Making documentation pay off: documenting client interaction not only provides good practice protection, it's good client service.

Clients often ask their CPAs for casual advice on potential investments, business transactions and taxes, to name a few. Sometimes clients consider casual advice an endorsement for an investment. If the investment fails, the CPA could be sued.

Documenting client interaction can protect CPAs from liability in client malpractice claims, preventing thousands of dollars in settlement costs. It also may keep CPAs from having to appear in court, saving precious billabe time, costly legal fees and the mental anguish of going through legal proceedings. And contrary to some beliefs, documentation does not have to be a bothersome administrative task that eats away at billable time. In fact, documentation can provide CPAs with a valuable revenue source by providing a good client service.

NOT ENOUGH DOCUMENTATION CAN BE A COSTLY MISTAKE

CPAs are known for the painstakingly detailed documentation that backs up audit work. Intense training is dedicated to mastering the techniques of preparing workpapers, but CPAs often fail to keep the same records for many other services. A Los Angeles law firm that defends CPAs in malpractice suits reports inadequate documentation is a factor in at least half of the cases it defends.

Jury studies conducted by a professional liability insurance company in California show jurors consider CPAs experts in documentation. Therefore, when practitioners are faced with a liability suit and have fallen short of that expectation, they are likely to be judged negligent. On the other hand, even an informal note documenting a brief telephone converstation can sway a jury in the CPA's favor. Legally, the burden of proof rests with the plaintiff, but as a practical matter, the burden to document falls on the CPA.

CAN DOCUMENTATION COME BACK TO HAUNT YOU?

CPAs often ask if documentation can be used against them in a liability suit. The answer is maybe. Some firms, believing it is better to defend on the basis of what is recalled rather than what is written, throw out workpapers as soon as the statute of limitations has expired on the engagement.

More often than not, however, comprehensive documentation will strengthen a CPA's position in court substantially. A defense panel of attorneys for the same professional liability insurance company in California reports that half of all claims center around conversations between a CPA and the client. In court, a jury hears two sides of the same story. The CPA's testimony is strengthened when there is documentation of the actual conversation.

It is critical to keep the documentation factual and professional, however. Personal comments about an employee or a client's performance are inappropriate and could damage the integrity of the documentation.

AVOIDING RISKY SITUATIONS

There are many examples of CPAs who have been sued because they documented client interaction inadequately. One scenario involves the use of multiple professionals to coordinate services for one client, such as when CPAs and attorneys work together on various tax matters, estates and acquisitions and sales. Agreements between the CPA and attorney to delegate responsibilities, share information and provide advice can be forgotten when a client files a malpractice suit.

A more frequent problem is the common practice of informal contacts. CPAs often face legal action because of casual advice given on matters such as tax deferrals from the sale of a primary residence. Often, a client approaches a CPA in a social situation or during a brief telephone call with a question about the sale of a home. The CPA offers a five-minute assessment and two years later ends up in court because the client acted on the advice and the transaction turned sour.

Another trouble area is when CPA and client informally discuss taxes pertaining to a potential investment. The CPA may not consider this investment advice, but the client believes otherwise and proceeds with the investment on the assumption that the practitioner has given the green light. If the investment succeeds, the CPA generally never will hear further; however, in some cases, when the investment fails, the CPA is the target of a lawsuit. Without documentation, it is his or her word against the client's.

CPAs also can be faced with claims when a client does not follow advice, misunderstands it or provides incomplete or erroneous information. For example, an owner of a security guard business in San Diego County wanted to treat his employees as independent contractors to avoid paying the related taxes. The CPA advised the client that he would likely be audited by the state Employment Development Department (EDD) and therefore should not treat his employees as independent contractors. Unfortunately, the CPA did not render this advice in writing and the client ignored it. The EDD audit took place and the client was required to pay thousands of dollars in back taxes along with a stiff fine. He sued his CPA, who had no proof of his warning to the client.

Documentation not only can help the CPA minimize exposure to lawsuits but also can provide the client with additional services. It can help a client understand all of the options as well as the context in which the information is provided. This will help prevent situations in which, for example, an informal conversation is considered an endorsement for an investment. The CPA also can bill the client for the work required to provide the documentation--it is a tangible work product the client can see, store with files and retrieve when needed.

