War Story Quiz: When Practices Merge, What Gets Lost in the Shuffle?

By:
Duncan B. Will, CPA/ABV/CFF, CFE
Published Date:
Jun 12, 2015

Teamwork

Editor’s Note: “War Stories” are drawn from the claims files of Camico, a CPA-directed insurer and risk management program for accountants, and illustrate some of the dangers in the accounting profession. All names have been changed.

Granger, Edwards, McDonald & Solo (GEMS) had audited the Benjamin County Sanitation Agency (BCSA) for 10 years. When the firm purchased the solo practice of a local CPA, Charles “Skip” Towne, it assigned him to the BCSA account, since the other partners had never taken much interest in it. The BCSA was perceived as a “no growth” client, and the static nature of the agency’s activities resulted in unchallenging audits that didn’t require 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 fieldwork and had nearly all of the firm’s contact with the agency.  

The year Skip was assigned the account, the BCSA staff shrank to just one person. Skip warned the BCSA’s board about the inadequacy of the organization’s internal controls and how those weaknesses would severely hinder the BCSA’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 gave mild warnings about internal controls and indicated that he had frequently experienced difficulty in obtaining timely documentation.  

Similar issues were present during Skip’s second year auditing the 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. The embezzled amounts were less than $30,000 annually. Though this may seem minor when compared to the overall budget, the theft added up to about $270,000 over a decade. 

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 that they were the fraudster’s personal expenditures. After quantifying the amount of the loss, the BCSA demanded $540,000, which included 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 its concerns about inadequate segregation of duties and had even met with a board member to discuss them. Unfortunately, the board member didn’t recall the discussions, and the firm had no documentation of them. Board members testified that they assumed the lack of adequate segregation of duties described in the management letters from earlier years had been resolved, since the comments had ceased.

After an independent investigation by the state, and a mediation session, the BCSA reduced its demand to $300,000. 

 

Which of the following describes the one best practice that would have been the most helpful in minimizing the likelihood of a claim?

A. GEMS should have continued to address the lack of segregation of duties in management letters, even though the BCSA board repeatedly ignored the problem. 

B. GEMS should have disengaged from the BCSA because the client repeatedly ignored the firm’s management letter advice. 

C. GEMS should have memorialized the discussions with the board member detailing the internal control concerns regarding the lack of adequate segregation of duties.

D. GEMS should have integrated the solo practitioner into the firm. 

 

Answers

A. Valid, but not the best response. AU-C Section 265, “Communicating Internal Control Related Matters Identified in an Audit,” of the AICPA’s Clarified Statements on Auditing Standards requires CPAs to communicate significant deficiencies and material weaknesses if remedial action hasn’t been taken to address the issues.

B. Valid, but not the best response. When a client does not provide the information you need, carefully consider the reason why. Is it because of sloppy recordkeeping, or is the client deliberately withholding something? If it looks deliberate, be cautious—especially if you’re urged by the client to proceed with work without appropriate documentation. This type of client behavior is a red flag, and repeated delays could be the result of unethical or illegal activity. 

C. Valid, but not the best response.
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.

D. Correct. Before considering a merger or acquisition, firms should assess each other’s clients and staff to determine whether the two are culturally a good fit. If the firms’ owners, team members or culture diverge dramatically, personnel may not be the only ones who feel lost—clients may also be uncomfortable with the new relationship. And 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 into assimilating the new personnel into the acquiring firm. Also, more senior personnel benefit from 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.

The firm had to settle this case—it had made multiple mistakes and was actually fortunate that the client’s staff member hadn’t stolen even more. The firm hadn’t integrated the new partner into the firm and should have disengaged from a client that repeatedly ignored the advice to strengthen its internal controls—advice the client could easily afford to implement. The firm also didn’t memorialize significant client interactions and repeatedly failed to communicate the lack of adequate segregation of duties. 

Duncan B. Will, CPA/ABV/CFF, CFE, is loss prevention manager/accounting & auditing specialist at Camico

For information on the Camico program, call Camico directly at 800-652-1772, or contact: (Upstate) Reggie DeJean, Lawley Service, Inc., 716-849-8618, and (Downstate) Dan Hudson, Chesapeake Professional
Liability Brokers, Inc., 410-757-1932.  

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