If you view popular television programs, you are probably familiar with the catch phrase "You're fired." You do not have to be a real estate mogul or television star, however, to be in the firing mode. But sometimes, it may be necessary to use the phrase in real-life engagement situations.
Consider the following CPA firm engagement situations:
- Tax return engagement
A CPA prepares a client’s individual income tax returns for three years. The client reports his business income on Schedule C. Subsequent to receiving his return from the CPA for the prior year, the client applies for a high six-figure mortgage loan and submits his most recent tax return with the loan application. The lender sends the CPA a copy of Schedule C asking that the CPA confirm that he prepared it. The CPA compares the copy received from the lender with his own file copy and finds that the net profit on the copy received from the lender had been significantly increased. Further investigation reveals that the client altered the return before sending it to the mortgage lender, presumably to increase his chances of getting the loan approved.
- Audit engagement
In performing an audit for a small business owned by a husband and his wife, a CPA firm notes that large round-dollar monthly payments had been made to a credit card company. The client bookkeeper told the firm staff person that the payments were authorized by the president/owner and that he signed the disbursement checks. Further investigation revealed that the disbursements were inappropriately allocated among several expense accounts in the general ledger. When questioned about the payments, the president became defensive and said he was an owner of the company and that the transactions were properly handled. As it turned out, the president had been overpaying the credit card bills, obtaining refunds from the credit card company, and depositing the refund checks in the accounts of a separate business that he owned himself.
Clearly, these actions reflect poorly on these clients integrity and raise serious concerns for the CPA firms involved. Firing these clients or, to put it differently, terminating these client relationships, is an important consideration, and one that most CPAs would view as a necessary action.
As a CPA, you encounter many situations that raise the possibility of terminating client relationships. Some may not be as clear cut as those described above, but they are no less important and no less fraught with risk. Recognizing situations that point to a need to evaluate a client relationship and taking the appropriate steps based on that evaluation are critical to an effective risk management program.
Red Flags
Information or situations indicating a possible need to terminate a client relationship may come to a firm attention at any time. Generally, negative information becomes known or situations develop while an engagement is in process. Evaluation of this information or such situations may coincide with the need to terminate the relationship. Or, based on the facts and circumstances, the evaluation may take place during a periodic review of all client relationships.
CPA firms are encouraged to evaluate client relationships at least annually (see Additional Resources). In doing so, be aware of the following risk factors (red flags) that generally indicate a need to consider terminating a client relationship:
- Lack of integrity Client integrity is a basic requirement of any professional relationship. If you cannot rely on the integrity of a client, any information received from or any assertions or representations provided by the client must be viewed with suspicion. A professional relationship cannot survive when suspicion exists and client integrity is an issue.
- Disregard for tax and other laws/regulations A client that is not committed to complying with applicable laws and regulations is working at cross purposes with the services of your firm. Skirting known requirements or adhering to a policy of compliance only if violations are caught is not an acceptable approach and poses increased risk.
- Uncooperative and overly demanding A client that does not cooperate in fulfilling its engagement responsibilities or that is overly demanding does not respect the value of your work and is likely to point the finger at you if something turns out other than expected. A client that does not provide necessary information or answer questions in a timely and forthright manner, or that sets unrealistic deadlines, is a risky client. •Chronic fee disputes A client that repeatedly disputes fee billings or that does not pay as agreed is a high-risk client and a candidate for termination. •Independence or conflict of interest issues Independence (where required) or conflict of interest issues that cannot be satisfactorily resolved generally require that a client relationship or engagement be terminated.
- Unprofitable relationship If your relationship with a client is not profitable and billing terms cannot be improved, termination is generally indicated. No one is required to work for nothing or give work away. Doing so could lead to cutting corners, and that is not good risk management. •Unfavorable trend in financial results/position A client with a deteriorating financial position or significant operating losses poses an increased litigation risk, particularly if the financial statements and any reports thereon issued by your CPA firm are relied upon by third parties. How to Say "You’re Fired!"
