed SAS does not change or expand SAS No. 57 or SAS No. 101 in any significant respect.

Proposed Statement on Auditing Standards, Audits of Group Financial Statements (Including the Work of Component Auditors)

This proposed SAS has been drafted using ISA 600 as a base. ISA 600 addresses group audits. A group audit is defined as an audit of group financial statements. Group financial statements are financial statements with more than one component, which is defined as an entity or business activity for which management prepares financial information that should be included in the group financial statements.

There is a difference in the proposed SAS and ISA 600. ISA 600 does not permit the auditor’s report on the group financial statements to make reference to another independent auditor (referred to as a component auditor), unless required by law or regulation to include such reference. The proposed SAS, consistent with the current AU section 543, permits the auditor’s report to make reference to a component auditor.

Issued September 4, 2009 with a comment period ending December 15, 2009 the proposed SAS would be effective for audits of financial statements for periods beginning on or after December 15, 2010. This effective date is provisional but will not be earlier than December 15, 2010.

Comparison of AU Section 543 and the Proposed SAS

The proposed SAS is broader than AU section 543. The proposed SAS lists the procedures necessary for the group engagement team to perform in order to be involved with component auditors to the extent necessary for an effective audit and, compared with extant AU section 543, better explains the degree of involvement required when reference is made to component auditors in the auditor’s report.

The requirements of the proposed SAS concern:

• Acceptance and continuance considerations
• The group engagement team’s process to assess risk
• The determination of materiality to be used to audit the group financial statements
• The determination of materiality to be used to audit components
• The selection of components and account balances for audit testing
• Communications between the group engagement team and component auditors
• Assessing the adequacy and appropriateness of audit evidence by the group engagement team in forming an opinion on the financial statements.

In situations when the group engagement partner does not make reference to a component auditor in the audit report on the group financial statements, all of the requirements of the proposed SAS apply, when relevant in the context of the specific group audit engagement.

The exposure drafts may be downloaded at http://www.aicpa.org/.

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FIN 48 Changed

Disclosure Requirements for Private Companies Under FIN 48 Dropped by FASB

On September 2, 2009, the FASB issued an Accounting Standards Update (ASU) 2009-06. As you recall, since July 1, 2009, the FASB Accounting Standards Codification™ (ASC) has been the source of authoritative U.S. GAAP. This latest ASU provides implementation guidance on accounting for uncertainty in income taxes. It also eliminates the disclosure required in ASC, Paragraphs 740-10-50-15(a) through (b) for nonpublic entities, including pass-through and not-for-profit entities.

The guidance in this ASU involves requirements in what was previously known as FASB Interpretation no. 48 (FIN 48). FIN 48 was first effective for fiscal years beginning after Dec. 15, 2006.

The Private Company Financial Reporting Committee (PCFRC) and others had recommended that FASB defer FIN 48’s effective date for nonpublic entities until annual financial statements for periods beginning after Dec. 15, 2008. Another PCFRC recommendation was that FASB exempt private companies from FIN 48.

What the FASB did was to decline to exempt private companies and not-for-profit entities from FIN 48 in its entirety, but they did decide to modify the disclosure requirements for nonpublic entities and provide further guidance for pass-through and not-for-profit entities.

The implementation guidance applies to financial statements of nongovernmental entities presented in conformity with U.S. GAAP. The disclosure amendments apply only to nonpublic entities as defined in Section 740-10-20.

The Amendments are effective for financial statements issued for interim and annual periods ending after September 15, 2009 for entities that are currently applying the standards for accounting for uncertainties in income tax. For those who deferred the application of standards for accounting for uncertainties in income tax, the guidance and disclosure amendments are effective upon adoption of those standards.

The Update contains a number of examples that you may find useful in applying the standards, including:

• definition of a tax position,
• attribution of income taxes to the entity or its owners,
• financial statements of a group of related entities, and
• transition related to ASU 2009-06.

