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Reducing the likelihood of litigation.

These are litigious times for public accountants. According to Time, U.S. practitioners currently face 4,000 liability suits alleging more than $15 billion in damages.(1)

The firms most vulnerable to litigation are those with staffs of 11-25 accountants. The chances that a practice will incur a claim in a given year are slightly less than 1% per professional,(2) so a firm with a staff of fifteen would stand roughly a 14% probability of being sued during that time period.

The purpose of this article is to describe defensive tactics the public accountant might employ to minimize the likelihood of a lawsuit in connection with the performance of professional services. The suggestions are classified as (1) firm general policies and (2) pre-engagement tactics. At the conclusion, the writer proposes an immediate course of action should the accountant be named in litigation.

Firm policies

The key policy a firm can employ to reduce the threat of a lawsuit is to conduct the practice in accordance with the highest standards. Taking short-cuts to complete an engagement by deadline or to stay within the hours budgeted can lead to a costly settlement. Even if no litigation results, such risky decisions, whether conscious or not, raise the level of anxiety and take their toll psychologically.

On the other hand, if quality drives the performance of all the accountant's work, he or she may rest assured that the statistics favor a minimum of litigation.

An accountant's practice is only as strong as the competence and integrity of its employees. The practitioner should take every precaution to assure that all new personnel are qualified to perform their duties and that their professional behavior has been ethical.

As a matter of course, the accountant will be wise to contact several references for each job applicant and confirm credentials.

The AICPA's Elements of Quality Control(3) apply to all accounting practices. The accountant may need to strengthen policies that address the supervision and advancement of employees and those that provide avenues of consultation on technical issues. Staff at all levels should be supervised to make certain that their work will support the final product, should working papers or tax returns be subpoenaed in court. The prudent firm adopts and documents formal means of assuring that employees considered for promotion are fully qualified to step into their new responsibilities. Firm management should also have in place procedures that ensure that when staff members have technical questions, they seek guidance from appropriate published sources and qualified persons.

To assure that professional staff members maintain and increase their competence in a changing world, the firm should require that all individuals complete a minimum number of continuing professional education hours each year. There is no substitute for the peace of mind that comes from knowing the precise answer to a technical question.

To demonstrate to others, including the court, that the firm has consistently complied with professional standards, the accountant may want to enroll in a quality assurance review (QAR) program. (The May issue of the National Public Accountant described the mission of the NSPA's Ad Hoc Committee on QAR, and its pilot program for off-site reviews.(4))

On to a more mundane suggestion: The accountant will profit doubly by billing clients promptly and then following up on past-due fees. If customers fail to make periodic remittances, the practitioner runs the risk that a plaintiff will allege the unpaid fees affected his or her professional judgment.

The astute accountant will maintain a benevolent vigilance over his or her employees. By paying attention to changes in their behavior, the alert practitioner is able to spot the signs of stress and alcohol or drug abuse that could result in negligence and then, in turn, arrange for assistance. Often an empathetic, "heart-to-heart" conversation will point a person in the right direction toward self-help or professional consultation.

Three further recommendations at the firm level deal with contingency plans in case the accountant is sued. The obvious one is to carry adequate malpractice insurance. Practitioners should be aware that even when they successfully defend their cases, the costs of litigating, including fees paid to expert witnesses, can be sizeable.

Policies generally do cover defense costs in addition to indemnification of losses.

A second tactic is to incorporate the practice in order to decrease the likelihood of liability for the negligence of co-owners and supervised employees, as well as to limit liability for the firm's general business obligations. Finally, the practitioner may sleep more easily knowing he or she has retained legal counsel to assist in the event a suit is brought.

Pre-engagement policies

As Broom and Brown pointed out in their article, "Public Accountancy: A Profession At Risk?"(5) prior to beginning an engagement, it behooves the accountant to screen prospective clients carefully. The integrity of the principals is a paramount concern, since association with those whose ethics are questionable destroys the confidence a practitioner places in client representations.

Conversations with the would-be client's banker and other business associates, as well as with previous accountants and local attorneys, can shed light on the integrity issue.

Before agreeing to perform services for continuing clients, the accountant may reflect on any past disagreements concerning the scope of procedures or the fees charged, and on observed inadequacies of records or of responses to inquiries during the previous year. A client who the firm has serviced for several years is not automatically entitled to a repeat engagement, and declining to stand for reappointment is less costly from a monetary and reputation standpoint than a lawsuit. The financial situation of a client, whether prospective or continuing, should play a part as well in the acceptance or retention decision. A prudent accountant will request D&B reports on client businesses before contracting to perform professional services for them.

A series of operating losses and/or current cash-flow inadequacies may signify impending trouble in the professional relationship.

A final consideration before accepting a new client is for the accountant to assess accurately his or her mastery in relation to the needs of the engagement. The practitioner may think twice before venturing into "new territory" that stretches existing expertise.

After an accountant decides to accept a client, the next defensive step is to draft an engagement letter. If properly written, it becomes a legal contract through which the practitioner and client agree on matters such as the scope of services to be performed, the responsibilities of the parties, the timing of the work and the expected fees. Such a formal letter, signed by both client and accountant, documents the agreement in a manner that constitutes persuasive evidence for the defense should litigation arise.

The exhibit on page 17 illustrates a suggested letter for compilation services that may be adapted to fit any professional engagement, including audits, reviews, consulting and financial planning. It draws on models developed by the NSPA(6) and the American Institute of CPAs.

