Mitigating risk (and legal action) with business intelligence and client relationships

By Jeff Borschowa 

Author, Freelance Writer, Speaker, Growth Specialist at Dream Practice

Possible Errors

Accounting is a risky business. Many accountants I know, myself included, worry about what could happen if we were to be sued. The sad reality is that accounting professionals are a target and are at risk for malpractice lawsuits. If we are conducting audit and review engagements, there is a real risk that an accountant may:

• Fail to notice suspicious activity

• Miss signs of fraud

• Misinterpret facts

• Make an error in disclosure.

One could argue that accountants working in tax planning and assurance areas are likely to face a malpractice suit at some point in their professional career, even if accountants diligently follow the AICPA Generally Accepted Auditing Standards. 

Lawsuit Themes

There are common themes as to why accountants may be targeted with a lawsuit alleging malpractice. Four of the most common lawsuit themes that I have encountered include:

• Drastic, adverse change in client financial circumstances – Adverse changes can occur for any number of reasons, including internal fraud, lost contracts, bad acquisitions or even random changes in the economy. Sudden changes can strain even the best relationships with clients. In a downturn, you may see an ugly side to your clients, as many will look to blame someone, and that someone might be you.

• In the event of fraud, lawyers will look to mitigate losses through any possible channel – In many cases, lawyers will assert that the accountant should have detected the fraud as an easy way to seek damages. Rather than address the actual source of the fraud, lawyers will look to recover losses by going after the accountant.

• Lawyers view accounting professionals as “deep pockets” – Whether we are at fault or not, lawyers see our professional liability insurance as an easy target for settlement. Lawyers will bring you into the lawsuit simply to access your insurance coverage. For instance, it is easier to collect from a professional liability insurance claim than from a fraudster who has absconded with your corporate dollars.

• Recovery of third-party losses – In the event of a business bankruptcy or insolvency, external lenders, shareholders and vendors are seeking to maximize their potential for recovery. Approximately 30 percent of all lawsuits against accounting professionals are raised by third parties looking for a quick recovery of lost funds. 

Mitigating Risk: Business Intelligence

An integral part of any audit strategy is to properly plan the engagement in the first place. Business intelligence in the form of analytical review and ratio analysis can assist at the planning and execution stage of an audit. Generally, planning should consider the following points:

• How comfortable are we with our overall risk assessment? Where does the client fit in terms of overall risk profile?

• Do we have a thorough understanding of the client and clear expectations as to what constitute expected values for a given period in question?

• Have we reviewed specialist advisory services and consulting engagements conducted by external firms? What can these engagements tell us about the health of the client’s business? Do they raise any warning flags?

• How does the client’s business data compare to benchmarking standards within the industry?

• What analytical procedures can we perform to reduce our risk? What ratios and metrics can we look at to confirm our expectations?

If we have a solid understanding of the business owner and our own expectations, we can focus our efforts to identify areas of risk and unusual results.

Mitigating Risk: Client Relationships

Familiarity with our clients is a double-edged sword. If we do not know enough about their business, we cannot possibly hope to conduct a proper audit. However, if we know them too well, we are considered to have impaired professional judgment. 

Business intelligence offers a means to reduce audit risk, build client relationships and ensure that we can maintain our independence. Business intelligence allows us to systematically and consistently gather and document our understanding of the client. We are then able to pass this knowledge along to new team members on an audit engagement and ensure a smooth transition from one partner to another.

Building client relationships is a key aspect in mitigating risk. Part of this is a properly documented engagement via an engagement letter. However, it goes deeper as we learn more about a client’s business and apply our understanding of the business to our engagement approach. The mutual understanding of scope and expectations can reduce risk as we help clients to better understand the nature and scope of our services. After all, most lawsuits actually come down to a breakdown in communication and mis-managed expectations. A close client relationship can help you counter this risk.

“The mutual understanding of scope and expectations can reduce risk as we help clients to better understand the nature and scope of our services.” 

As an added bonus, you can also leverage business intelligence to facilitate firm growth. Demonstrate your expertise in an industry to attract more clients and build your practice.

Conclusion

Accountants are at risk for being sued. If we incorporate business intelligence into our audit regime, we can mitigate our risk by leveraging our expectations of the client’s operations and by building solid client relationships. 

Learn more about audit risk mitigation in our upcoming webinar, “Mitigating Risk (and legal action) with Business Intelligence and Client Relationships” which will air on Feb. 5 from 12-1 p.m. ET. We will address the risk of malpractice lawsuits and how to mitigate that risk. Register for the free webinar here.