ASU 2009-06 may be assessed on the FASB Website, http://www.fasb.org/.
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Safeguards to Prevent Ethics Rules Violations

The Conceptual Framework for AICPA Independence Standards and Guide for Complying with Rules 102-505 identify seven threats to ethics rules violations. These pronouncements also discuss professional, client and CPA firm safeguards to eliminate or mitigate the threats. The quality control safeguard may be the most important for smaller CPA firms.

For smaller CPA firms, especially sole practitioners, meeting quality control standards for attest engagements is increasingly difficult. Staying abreast of new professional standards and providing for thorough internal reviews of engagement performance, for example, are essential ingredients for audit quality and among the most costly for smaller firms.

Increasing the focus on quality control, the AICPA issued SQCS No. 7 which became effective January 1, 2009. This quality control standard incorporated the requirements of previous standards and, among other things, requires documentation of compliance in firm administrative or engagement files. Fortunately, the AICPA has created a practice aid, Establishing and Maintaining a System of Quality Control for a CPA Firm's Accounting and Auditing Practice, which provides a framework for quality control documents for smaller firms. Creating a quality control document, and complying with its provisions, could be a primary safeguard against threats to ethics rules violations.

Please post your comments about what your CPA firm has done to comply with the new quality control standards. Do your think these standards are essential for audit quality? Do you think the standards eliminate or mitigate the threats to ethics rules violations?

FASB'S ACCOUNTING STANDARDS UPDATES

As you know, the FASB Accounting Standards Codification™ has been the source of authoritative U.S. GAAP since July 1, 2009. As a result of this change we now have a new acronym, ASU. An ASU is an Accounting Standards Update. This is how changes to the FASB Codification are now made. Note that ASUs are not authoritative. Instead they are transient documents that summarize the key provisions of the project that led to the ASU, details the specific amendments to the FASB Codification, and explain the basis for the Board’s Decision.

ASUs are numbered using the year (2009) and the order in which they are issued (01, 02, etc.). So far this year the FASB has issued six ASUs.

No. 2009–01—Topic 105—Generally Accepted Accounting Principles—amendments based on—Statement of Financial Accounting Standards No. 168—The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles.

No. 2009–02—Omnibus Update—Amendments to Various Topics for Technical Corrections.

No. 2009–03—SEC Update—Amendments to Various Topics Containing SEC Staff Accounting Bulletins. (SEC material is included in the Codification for the convenience of those who are involved with public companies.).

No. 2009–04—Accounting for Redeemable Equity Instruments—Amendment to Section 480-10-S99 (Another amendment to SEC material)

No. 2009–05—Fair Value Measurements and Disclosures (Topic 820)—Measuring Liabilities at Fair Value.

No. 2009–06—Income Taxes (Topic 740)—Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities.

ASUs are available on the FASB website, http://www.fasb.org/.

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More on the Familiarity Threat and Ethics Rules Violations

In the last blog in our series on small audits, I discussed the AICPA’s Conceptual Framework for Independence Standards and Guide for Complying with Rules 102-505. Among seven identified threats to independence and other ethics rules, the familiarity threat may be one of the most important. Here is an example from my personal experience.

Working for an international CPA firm, I supervised a director’s examination of a small bank for the last two of the five years the engagement was performed by the firm. I liked the bank’s three employees and quickly developed a personal relationship with them. Our engagement team found very few deficiencies or circumstances to include in our agreed-upon procedures report. In fact, we were amazed at the quality of employees work. For example, we had no exceptions to notes and deposit confirmations and their loan files were perfect!

Shortly after our last visit, however, a bank director discovered two complete sets of bank records indicating most of the bank’s assets were missing, and had been missing for nearly ten years! A subsequent review of our last examination by firm partners and legal counsel revealed a few findings that may have been clues to the potential fraud. Our team failed to recognize the clues mainly because of our familiarity with the bank’s personnel.

Because of our personal relationships with bank employees, our level of professional skepticism inadvertently decreased. We applauded the bank employees work in maintaining perfect loan files instead of asking ourselves, “How could loan files be perfect?” Excessive familiarity through long client associations can influence our evaluations of observations of engagement circumstances and audit findings. Extra “due professional care” must be employed on audits performed by the same CPA firm personnel over a number of years!