Record Retention Policies for Accounting Firms

By John F. Raspante

As recent events in the accounting world indicate, there are significant ethical, legal and operational reasons for accounting firms to establish a record retention policy and to apply that policy consistently. Firms need to retain records to provide certain levels of service to their clients, to comply with regulatory and professional requirements, and to operate efficiently. Camico has long advocated that CPA firms retain records for a period of five to seven years as a rule of thumb, based on a variety of considerations.

One major consideration is the need to properly and adequately document work and to retain that documentation. The main question to ask in this process is: “What is best for the clients?” Accounting firms retain documents as part of an ongoing effort to provide high levels of service to clients. Accordingly, documents need to be well organized, secure and accessible. They should also reflect competent work and well-informed due care by a firm performing services in accordance with the professional standards of conduct.

When a client leaves a firm, the firm’s records become the only physical evidence the firm has for supporting the reports, opinions and other services provided. In the event of litigation, work papers provide evidence that the engagement was conducted in compliance with professional standards. By the same token, work papers can also be used by potential claimants in attempts to prove that a CPA acted in some inappropriate manner, or that the engagement was not in compliance with standards.

Document Destruction

Some firms have chosen to destroy documents after one or two years in the hopes of reducing the chances of litigation and costly claims. “Such adjustments may not be the most prudent course of action,” said Dan Goldwasser, Esq., a partner with Vedder Price Kaufman & Kammholz in New York. “Most courts will allow a jury to infer from a firm’s destruction of work papers that those papers would have demonstrated malfeasance.”

Further, without records or documentation, a jury may be presented with a “he said, she said” scenario between the client and the CPA. The benefit of the doubt in such cases generally goes to the client and against the CPA. Jury studies have shown that jurors perceive CPAs to be experts in documentation, causing CPAs to be held to a higher standard than their clients. Therefore, in general, it is easier to defend a claim when there is appropriate supporting documentation.

On the other hand, the need to retain documents has to be balanced against the costs of retaining documents for too long after they are likely to be of use to the firm or its clients. The costs of retaining too many documents fall into two main areas.

First, there are costs associated with potential litigation. “Litigation often involves broad and far-reaching document requests, with the result that the more documents that are retained, the greater the burden of such requests and the length, complexity and costs of the litigation,” Goldwasser said. “This is especially true when one considers that defense counsel and engagement personnel must review and discuss these documents, and some firm personnel will be interrogated regarding the full scope of the documents turned over during the course of a litigation.”

Second, there are costs associated with organizing, cataloging, storing and securing client and firm records, including the cost of purchasing and maintaining computer and other equipment needed to retain those records.

Accordingly, a firm’s document retention policy represents a balance between competing legal and operational considerations. The first and most important step is for the firm to establish, in writing, a record retention policy that is best for its clients and that can be applied consistently to all clients in accordance with the provisions of the policy.

Retention Periods

Technology has enabled firms to retain records longer, but it has done little to alter the types of documents a CPA firm should retain or the length of time that those documents should be retained, according to Goldwasser. Thus, document retention periods today largely resemble those utilized in the past. Claims can arise years after work was completed by the CPA (see “The Claims Lag” chart). After three years from the date of the alleged error, about one-third of all claims have yet to be filed.

In addressing the issue of how long to keep records, the following factors need to be considered:

• The level of service your firm seeks to provide clients. Some firms view their retention of client records as a client service. Also, by retaining records, some firms believe they can improve their chances of obtaining future engagements.
  
• Allocating different record retention periods for different scopes of service and different types of clientele; for example, a policy for litigation support services vs. one for estate planning services. This may depend on statutory requirements and what works best for your firm.
  
• Allocating a shorter record retention period for former clients (at least six or seven years for audit services) and a longer one for current clients. Incidentally, the likelihood of having a claim filed against your firm is not affected by the client’s status as a current or former client.
  
• The potential impact of storage costs and space limitations on policy decisions regarding record retention periods selected.
  
• The impact of potential litigation. Again, not keeping records long enough can negatively impact a claims defense, and keeping them for too long can increase litigation costs.

General Guidelines

Typically, Camico recommends that CPA firms retain records for a minimum period of five to seven years. Ensure that the necessary staff is informed of the details of your policy. Some firms include a paragraph regarding their record retention policy in their engagement letters to make sure their clients are also aware of it. Sample letter language follows:

It is our policy to keep work papers related to this engagement for <number> years. Upon the expiration of the <number>-year period and after reasonable notice to <client> that the work papers will be destroyed, <client> agrees that we shall be free to destroy our work papers. Notice shall be deemed to be reasonable if given by U.S. mail postage prepaid to <client’s> last known address whether actually received or not. It is <client’s> responsibility to keep us informed of its current address at all times.

When records are returned to you, it is your responsibility to retain and protect your records for possible future use, including potential examination by any government or regulatory agencies.

Exceptions

Record retention policies should include an exception to destroying documents that are (or are likely to be) the subject of litigation. If your client has been sued with regard to a material misstatement in the financial statements, the work papers related to the client’s engagement should be kept indefinitely. This holds true even if the firm has not been named in the suit. Also, certain documents should be kept beyond the standard retention period (e.g., tax returns, financial statement reports and permanent file materials).

Your record retention policy may also need to address the issue of draft versions of documents, review notes and similar documents. It is often best practice to retain only final versions of documents rather than each and every draft version.
Ultimately, the firm is the best judge of what it should keep, what it should destroy and when, based on the preceding guidance. The firm may also want to check with its state board of accountancy and its state CPA society for their suggested guidelines. When in doubt, consult with your risk advisor or legal counsel.