There seems to be a national trend of accounting firms getting into the software business. This is usually in an effort to grow revenue by selling additional products and services to an existing client base. That’s usually harmless unless the firm is customizing the software or receiving a commission from the software provider, especially if an accounting firm is providing attest services to that same client.
Accounting firms are held to a higher standard. After all, accountants have a duty to maintain and broaden the public’s confidence in the profession and their related work product. According to the American Institute of CPAs, the organization responsible for setting ethical and professional standards for accountants and accounting firms, “members are required to follow a rigorous Code of Professional Conduct (AICPA Code) which requires that they act with integrity, objectivity, due care, competence, fully disclose any conflicts of interest (and obtain client consent if a conflict exists), maintain client confidentiality, disclose to the client any commission or referral fees, and serve the public interest when providing financial services.”
The AICPA Code defines strict rules for accounting firms and their ability to implement and customize commercial off-the-shelf (COTS) software and financial information systems (FIS). According to the code, “To customize a COTS FIS software solution means to modify or enhance the features and functions in ways that go beyond the options provided by the third-party vendor when configuring the COTS software solution.” Specifically, “Modification involves altering the COTS software solution code to change or add to the functionality provided by the third-party vendor. Enhancements involve developing new code, external to the COTS software solution, that works in concert with the COTS software solution to provide altered or additional functionality.” According to the AICPA Code, if an accounting firm customizes a client's COTS FIS software solution, independence would be impaired. This also applies to custom developed software that impacts financial reporting.
With independence impaired, accounting firms are not allowed to provide certain services to clients. Specifically, the AICPA Code prohibits accounting firms from providing audits of financial statements, reviews of financial statements, or compilations of financial statements where the report does not disclose a lack of independence. An accounting firm cannot provide any attest services for any client where it has customized a COTS FIS. If attest services are provided contrary to the AICPA Code, the client and other potential third parties might inadvertently rely on information that cannot be relied upon.
Also, according to the AICPA Code, in the performance of any professional service, a member must maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts. As a result, accounting firms are prohibited from receiving a commission in situations where independence is required. The AICPA defines a commission as “any compensation paid to [an accounting firm] for recommending or referring a third party’s product.” Accounting firms are expressly prohibited from accepting a commission from a third party related to a client for which the accounting firm provides attest services. When no attest services are provided, an accounting firm can accept a commission from a third party provided that the client has signed an appropriate disclosure and has acknowledged the conflict of interest.
Regardless of disclosure forms, accounting firms are expressly prohibited from providing any attest services (audit, reviews or compilations that do not disclose the lack of independence) or any examination of prospective financial statements. Therefore, by accepting a commission, an accounting firm is also prohibited from providing any valuation, sale-side M&A or any other services that would require an examination of prospective financial statements, including financial forecasts and financial projections. While it is up to the accounting firm to decide to forego certain services by accepting a commission, those prohibitions should also be disclosed to the affected clients. This is especially important considering how accounting firms market themselves as one-stop shops for all of their clients’ needs. Few clients would understand that their service options were limited by their accounting firm’s unilateral decision to accept a commission without a full disclosure.
This all seems very straightforward. If an accounting firm has customized a software product or developed its own software, it is not independent of the results produced. It is also clear that if an accounting firm accepts a commission from a software company to recommend the software, a conflict of interest exists. Full disclosures must be required. Many accounting firms have attempted to satisfy these requirements by adding more text to their generic disclosures included in engagement letters. This, however, is not enough: According to the AICPA Code, specific disclosure is required to provide sufficient information to “enable the client to make an informed decision with respect to the matter and to provide specific consent.” Many states, including California, Colorado, Oregon and Washington, go even further by requiring disclosure of the relationship, and the amount and calculation method of the commission, and require the client’s consent to the specific disclosure in writing before the goods and/or services are purchased. Accounting firms should also disclose, in advance, what additional services the firm is prohibited from providing as a result of the software customization and/or the acceptance of a commission.
Failure to disclose a lack of independence or a conflict of interest can open the door for potential liability and litigation for both the accounting firm and its clients. The accounting firm may also be subject to additional complaints, penalties, sanctions and loss of credibility. The client might use the resulting financial statements without knowing that the accounting firm was not independent because of software customization or accepting commissions. Third parties might rely on the financial statements provided. If something negative occurred, banks and investors may pursue legal remedies against both the accounting firm and the client.
All of these negative ramifications are unnecessary and can be easily avoided. Accounting firms should leave the development, implementation and customization of accounting software to software companies. If not, the worst is yet to come.