- Terminating a client relationship should not be taken lightly; it can be a risky situation if not done properly or in a timely manner. Do not procrastinate in addressing an issue with a client when you determine that it needs attention. Procrastinating will not make a problem go away and will usually complicate or even make matters worse.
- Once you decide to terminate a client relationship, it is generally not recommended that you defer it and continue to complete in-process work. Once a client is aware of your decision, continuing to provide services generally leads to an unsatisfactory working relationship. Client cooperation tends to decrease, and even the smallest issue can develop into an acrimonious situation. Make the effective date the same date you notify the client of your decision. An exception to this general rule may be appropriate if the client is facing an imminent tax or regulatory filing deadline, and a delay in providing the firm work product may result in the imposition of penalties, interest, or other sanctions. This is a facts-specific evaluation and decision. Before coming to a final decision in this regard, however, consider discussing the matter with your attorney and professional liability insurer.
- Verbally informing a client of a decision to terminate a relationship can be sensitive. Be factual, maintain your composure, and stick to your decision. If you properly evaluated the matter, it is unlikely that new information will be presented that could persuade you to change your decision. Follow up with a letter to the client confirming your discussion and detailing your termination action, and send it via a delivery method that will provide you with documentation that the client received the letter on a specific date.
Your termination letter should address several important matters, including, for example, the following:
- Effective date of termination, which is generally the date you tell the client or the date of the letter if you have not previously discussed your decision with the client.
- Status of your work in process, if any. If a completed work product will be provided, indicate such. From a risk management perspective, avoid providing partially completed work and be prepared to write-off the time incurred on this work.
- Matters requiring client follow-up or completion (e.g., filing quarterly estimated tax returns and making payments, and other deadline-sensitive requirements). Status of client records provided to the firm in connection with prior engagements (see Additional Resources) and a statement of your record retention policy covering work papers. All client records should be returned to the client.
- Outstanding fees expected to be paid. For sample language that may be used in drafting your termination letters, see the article Client Termination Letters referenced in the Additional Resources section.
When you have had a long client relationship, termination can be a difficult action to take. Nevertheless, continuing to work for uncooperative or otherwise problem clients is not good business. Even more so, it is not good risk management. Delivering the substance of the ”You’re Fired” message may just be the best way to minimize your professional liability risks.
April 2007
By John McFadden, CPA, CFE, Risk Control Consulting Director, CNA, Accountants Professional Liability, CNA, 333 South Wabash Ave., 39S Chicago, IL 60604.
Additional Resources
- Management of an Accounting Practice Handbook, American Institute of Certified Public Accountants, 5/05 Rev., Chapter 204.06, Client Evaluation
- AICPA Professional Standards, 501.02, Retention of Client Records, at http://www.aicpa.org/about/code/et_500.html#et_501.02
- AICPA Professional Liability Insurance Program, Client Termination Letters, May 2005, at http://www.cpai.com/show-article?id=78
- AICPA Professional Liability Insurance Program, Terminating a Client Relationship, at http://www.cpai.com/show-article?id=43 The purpose of this article is to provide information, rather than advice or opinion. It is accurate to the best of the author’s knowledge as of the date of the article.
- Accordingly, this article should not be viewed as a substitute for the guidance and recommendations of a retained professional. In addition, CNA does not endorse any coverages, systems, processes or protocols addressed herein unless they are produced or created by CNA.
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To the extent this article contains any examples, please note that they are for illustrative purposes only and any similarity to actual individuals, entities, places or situations is unintentional and purely coincidental. In addition, any examples are not intended to establish any standards of care, to serve as legal advice appropriate for any particular factual situations, or to provide an acknowledgement that any given factual situation is covered under any CNA insurance policy.
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Executive SummaryTimely evaluation of client relationships is critical to an effective risk management program.
