On Clients and Their Files

After reading “...And Nothing But the Truth: Uncovering Fraudulent Disclosures” ( JofA, July01, page 47), I take exception to the implications regarding clients who resist allowing auditors open access to files.

The article admitted that a client has the right to refuse free access and that even an honest client may resist. However, it implied that a client who does so is likely hiding something. In my opinion, there are legitimate reasons to deny free access, such as record integrity, administrative efficiency and competitive privacy.

As a corporate accounting manager previously involved in both internal audit and public accounting functions, I have real concerns about allowing anyone who is not on the accounting or finance staff free rein in the files. I do not believe audit staffs, internal or public, give consistent, proper regard to handling and protecting client workpapers and records.

Staff auditors, especially inexperienced ones, tend to hold records for the entire length of an audit—adding one more place to look if a needed file is not where it should be.

The high turnover of staff in their first few years at public accounting firms is exacerbated by the declining number of large firms and the better salaries available outside of auditing. Client confidentiality is more at risk than ever, and free access to files adds to this risk. Who is to say the second-year “Big Five” staff auditor rummaging through my files today won’t be working for a competitor next week or next month? What privileged information will he or she see that can be taken along to a competitor?

The article suggested an approach for the auditor to request free access to file cabinets—to bill it as a convenience and expense saver for the client. I believe it is condescending and deceptive to sell an approach from an efficiency standpoint when the real reason is to enhance the auditor’s investigation.

Despite having seen some attempts at dishonest or misleading disclosures as a public accountant and internal auditor, I still believe the client is right to be circumspect when it comes to auditors’ getting free access to files. I want to know which auditor borrowed each file, what condition it was in when given, where it will be while the auditor has it and when it will be returned. Anything less, and I am not doing my duty to my employer. Allowing auditors open access to one’s files makes that impossible.

Alan Russell, CPA
The Marmon Group, Inc.
Chicago

Not All Are Fraud Audits

“...And Nothing But the Truth: Uncovering Fraudulent Disclosures” ( JofA, July01, page 47), contains interesting recommendations—but to be used under what circumstances?

The article leads one to believe the recommended procedures should be added to every audit program as standard steps. I disagree.

SAS no. 82, Consideration of Fraud in a Financial Statement Audit, makes clear that the auditor has broad responsibilities in detection of fraud. However, the statement does not require every audit engagement to become a fraud audit. Audit procedures may lead to some of the steps recommended in the article, but without a “red flag” requiring the auditor to expand or modify his or her audit procedures, I believe the following suggestions represent overkill:

Check public records at the federal or state level to look for undisclosed liabilities.

Interview recently departed employees and ask if they had any suspicion of management fraud.

Review corporate records maintained by the state to find whether a client’s officers are also listed as officers of another corporation, in search of related-party transactions.

Review published material covering the client or its key officers, looking for possible conflicts or controversy.

Ask for unrestricted access to the client’s files so the auditor can go on a fishing expedition.

Skepticism is the auditor’s middle name, but that doesn’t mean that every audit should become an adversarial procedure.

Charles Chazen, CPA
Los Angeles

Charitable Giving: Other Points to Consider

“The Right Philanthropic Vehicle” ( JofA, July01, page 22) addresses one of the fastest growing areas in financial planning.

The article correctly states that a foundation can be used to fund several years of normal charitable giving. Making a substantial or extraordinarily large charitable gift in an unusually high income year may provide a valuable deduction when the client moves into a higher tax bracket. It should be noted, however, that while the client’s economic benefit is derived when the gift is made to a foundation, the “end-user” charities do not receive any economic benefits until the foundation distributes the funds. Some large foundations distribute only the minimum required 5% of their assets every year. Understanding these issues and learning to probe and uncover clients’ charitable goals will enable CPAs to participate in the whole philanthropic planning area, not merely the tax planning.

Also, the article presented an example: “After selling a substantial portion of his company, Mr. A established a multimillion dollar private foundation to help offset his taxable gain.…”

Unfortunately, Mr. A’s CPA may have already missed an opportunity to save him hundreds of thousands of dollars. Proactive philanthropic advice could have reduced Mr. A’s taxable income by the same multimillion dollar amount: If Mr. A had given $2 million of his company to a foundation before selling the business instead of after, it would have reduced his taxable gain by $2 million and provided him with the same charitable deduction.

Because of its complexity, not all foundations can accommodate this type of transaction (receiving a business interest and then selling it), but some do have the capability and expertise.

Efficient and proactive philanthropic planning, not just knowledge of tax laws, is becoming a necessity to provide valuable counsel to clients.

William B. Ertel, CPA
Ronald Blue & Co., LLC
Charlotte, North Carolina

Author’s reply: In many cases donating stock before a sale is a wise move, both for tax and philanthropic reasons.

However, the “Mr. A” referred to in the example was a real client who did not establish his foundation until after he had sold his company. Had he donated company stock before the sale, his deduction would have been limited to his basis, since the stock was not publicly traded.

In fact, his basis was quite low. By donating cash afterwards, he was actually better off—the gain on the sale was taxable at 20%, but some of the donation deduction offset ordinary income taxable at 40%.

One of the hazards of trying to squeeze a lot of information into an article is that some details have to be omitted. Here, the low basis of the stock was one of those details.

Laura Peebles, CPA
Washington, DC

Right Guidance = Right Choice

“The Right Philanthropic Vehicle” ( JofA, July01, page 22) laid out clearly the major alternative strategies and rationale that should guide a donor’s choice.

The CPA, along with the client’s trusts-and-estates attorney and a philanthropy adviser, should be part of the team that guides a high-wealth individual in this decision-making process.

Deciding to be philanthropic and choosing the appropriate instrument are only the first two steps in the planning process. The third is the development of a thoughtful giving strategy. The same thinking that goes into the business plan must go into the actual investment in the nonprofit sector.

The philanthropy adviser should counsel the client on the following:

What social issues he or she hopes to affect?

Which nonprofit organizations working on those issues are the most effective?

Should the client make many small grants or a few large ones?

How to evaluate the effectiveness of the nonprofit organization or program that the donor funds.

How to support non-U.S. charities and still get a tax benefit.

How to choose between anonymity and visibility.

It takes a complete team to provide full service to a client who has the desire to be philanthropic.

Phyllis R. McGrath, President
Philanthropy Management, Inc.
Basking Ridge, New Jersey