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The Risk of Being Consistent

(How Claims Arise From Following Past Work and not Our Independent Judgment)

By Ralph G. Picardi, Esq.

“A foolish consistency is the hobgoblin of little minds….”

When Ralph Waldo Emerson penned those words in his essay, Self-Reliance, almost 175 years ago I think it is fair to say he didn’t have accounting risk management in mind.  He did, however, intend to convey to the readers of his day the message that the exercise of independent judgment should be valued over blind adherence to the thoughts and opinions that we and others have expressed in the past.  That message should resonate with equal force among 21st century accounting professionals as they search for ways to provide high-quality client service in a hyper-litigious environment.

When I work with clients, helping them build effective risk management programs, one area I cover is documentation, and in particular, the use of checklists.  We discuss how checklists help preparers and reviewers in a broad range of engagements to stay focused, be consistent in their thinking, and avoid omissions.  They also provide a mechanism for technical members of the firm to ensure that new technical issues discussed in staff meetings and in training sessions are reinforced with engagement teams as they perform their work.  But we also discuss the inherent risks of introducing checklists into engagement performance.  The greatest of these risks, in my view, is that users will begin to rely too heavily on the checklists, becoming slaves to consistency while subordinating their independent judgment.  A checklist can become a limit to the work to be performed, instead of a guide.  Another risk is that checklists are seen by users as things to be gotten through so that the file can be papered to satisfy the field reviewer, or the partner reviewer, or the peer reviewer.  When these risks manifest themselves, engagement professionals lose the ability to take a broader, holistic view of the task at hand, the client, and the industry, and unanticipated errors and omissions tend to follow.  Emerson could relate to these risks.

This “consistency” problem is not limited to the use of checklists, however, and a recent call on the Hotline reminded me of that.  The caller, from a mid-size firm (the “caller”), described a 1040 client with various business interests (the “taxpayer”).  The caller serviced the taxpayer’s tax needs for a few years.  Then the caller’s assets were acquired by a larger firm, which succeeded the caller as the taxpayer’s accounting firm (the “successor”).  Now the stage is set.

All appeared well until the taxpayer recently asked his contact at the successor why he had such a large tax liability.  He said that an even larger accounting firm he had retained to review his overall tax picture noted that the taxpayer was not taking advantage of a certain deduction to which he should be entitled (the “deduction”).  The successor agreed to look into the question and get back to him.  The successor did look into it and confirmed that there was, in fact, such a deduction, that the taxpayer was entitled to take advantage of it, and that neither the successor nor the caller had prepared the taxpayer’s returns to take that deduction.  Further, although the tax years since the successor took over the taxpayer’s account remained open at that point, permitting the successor to amend those returns, take the deduction, and obtain refunds, the tax years prior to that (i.e., the years for which the caller had been the taxpayer’s accounting firm) were closed such that amendments could not be filed and refunds could not be obtained.

When the successor presented its findings to the caller, it took the position that this was a matter for the caller to resolve, and urged it to do so quickly so that the successor could preserve its client relationship.  The problem with that position was that although the caller may have overlooked the available deduction (we’ll get to that in a moment), the successor did as well.  And, had the successor recognized this issue when it began preparing the taxpayer’s returns, it would have recognized the need to amend the prior-year returns at a time when that was still possible.  Because it didn’t, it was as responsible as the caller for resolving this matter with the taxpayer.

In conducting my own, limited inquiry on the Hotline, I learned that the caller had been aware of the deduction in question, having applied it to several other client returns over the years.  Further, I noted that the accounting firm that serviced the taxpayer before the caller (the “predecessor”) had taken the deduction for the taxpayer in the year prior to the caller taking over the account, and a copy of that prior-year return was in the caller’s permanent file.  In light of those facts, I strained to comprehend how the caller, as well as the successor, could have overlooked the deduction in this instance.  At the end of my analysis it became clear to me that what Emerson warned us of all those years ago was at the root of the claim I was discussing….a foolish consistency.

It turns out that although the predecessor had taken the deduction for the taxpayer, and a copy of that prior-year return was in the caller’s file, the deduction was not an issue in the first year of the caller’s tenure.  Due to changes in the taxpayer’s affairs, which turned out to be temporary, the circumstances that would have given rise to the deduction did not exist and the deduction could not be taken.  Memories had faded by the time of my Hotline discussion, but I suspect that the caller’s engagement team in that first year reviewed the prior-year return, noted the deduction, noted that it was inapplicable in the current year, and moved on.  The problem arose in year two of the caller’s tenure.  When the caller prepared that second return, a different preparer and a different reviewer used only the immediate prior-year return as a guide.  They never looked back further, and seeing no deduction in the immediate prior year, failed to even consider the issue.  Yet because the taxpayer’s affairs had returned to their norm in that second year, the deduction should have been taken.  That process was likely repeated in year three, a year in which the deduction should also have been taken.

It is obvious that nobody within the caller’s engagement team stepped back, took off the blinders, and evaluated the overall tax circumstances of this taxpayer.  Consistency with the prior-year analysis trumped the team’s exercise of independent judgment.  Yet, the caller was not alone in that regard.  The taxpayer remained entitled to the deduction in the ensuing years, but the successor apparently looked only to the caller’s prior-year analysis to guide its current-year work.  The result for both firms is entanglement in an embarrassing and costly claim scenario that could have/should have been avoided had they brought their “bigger minds” to the task.

 

© May 2017, PICARDI LLC

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