DANGEROUS ENGAGEMENTS

Engagements are considered risky when their scope and the areas of responsibility are unclear. As a general rule, any advice or practice area that can result in adverse tax or financial consequences is at high risk. Documentation is absolutely vital in the following areas:

Financial or business management.

* Funds handling. CPAs should document any verbal instructions by the client (for example, specific instructions on moving or disbursing funds).

* Valuations. It's necessary to keep track of any information relied on to formulate values, whether it be from the client or a third party.

* Projections. Practitioners should make notes on any conversations with a client that establish baseline assumptions.

* Rent-a-controller services. It's important to document the client's expectations, especially those that develop after the engagement letter is drawn. CPAs should make a note of any services the client does not want performed.

* Trustee work. CPAs need to write up notes on meetings with the client or trustor and other professionals, including attorneys and investment advisers. It is especially important to document who is assigned specific responsibilities and what professionals are involved.

* Aggressive tax positions. Practitioners should document all positions and alternatives presented to the client, their ramifications and the client's final decisions.

Management consulting services.

* Business and investment advice. CPAs must be very specific. If the firm does not provide business or investment advice services, the practitioner should document the fact that this was communicated to the client and clarify that the CPA's role is limited to, say, the tax implications of a particular situation or investment.

* Systems analysis. Nontraditional engagements such as analyzing information systems should be documented in an engagement letter and in a detailed plan that lists milestones and evaluations. Documentation should show when milestones are reached and when variations develop.

* Mergers and acquistions. The large dollar amounts involved in these engagements make then a high-risk area that also tends to involve a number of clienthired professionals. Should something go wrong, it is likely that everyone involved will be sued. That's why it's important to document all involvement no matter how informal or how insignificant it may seem at the time.

The above engagements are consulting service engagements and are guided by AICPA Statement on Standards for Consulting Services No. 1, Consulting Services: Definitions and Standards. Consulting services are typically free-from, creative engagements although their performance must adhere to the tenets of the AICPA statement. Since there are no requirements to document the work, it is important that there is a clear understanding with the client at the outset of the assignment regarding the scope and responsibilities of the work.

Therefore, documentation must detail exactly what an engagement will entail to ensure the client understands the boundaries of the CPA's commitment. Also, it is important to take the time to record the kinds of critical conversations and information shared by the CPA and the client that typically go undocumented.

In addition, CPAs should be careful to use adequate documentation when a client is deemed a malpractice risk. Consider disengaging a client if that client

* Is experiencing present or impending financial difficulty.

* Is having organizational difficulties.

* Participates in suspicious or illegal transactions.

* Fails to provide information.

* Rejects advice or implements it late.

* Exerts fee pressure.

* Demands overly aggressive or risky services.

* Lacks internal controls.

* Frequently enters ligigation.

MAKING DOCUMENTATION ROUTINE

CPAs should tailor their engagement letters to the specific engagement and keep informal notes of all but perfunctory client interactions, including brief telephone conversations or informal meetings. These notes should be written contemporaneously with the conversations and should include any key points and details, such as dates and deadlines.

CPAs and their firms should develop and adopt formal documentation policies. Key to any policy's success is management support and routine adherence by the entire staff.

Using a standard form to document telephone and face-to-face client interactions can ensure that documentation will in fact take place (see the exhibit above). Also, most standard computer software programs include a diary function that can be used for this purpose. Whatever method is chosen, it must be one everyone is comfortable using and should be easily accessible to staff; for example, firms should place documentation pads by every telephone.

SHARING DOCUMENTATION WITH THE CLIENT

Practitioners simply can add their notes to the client file, but sending a copy to the client can be a way to generate new business. It could even become a billable service. CPAs informally approached by a client with questions can protect themselves from future litigation and create some new business at the same time. A simple follow-up letter noting the complexity of the transaction along with a suggestion that it be discussed in more detail before any action is taken can satisfy both goals. For example, a CPA's recommendations about a client's weak internal controls should be documented and sent in a letter to the client along with an offer to provide additional services, such as a review of the internal control system. The CPA also can attach a pertinent newsletter or article on the subject being discussed. This kind of communication protects both the client and the CPA and provides a sound client service.

