Independence and Profitability

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By Alex Vuchnich, CPA, CFE - I have had the opportunity to work with a large number of accounting firms of varying sizes, from sole practitioners up to the top ten largest firms in the nation. One thing I have observed across the board is that those firms that implement standardized processes for monitoring independence with respect to their clients tend to be able to charge a higher premium when it comes to their fees. This correlation is also observed in the fact that larger firms tend to have more standardized processes and typically charge the highest rates. Part of the increased independence that these firms maintain is a result of the relative insignificance any one SMB client has to the firm as a whole. Larger firms are more easily able to walk away from a 'problem' client since the revenue impact may be slight.

It is quite common in the SMB environment for smaller firm audits to require significant adjustments to the financial statements in order to properly present them in accordance with GAAP. Although recording adjustments approved by the client's management is a permissible non-attest service under 101-3, there is no question that it results in diminished independence and in diminished profitability for the firm. All firms would benefit greatly if they began to not only recognize this trend but to also start taking steps to move toward a more independent stance from their clients.

One solution is to systematically begin to identify those attest clients where a significant portion of the time budget on a job is spent providing non-attest services allowed under 101-3. The firm can begin to transition services to these clients from attest engagements to solely non-attest work. This provides the firm a way to continue a relationship with the client and to continue generating a revenue stream. The attest work will need to be referred to another firm. It is likely that overall fees for both your firms services and the new firm will be higher than the original fees under the single firm model so it is necessary to properly manage the transition and present the overall benefit to the client. The primary benefit will be that you will be able to provide a higher level of advisory service to the client (and you must provide concrete examples) and at the same time reduce the overall disruption and discomfort associated with the annual audit. Just like with larger firms that may have the luxury of walking away from SMB clients, all firms that can maintain a higher degree of independence will likely be able to maintain higher profit margins on their engagements (attest and non-attest alike).


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