Competition from unexpected places
By Nicholas J. Mastracchio, Jr.
Don't Fight the Inevitable
Perhaps the biggest perceived threat to the livelihood and well being of the local CPA firm is no longer the large, national accounting firms. The entities that seem to have their sights on the clients of small and medium-sized firms are commercial and financial institutions that are acquiring CPA practices and operating them through their tax and business services subsidiaries.
Could or should professional organizations or regulators have stopped the entry of these alternative forms of practice into the market. The courts in Florida could not do it. The Supreme Court saw nothing evil about the advance.
Compilations under SSARS may also be a victim of the new breed. The AICPA is considering allowing CPAs working in nonlicensed entities to issue compilation reports on financial statements. Also, a financial statement submitted to a client bearing the logo of a well-known financial services company may be accepted in lieu of a compilation report issued by a relatively unknown local practitioner.
Regulators and the profession are trying to grapple with the changing nature of the practice of public accounting. How can regulators exercise their responsibilities to protect the public? Do those responsibilities extend to CPAs working for unlicensed commercial entities? Will the new Uniform Accountancy Act resolve some of these problems?
Changes are occurring in the marketplace for services offered by CPA firms. Not so long ago, at Management of an Accounting Practice conferences, associations of CPA firms meetings, and informal get-togethers of local firm practitioners, there were countless discussions about the threat of the large international firms targeting small and medium-sized businesses. However, not a word was spoken about the threat from banks and other financial institutions that are now in search of CPA firm clients. Are grocery chains next? It seems incredible that the greatest sources of change in the CPA marketplace are financial and commercial organizations and not the large international CPA firms. Many firms seem to be denying changes are taking place or confused about what they should do. These firms must realize that things will never be as they used to be and there are actions to be taken.
We always assumed that most of what the profession does would be done by CPAs in licensed CPA firms. Now it seems that this assumption is false. The right of other commercial entities to offer the services we offer and advertise that CPAs will perform them has been conceded by the profession and the regulators.
Could we have stopped the entry of these organizations into the market? The question is moot. What is more important now is to decide what strategy CPAs in small and medium-sized practice units should employ to successfully compete and remain viable.
Our role as CPAs has always been rather unique in the business world. We are trusted and valued for our objectivity, competence, and professionalism, values derived from performing audits and other attest services. We believe the public expects these same values to apply when the CPA performs other tax and consulting functions in a licensed environment. This is what distinguishes the CPA from others providing similar services; however, this distinction is subject to challenge by others that are entering the marketplace.
The Lesson of SSARS
Many local firms perform more reviews and compilations than audits, and compilations are more common than reviews. When Statement on Standards for Accounting and Review Services (SSARS) was first introduced, reviews became a new type of attest function, providing negative assurance to third parties. The intent was to give businesses an alternative with a higher level of assurance than the old prepared without audit service. Indeed, many clients did opt for reviews. Another somewhat unexpected result was that clients needing an audit only for lending purposes were sometimes able to convince banks to accept a review. Since reviews are considerably less expensive, other banks agreed to accept them in order to remain competitive. The marketplace demonstrated that it was willing to accept less assurance.
Similar reasoning may now threaten SSARS services altogether; they may be replaced by services from businesses not owned by CPAs. For example, a plain paper statement with the logo of a recognized financial services firm may prevail in the marketplace over a compilation report from a lesser-known CPA firm.
In some jurisdictions, CPAs working in businesses not owned by CPAs can call themselves CPAs and issue financial statements on plain paper or using safe harbor language. Could such statements replace the compilation as the low-end product, acceptable to third-party users?
Another prospect on the horizon is the possibility that the AICPA will permit all CPAs, even those working in businesses not owned by CPAs, to issue compilation reports. If this were to happen, compilations would no longer be subject to peer review requirements and would lose value in the marketplace.
