A Liability That Could Have Been Avoided

Source: Pennsylvania CPA Journal

In this article, the author relates a story about a CPA who was sued for failing to discover a theft at a client. The case was settled for $300,000. The article includes some lessons to be learned.

The CPA was engaged to prepare quarterly payroll tax returns and W-2s at year-end. He noticed that the bookkeeper seemed disorganized. Some of her check stubs did not have the names of the payees. It turned out that these were payable to the bookkeeper and her husband. She had been doing this for six years.

The complaint against the CPA included allegations that he did not:

• Prepare 1099s. The information needed to prepare 1099s might have disclosed the embezzlement.
• Review copies of cancelled checks. This would be done in a review engagement but not in a compilation.
• Prepare bank reconciliations.
• Communicate to the client that the bookkeeper seemed muddled or disorganized.

The CPA did not have an engagement letter. He didn't think one was necessary in the case of an engagement to prepare payroll tax returns and W-2s. When the engagement was expanded to include income tax return preparation, the CPA believed an engagement letter was unnecessary in view of the excellent relationship he had established with the client.

The lack of an engagement letter deprived the CPA of a good defense. The engagement letter would have, among other things, included a provision relieving him of the responsibility to discover or prevent fraud.

To read the original article, see the link below.

From Pennsylvania CPA Journal, Winter 2010, http://www.picpa.org/Content/41044.aspx. See Liability Lessons, "Job Creep Can Cause Engagement Trap."