CPAs whose clients choose not to follow given advice should write a follow-up letter reiterating that advice. If the client does not reconsider, the CPA can produce the letter and possibly avoid litigation later on. If litigation does occur, the letter will present the CPA's case in a very good light in court.

DON'T WORK WITHOUT IT

There are many benefits to making proper and adequate documentation a routine part of a practice. No matter what type of services the firm provides, employees should prepare documentation beyond the minimum workpaper requirements. Any client interaction could be used against a firm, so it is paramount to document all of them, from formal consultation with the company president to the telephone inquiry with the accounts receivable clerk.

Even if the chances of a firm becoming engaged in legal action seem slim, the chances of surviving such action are even slimmer if there is no backup. Aside from protecting a practitioner's livelihood, documentation also can enhance the practice by serving as a client development tool or as a valued billable client service.

CASE STUDY: BILLING FOR DOCUMENTATION

A. V. Arias & Co., a full-service, 14-person CPA firm specializing in small business in San Diego, California, developed a computerized documentation system supported by management and followed by all staff. It has been the firm's policy to document all client interactions since day one, and the policy is considered by Al Arias, managing partner, as a cornerstone of the firm's success. All documentation is sent to the clients, who subsequently are billed for the service.

The firm's work assignments are written up on computer using a special document managing software Arias developed inhouse. It took the firm little effort to get the program started, and over the years it has been refined to meet the needs of the practice. Arias begins each week with a management meeting to review a work-in-progress report generated by the software package that documents all ongoing tasks within the firm. Client files are linked to the special documentation software and coded and indexed for easy reference.

Arias encourages his staff to meet with clients in person as often as possible because personalized service creates more opportunities to offer new services. The firm members then document these meetings, dictate them to notes and add them to the computer files as a memorandum that is later monitored by managers and partners. Documentation can cover any advice as well as any random points that may have been discussed. Arias says the notes are written in a clean business style and that his staff members have developed excellent communication skills as a result of this process. In fact, one of the biggest hurdles Arias jumped when implementing his documentation policy was improving his staff's writing skills. Arias believes many accounting graduates have poor or inadequate writing skills that need additional training, practice and coaching before a successful documentation policy can be implemented in any firm.

Final copies of the documentation are distributed to the staff person who generated it, the appropriate manager, partner and client. The client's bill includes a fee for the preparation of the documentation.

A WORTHWHILE EFFORT

Arias believes implementing a high-quality level of documentation takes total commitment. Firms interested in implementing a documentation policy cannot take half a shot at it. To ensure the benefits, a firm must immerse itself in the documentation philosophy. Arias says good documentation is a part of his firm's culture and is almost second nature for his staff.

Arias believes documentation is part of any high-qulity service, and a firm should be paid for this level of quality. Arias says his clients appreciate receiving the documentation; consider it a reflection of the caliber of service the firm provides; and rarely balk at documentation fees. Conversely, he says documentation is a great tool for collection purposes because clients have tangible results in hand. In addition, the documentation reminds clients of what has been done for them, actually making it easier to collect payment.

EXECUTIVE SUMMARY

* DOCUMENTING INTERACTION with clients can protect CPAs from liability in malpractice claims and help generate more billable client services.

* COMMON SITUATIONS in which documentation can save a CPA from lawsuits occur when more than one professional is coordinating services for one client, when CPAs are approached by a client in a social setting for advice on potential investments and when clients choose not to follow the CPA's advice.

* DOCUMENTATION IS IMPORTANT when the scope of the engagement and the areas of responsibility are not clear. Any advice or practice area that could be associated with adverse tax or financial consequences is at high risk.

* CPAs SHOULD ADOPT a formal documentation policy. At the very least, they should keep informal notes of all but perfunctory client interactions and write followup letters to client who have asked informal investment questions suggesting the investment be discussed in more detail before any action is taken.

* EVERY CLIENT CONTACT can be used against a CPA, so it is essential they all be documented and that the documentation is kept detailed and professional.

DOCUMENTATION ESSENTIALS

* Adopt a policy on documentation procedures that is supported by management and routinely followed by all staff.

* Develop a preprinted form or computerized system for caputring all documentation and make it accessible to all firm members.

* Document all client interactions, except those that are strictly perfunctory.

* Make documentation notes contemporaneously with client interactions.

* Retain all documentation for five to seven years.