The Growth of Consulting Services
In some firms, particularly the larger firms, consulting services have become the fastest-growing and most profitable segment of the business. As consulting has become more important, there has been an increasing concern over independence. For example, could the CPA install an accounting system and still make a judgment on the effectiveness of internal control for purposes of conducting an audit? The SEC has also expressed concern that fees from these services might impair the independence of CPAs and admitted that it was a major factor in its involvement in the creation of the Independence Standards Board. By their own doing, CPA firms have caused the marketplace to view them as multidimensional providers not unlike the financial institutions and others seeking to enter the CPA business.
Defending Our Turf
For the most part, state regulation of CPAs has been different from that of most professions. For example, there is very little that a physician does in a medical practice that a nonphysician can offer to the public as a service, even if the public is informed that the service is being provided by a nonphysician. This is not true of CPAs. Excluding various grandfathering of non-CPAs, most states do not allow for the attest function to be performed by someone other than a licensed CPA. However, many of the other services CPAs routinely provide may be performed by unlicensed individuals. These services include tax preparation and consulting.
How are CPAs regulated when performing these nonattest, unrestricted functions? For instance, if a few CPAs were to open up an ice cream stand and not adhere to state health regulations, would their CPA licenses be in jeopardy? Not likely. However, if they were to perform audits in a grossly negligent manner their licenses would be in jeopardy. The problem is in dealing with service issues lying somewhere between these two extremes. What other activities besides attest functions are covered in the regulation of CPAs? Can a CPA prepare tax returns for
a commercial establishment that advertises that the returns will be prepared by CPAs? If unlicensed firms can
provide these services with CPAs, can the state licensing agencies regulate their conduct?
State regulators are concerned that because services are being performed by unlicensed firms, their ability to protect the public through regulating CPAs may be diminished. A look at licensing issues in a few states will help to understand the dilemma faced in contending with the question of who can provide services and the potential erosion of the public's protection through a regulated profession.
Could the Arrival of Unlicensed Firms Have Been Halted?
Although each state has its own laws defining and regulating the practice of certified public accounting, many are modeled after an old uniform accountancy act, which basically attempts to regulate all the services a CPA offers the public.
Perhaps the most significant challenge to a typical state law is the case of Ibanez v. Florida State Department of Professional Regulations [(114 S. Ct. 2084(1994)]. Silvia Ibanez, a licensed Florida attorney practicing as an attorney, advertised her credentials as a licensed CPA and certified financial planner. The Florida Board of Accountancy, among other allegations, claimed that since her firm was not licensed as a CPA firm, advertising that she was a CPA was misleading to the public.
Ibanez claimed that she was practicing law, not accounting, that the use of her titles was not deceptive or misleading, and that to deny her the right to say so was against her First Amendment right to free speech. The Supreme Court noted that Ibanez was not charged with any noncompliance of regulatory standards in the conduct of her work. They concluded that for Ibanez to say she was a CPA was not misleading, because she was in fact a CPA.
Florida was also the site of another losing battle. In 1997, Stephen M. Miller, a CPA, and American Express Tax and Business Services, his employer, brought action against the secretary of the Florida Department of Business and Professional Regulations and members of the Florida Board of Accountancy. Miller held an active CPA license in Florida and was managing director of American Express Tax and Business Services (TBS) in Tampa, Fla. In his complaint, Miller sought to assert a First Amendment right to disclose his CPA designation on business cards, letterheads, and written advertisements. He would be holding himself out as a CPA under Florida law. In contrast to Ibanez, he would be offering services to the public that involve the use of accounting skills. Florida asserted that holding oneself out as a CPA and offering such services constitutes the unlawful practice of public accounting and therefore revoked his license. The court held that, as applied to plaintiff Miller and other similar individuals, the enforcement of Florida statues violates the First Amendment. Laws may not prohibit a CPA employed by an unlicensed accounting firm and performing only nonattest business services of the kind identified in Florida statutes from truthfully informing clients or prospective clients that he or she is a CPA. (Miller v. Stuart 1997 WL 3944601 11th Cir Fla). The Supreme Court denied a writ of certiorari on the decision. Within 10 days, the Florida Institute of CPAs began a legislative initiate to adopt a new definition for the practice of public accounting in Florida.