The writer recommends that the accountant secure a signed letter on every engagement, including those for routine tax return preparation. Practitioners should be aware that tax preparation accounts for fully 40% of all claims.(7)

Implicit in the concept of the engagement letter is the established fee. Although competition has forced the profession to bid conservatively, the failure to provide for reasonable remuneration at the onset may provide an undesirable incentive to cut corners when performing the work. Stipulating a realistic fee, commensurate with the level of risk implicit in the services to be provided, will keep the accountant "on track" should, for example, actual hours exceed the budget due to supervision overruns.

Some practitioners may balk at implementing all the pre-engagement policies suggested in this section, as the procedures may consume several hours, especially for new clients. However, the benefits are enormous when we ponder the potential consequences of failure to give them adequate consideration.

If you are sued

Although comprehensive practical advice in the event of a suit is beyond the scope of this article, it is imperative that the firm notify both its insurance carrier and legal counsel as quickly as possible. If the firm tries to settle the claim on its own, it may irreparably damage its case and even void insurance coverage.

Traditionally the accountant has had two choices when a client or third party commences litigation: try the case or settle out of court. Two other options, mediation and arbitration, may prove to be less costly in terms of time, money and stress. The practitioner may wish to explore all relevant alternatives with his or her attorney at an early stage of discussions.


The independent public accountant may adopt several common-sense strategies to enable him or her to conduct a practice in which litigation plays an insignificant part. Tactics at both the firm and the individual engagement level may pay handsome dividends to those practitioners who heed them.


1 "Who's Counting?" Time (April 13, 1992), p. 48.

2 Dan L. Goldwasser, "Importance of Having Insurance," The CPA Journal (March, 1992), p. 66.

3 American Institute of CPAs, "Statements on Quality Control Standards."

4 William H. Sager, "NSPA's Experimental Program on Quality Assurance Review," National Public Accountant (May, 1992), pp. 8-9.

5 Lowell S. Broom and Steven C. R. Brown, "Public Accountancy: A Profession At Risk?" National Public Accountant (October, 1991), p. 33.

6 National Society of Public Accountants, "Model Letters, Contracts and Agreements for Accounting Practice," pp. 6-7.

7 Goldwasser, ibid, p. 66.

8 Denzil Y. Causey and Francis McNair, "Updating Your Audit Engagement Letter for the 1990s," The CPA Journal (July 1990), pp. 58.

9 Ibid.

Larry Godwin, DBA, CPA, is Assistant Professor of Accounting at the University of Montana in Missoula. His primary teaching area is Auditing. He gratefully acknowledges the assistance his students provided in drafting the suggested engagement letter.


Dear _____________,

Purpose of letter: This letter will confirm our understanding of the arrangements for the compilation of the year-end financial statements of |company name~ as of |date~.

Engagement purpose: We will compile, from information you provide, the company's balance sheet at |date~, and the related statements of income, retained earnings, and cash flows for the year then ended. A compilation is limited to presenting, in the form of financial statements, information that is the representation of the company's management. We will not audit or review the financial statements. In all circumstances, our responsibility for this engagement will be limited to this period.

Standards applicable to engagement: We will conduct our compilation in accordance with standards established by the American Institute of Certified Public Accountants.

Tax services: At your request, we will also prepare the Company's federal and state |identify states~ income tax returns for the year ended |date~. In addition, we will be pleased to advise you concerning any income tax matters you bring to our attention, including the tax effects of proposed transactions or changes in business policies.

Responsibility for detecting fraud and illegal acts: The purpose of our engagement is not to detect errors, irregularities or illegal acts. However we will inform you of any such matters that come to our attention during the course of our work, unless they are clearly inconsequential.

Printers' proofs: If you intend to publish or otherwise reproduce the financial statements we have compiled, and make reference to our firm, you agree to furnish us with printers' proofs for our review and approval before printing. You also agree to provide us with a copy of the final reproduced material for our approval before you distribute it.

Engagement staffing: You may expect two members of our professional staff to be present in your office during the course of our work. |For continuing engagements~ To promote continuity, we will make every reasonable effort to assign the same personnel from previous years to the current engagement.

Client assistance: We understand that your accounting personnel will assist our staff by preparing a trial balance and the supporting schedules we require to complete our work on a timely basis.

Fees: We will base our fees on the amount of time required to complete our services, plus travel and other out-of-pocket costs. Assuming adequacy of records, and the assistance of your personnel, we estimate that our fee for all services will be |specify amount~. We will notify you immediately of any circumstances we encounter that materially affect this figure.

Billing: We will bill you for our services at the conclusion of the engagement; our invoice is payable on presentation. Unpaid fee balances will bear interest at |percent~ per annum, and we will formalize any balance not paid after sixty days by execution of a promissory note.9

Timing: We anticipate the following time-table for the performance of our services and delivery of the financial statements, and will promptly notify you of any necessary changes:

|Date~ We will begin our work at your office. |Date~ We will complete our work at your office. |Date~ We will deliver your compiled financial statements and tax returns.

Appreciation: We appreciate your confidence in retaining our firm to perform these services and are happy to have this opportunity to serve you.

Request for client: If this letter correctly expresses your understanding, please sign the enclosed copy and return it to us at your earliest convenience. If you have further questions concerning the engagement, including any of the detailed contents of this letter, or questions about additional services we might provide, do not hesitate to call me.

Sincerely yours,


The terms of this letter constitute our contract. I have read it and fully understand its terms and provisions.

Accepted by: ________________________________________

Title: ______________________________________________

Date: _______________________________________________
COPYRIGHT 1993 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Article Details
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Title Annotation:Debits & Credits
Author:Godwin, Larry
Publication:The National Public Accountant
Date:Feb 1, 1993
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