Improving Your Audit Process, Part 1: Selecting the Right Clientsby
About three decades ago when I presented my first course on audit efficiency, the key was simply starting with the professional standards and finding the most efficient way for compliance. Essentially this is still true, but there are improvements to be made.
This 10-part series of articles will focus on ways to improve the audit process, reduce audit costs, and enable CPA firms to make some money on audit engagements. This first piece in the series starts with some foundational guidance for selecting the right clients to enhance overall audit engagement and firm profitability.
Starting With the Standards
The AICPA Statement on Quality Control Standard No. 8 (QC-10, which can be obtained free of charge from www.aicpa.org) requires that a firm establish and document policies and procedures for, among other things, the acceptance and continuance of clients and engagements. It reads in paragraph .27:
“The firm should establish policies and procedures for the acceptance and continuance of client relationships and specific engagements, designed to provide the firm with reasonable assurance that it will undertake or continue relationships and engagements only when the firm:
- is competent to perform the engagement and has the capabilities, including time and resources, to do so; (Ref: par. .A11)
- can comply with legal and relevant ethical requirements; and
- has considered the integrity of the client and does not have information that would lead it to conclude that the client lacks integrity. (Ref: par. .A12–.A13)”
Section AU-C 220 of the AICPA Clarified Auditing Standards(which can be downloaded free of charge from www.aicpa.org) states in paragraph .14:
“The engagement partner should be satisfied that appropriate procedures regarding the acceptance and continuance of client relationships and audit engagements have been followed and should determine that conclusions reached in this regard are appropriate. (Ref: par. .A7–.A8)”
Client acceptance and continuance procedures normally include the evaluation of management’s integrity, use of the financial statements and going concern problems.
Making the Client Investigation
To comply with these professional standards, engagement leaders must make or approve an investigation of new client entities and their management on first engagements. These matters should be considered and reviewed for continuing engagements:
- The CPA firm is independent in fact and in appearance.
- The CPA firm is qualified to undertake the engagement.
- Management is honest and not involved in illegal acts.
- The entity’s financial reporting system can provide, and management intends to provide, financial statements that are fairly presented.
The auditor’s investigative procedures may include:
- Obtaining credit information on the company and its officers.
- Discussion of the prospective client with the company’s bankers and attorneys.
- Asking the potential client management why the company is changing CPAs.
- Obtaining the company’s permission to communicate with its former auditors.
- Making inquiries of former auditors about disagreements, management’s integrity, uncollected fees, or other reasons why the engagement should not be accepted.
- Reviewing reports of former auditors.
- Asking management if any officers and directors have been convicted of a crime.
Client Acceptance and Continuance Practice Aids are normally designed to facilitate new and continuing client investigations. These forms should be reviewed and updated to annually evaluate continued association with a client and an engagement.
The investigation of potential new clients, and the ongoing evaluation of existing clients, provides information that enables a CPA firm to determine that a client meets it quality standards. Once a decision is made to accept or continue a client relationship, the quality of client personnel generally should be evaluated as high, high in competence, and high in integrity. These attributes form a foundation for other risk assessment procedures.
Declining Acceptance or Terminating Continuing Relationships
Most practitioners will agree that problem clients are almost always the least profitable. The biggest complainers about billings are usually the clients that consume the most time to service.
The clients that don’t hire competent employees often ask the most questions and demand the most attention. Smaller clients generally are the least capitalized and are most prone to financial difficulties.
Management personnel of clients with financial difficulties are most likely to override internal controls and to perpetrate fraud. Clients with threats to continued existence are most likely to fail ... and to sue their auditors or accountants to try to recover losses!
Terminating client relationships is difficult for most CPAs. It requires great courage! Many problem clients are old friends, and we don’t want to lose those relationships (or maybe our golf partner!).
Mostly, the potential loss of cash flow strikes fear into our hearts! We sometimes may be afraid we can’t replace these problem clients and that we’ll have to give up eating one day a week! So, we grin and suffer with the problems.
The truth is that CPA firms that annually terminate their least-desirable clients have more time to develop new, higher-quality client relationships that increase engagement and firm profitability. As the quality of a firm’s client portfolio improves and profits increase, firm personnel also enjoy more satisfaction and fulfillment from serving clients’ needs.
Many practitioners can attest that annually purging their client list has made direct contributions to their firm’s growth, both in total revenues and in employee compensation. Selecting and serving the right audit clients is the first step toward improving the audit process!