One aspect of the initiative was to establish a new level of services in Florida called "assembled financial statements: providing various manual or automated bookkeeping or data processing services the output of which is in the form of financial statements." Only a CPA can provide this service, but the entity identified on the letterhead need not be a licensed firm.
In Texas, the courts found in Opella v. Texas State Board of Public Accountancy that an association comprised in part of nonlicensed members was required to use a prescribed transmittal form disclaiming any form of assurance with respect to balance sheets and related statements of income. In 1997, however, TBS attempted to issue letters that referred to AICPA standards. The court (Para 64,205 D. CT. Travis Co. 1986) permanently enjoined them from issuing in Texas the form of transmittals that they were using and stated that they may only lawfully issue basic financial statement transmittal letters of the kind approved in Opella.
TBS in New York
By late 1997, TBS had over 40 offices in approximately 20 states and employed more than 1,000 people, over half of them CPAs. TBS was ready to take on New York State. Section 7401 of the state education law is relatively imprecise in its definition of public accountancy. It states as follows:
The practice of the profession of public accountancy is defined as holding one's [sic] self out to the public, in consideration of compensation received or to be received, offering to perform or performing for other persons, services which involve signing, delivering or issuing, or causing to be signed, delivered, or issued any financial, accounting, or related statement or any opinion on, report on, or certificate to such statement if, by reason of the signature, or the stationary or wording employed, or otherwise, it is indicated or implied that the practitioner has acted or is acting, in relation to said financial, accounting, or related statement, or reporting as an independent accountant or auditor or as an individual having or purporting to have expert knowledge in accounting or auditing.
In mid-November 1997 it was reported that TBS was close to buying Goldstein, Golub, Kessler & Co., one of New York's largest regional firms. At first it was not clear to state regulators that TBS could offer to provide services performed by CPAs that were employed by unlicensed businesses. TBS, however, expressed the belief that its typical method of operation would be legal in New York.
Under the typical TBS arrangement, TBS hires the staff and owners of the CPA firm, the CPA firm remains in existence and provides attest services using staff hired from TBS, and TBS provides the nonattest functions. In addition, the CPA firm leases space and equipment from TBS. The CPA firm is responsible for the attest function and maintains its own malpractice insurance. Although substance over form comes to mind, there is technically a separation of attest functions and other functions.
New York State had to decide where to draw the line in order to maintain regulatory oversight over the activities of CPAs while not putting itself in a position to lose a court battle with TBS, based upon the decisions in other states.
One of the issues facing the state was that the New York definition of the practice of public accountancy does not prohibit a CPA from issuing a financial statement without any acknowledgement of the degree of responsibility taken with respect to the financial statements, i.e., plain paper reporting. However, under the definition, financial statements issued under SSARS that include SSARS cover language are the practice of accountancy. Finally, if there are attest services that do not include a financial statement, New York State law would not consider them to be the practice of accountancy. For example, an opinion that a business's internal controls were adequate would not constitute the practice of accountancy.
The Threat to the Small Firm
Essentially the position apparently formulated by the New York regulators is that the audit, compilation, and review of financial statements constitute the scope of practice of public accountancy and nothing more. It is evident from the correspondence from regulators that this decision was made with grave concern about the future of the accounting profession and the ability of the state to oversee it. The current regulatory environment creates an opening for any company to offer services performed by CPAs.
If the CPAs employed by an unlicensed firm are not practicing accountancy, how are they regulated? How is the public protected? There is nothing in the Ibanez decision to imply that the defendant could not have notified her clients that she possessed a CPA certificate even if the certificate was from another state. What would prevent a business from employing a CPA licensed in another state? If the employee performed in a negligent manner, what could state regulators do?
The New York law requires continuing professional education for CPAs, but only if they are practicing public accounting. Under current regulations, the CPA in the unlicensed firm could theoretically ignore the education requirements, especially if she did not participate in attest engagements. This would appear to put the local CPA firm at a competitive disadvantage.
