The “urge to merge” has profoundly affected the public accounting profession in recent years, as firms combine, acquire smaller boutique firms, expand service lines, and add people. The impact on the profession has been broad and deep, affecting firms of all sizes. The reasons behind these mergers are economic and strategic: they can help firms fuel growth, develop the next generation of leadership, enhance technical capabilities, expand geographically, compete, and maintain relevance in a rapidly changing environment. All are valid reasons for merging; however, maintaining independence of assurance clients post-merger becomes more complex as a firm adds locations, services, and people, including non-CPA specialists. Consider these questions:
- Is there a process for evaluating independence implications of new service lines and determining whether the firm can provide these services to assurance clients?
- If new services impair independence, does the firm have a process for evaluating, from a business standpoint, whether to perform assurance or nonattest services for the client?
- How are new non-CPAs educated about their new professional responsibilities as an audit firm employee?
These are just a few of the questions firms should consider as they grow; other, more immediate issues can come up while deals are being worked out. Business and employment relationships and nonattest service arrangements gained in a merger or acquisition can impair independence for the immediate past period (i.e., the financial statement period subject to assurance services).
This article uses three short case studies to illustrate issues that can arise when firms merge, acquire, or are acquired by another firm, and the relevant guidance in the AICPA Code of Professional Conduct, section 1.220.040, “Firm Mergers and Acquisitions.” The questions to consider are addressed in the context of the case studies.
Case Study: Partner of Acquired Firm Serves on Audit Client Board of Directors of Acquiring Firm
Marker CPAs has been searching for acquisitions that complement the firm’s strong audit and tax practices by adding certain industry expertise and opportunities for additional advisory services. Negotiations to purchase 100% of Song & Finch, CPAs (S&F) were almost complete in November 2017 when Marker discovered that Janice, an S&F partner, was a director of Widgets, Inc., an audit client of Marker’s. Both firms realize that a partner may not serve in a management capacity at an audit client during the period of the professional engagement or the period of the financial statements. What actions, if any, can the firms take to rectify the independence issue?
First, Janice should resign from the Widgets board before the transaction closing date and sever any other ties with Widgets in accordance with section 1.277.010, “Former Employment or Association with an Attest Client,” including selling her Widgets stock. Second, Janice should not participate in the upcoming audit engagement or oversee the Widgets engagement for any periods in which she served as a Widgets director. Before the audit report is released, Marker’s quality control director should evaluate whether Janice’s prior position with Widgets and her current role in the firm create any additional threats to the firm’s independence. For example, if Janice will interact with the Widgets audit team or the team will be evaluating her work as a Widgets director, the firm should apply safeguards to reduce the threat to an acceptable level. Specifically, a suitably experienced and objective professional with sufficient stature should evaluate the next audit engagement to determine whether the team maintained its independence. Before issuing the report, the Widgets audit partner should also discuss Marker’s independence assessment and the safeguards applied with the Widgets board. The rule encourages the partner to document the evaluation and actions taken (generally a good practice).
Shortly after the transaction closes, Marker’s quality control director meets with the firm’s learning and development team to discuss training to bring the newly acquired personnel up to speed with the firm’s practices, including independence and ethics compliance. Approximately 25% of S&F’s staff and partners are from outside the accounting profession, so the team plans to take that fact into consideration when planning its approach.
Case Study: Acquiring Firm Performed Prohibited Valuation Services for Acquired Firm’s Audit Client
Telent & Moyers, LLP (T&M) acquired Durham Durham & Feldman, LLP (DDF), in a transaction completed on January 15, 2018. DDF is the auditor of Bell Co (December 31, 2017, year end) and has learned that T&M provided two nonattest service engagements to Bell. In 2016, T&M completed a valuation of Bell’s employee stock ownership plan (ESOP), and six months ago, the firm valued certain assets that were material to Bell. The ESOP valuation preceded the period covered by the financial statements that the combined firm will audit in early 2018, and therefore does not affect independence; however, the more recent valuation engagement occurred during the 2017 financial statement period and will disqualify the firm from performing the audit in 2018.
Case Study: Acquired Firm Provides Prohibited Nonattest Services to Acquiring Firm’s Review Client
Stanwick Ledge & Associates (SLA) is a large regional accounting firm that commits to purchase 100% of HR Management, LLC, (HRM), a small consulting firm that advises technology startups on hiring practices. The transaction is expected to close on December 1, 2018. A review of pending engagements shows that HRM is providing nonattest services to EES, Inc., an SLA financial statement review client with a December 31, 2018, year end. SLA determines that these services do not meet the AICPA independence requirements for nonattest services (section 1.295). What, if anything, can the firms do to resolve the independence issue?
First, assume that SLA wishes to retain both the review and the nonattest services. Prior to the closing, the firm can modify the scope of the services or ensure that a member of client management is responsible for decision making in relation to the services to align the engagement with the independence standards. (Note that the firm should also revise the scope section of the engagement letter as documentation for the change.) As in the first case study, before issuing the next review report, SLA should discuss the independence evaluation and any steps taken to safeguard independence with EES’s governance body. If the independence issue cannot be resolved through a scope or other change, HRM should complete or terminate the nonattest engagement prior to the closing, or SLA should resign from the review engagement.
SLA should also consider whether any other threats impact the firm’s independence. SLA will take responsibility for the result of HRM’s nonattest services, so the evaluation should address all prohibited services HRM performed for EES for the calendar year ending December 31, 2018. The interpretation provides factors to consider in the evaluation and potential safeguards (section 1.220.040, paras. .08, .10). If SLA were not assuming responsibility for HRM’s services, SLA’s evaluation would apply to prohibited services performed in the period in which the acquisition was pending—that is, from the start of negotiations to the transaction’s effective date.
One question going forward will be whether the firm’s current process for evaluating new and different advisory services for independence issues is robust enough. Strong policies and processes to track and review nonattest service engagements before they are accepted are imperative as a firm’s service offerings and the number of service providers increase. Nonattest service providers and assurance partners must communicate early in the process to ensure that advisory services meet applicable independence standards or are not accepted. The firm should have a fair and thoughtful process for determining which options to present to the client when independence rules force a choice between assurance and nonattest services. Conversations among firm members will be far more productive, efficient, and congenial when the firm determines ahead of time how to handle these matters.
Looking Ahead
Although the current business environment drives many smaller audit firms toward mergers or acquisitions to achieve growth, being a larger firm comes with its own challenges—particularly when expansion is rapid. More staff, office locations, clients, and service offerings mean more independence and ethics-related issues. Firms can manage risks, protect their reputation, and stay ahead of compliance issues with proper planning and diligence. As soon as merger plans are announced, firms should work together to identify possible independence issues caused by relationships and services and resolve those issues in a timely manner. Looking ahead, firms should educate their newly acquired personnel (especially new entrants to the profession) about their commitment to serve clients with integrity and independence. With significant growth, firms may also need to reconsider policies and procedures that were effective in the past but may no longer meet their needs as a larger, less centralized organization.