The actions of TBS (and other potential consolidators, such as HRB Business Services or Century Business Services) are a threat to the smaller CPA firms where attest functions are not a significant part of the practice. Another concern is whether firms without attest practices will remain CPA firms. What would prevent them from changing to an unregulated form of business and abandoning the rules that come with regulatory oversight, such as continuing professional education? In 1977, when the AICPA initiated the division of firms, it provided membership to the firms themselves and not just individuals. Membership required a variety of quality control procedures. Many small CPA firms chose not to join, explaining that the additional cost of compliance from quality control documents and continuing professional education requirements would make them less competitive with those who did not join. In the future, smaller firms may decide that the cost of remaining a regulated entity makes them less competitive.
The entrance of entities such as TBS may cause a loss in value for the attest financial statement services in two ways. Many of their clients may only need attest financial statements for purposes of a loan made by a related entity. If these related entities will lend money on the basis of a financial statement prepared by CPAs working in the sister company, the need for an attest report is eliminated. In response to this, other financial institutions may be willing to accept financial statements bearing the imprimatur of the other commercial entity. It is not difficult to imagine a representative from one of these entities talking to a small firm client and stating that the entity's reputation is behind the financial statements, with its quality control and training programs. If the commercial organization's issuance of financial statements becomes as acceptable to businesses and the financial community as the unaudited SSARS statements issued by licensed firms, SSARS statements may lose their value.
This may not be an issue for the largest of the CPA firms; however, a 1991 AICPA study indicated that there were 46,641 practice units in the United States and 45,146 (96.8%) had fewer than 10 AICPA members and 25,332 (54.3%) were sole practitioner units. According to a Texas survey, attest services represent only about 10% of the current workload of practicing CPAs. Thus, the potential impact on the profession and the services offered to businesses is extremely significant. The professional organizations are aware of the problem and have offered some remedies.
Solutions in Process
The AICPA and NASBA have recently published the third edition of the Uniform Accountancy Act and Uniform Accountancy Act Rules. While this document is designed to make the CPA certificate more portable over state lines and establish more uniformity between states' rules, it also addresses some of the issues discussed above.
The Uniform Accountancy Act (UAA) originally redefined the attest function to include both reviews and compilations of financial statements and the examination of prospective financial information. The restriction of attest functions to licensed firms would have reserved all SSARS work to those firms. At its May 1999 meeting, the AICPA Council voted to allow CPAs working in unlicensed firms to issue compilation reports over the individual CPA's signature. As a result, the UAA will be changed to permit this service. The new UAA also notes that anyone, whether licensed or not, may offer and perform any other kind of accounting service, including tax services, management advisory services, and the preparation of financial statements that do not include such reports.
The new UAA also requires continuing professional education (CPE) for all licensees. Not all states currently have a CPE requirement, and many do not require CPE for CPAs not actively engaged in offering services to the public. This provision would thus require all CPAs using the designation to complete mandatory education requirements. The alternative would be to use the credential followed parenthetically by the word "inactive."
It has yet to be determined to what extent the various state legislators will be inclined to conform their accountancy statutes to the UAA. Two bills have been submitted to the New York State legislature that seek to address some of the recent developments. One bill includes many of the provisions of the UAA, including the requirement that all CPAs using the credential must comply with the CPE requirements and a provision to allow non-CPAs to own a percentage of CPA firms. The other bill seeks to redefine the scope of practice of CPAs providing services to the public to clarify what activities of a CPA are subject to discipline by state regulators. Neither of the bills reflect the AICPA Council's decision to allow CPAs in unlicensed firms to issue compilation reports. CPAs in public practice, especially those in small and medium-sized firms, should watch the progress of legislation in their states very carefully and let their opinions be known.
Will the Small CPA Firm Become Extinct?
TBS is not alone. HRB Business Services, a subsidiary of H&R Block, recently reached an agreement to purchase Freed Maxick Sachs & Murphy P.C., the largest local accounting firm in western New York. News reports have indicated that HRB is negotiating with McGladrey & Pullen, the sixth largest CPA firm in the United States with revenues in the $300 million range. Banks may begin providing similar services as a way to broaden their business activities or in response to the threat to their retention of loan customers. With the ability to advertise that tax returns are being done by CPAs, the general retail public could be attracted to offering such a service. Imagine advertisements calling for a customer to shop at their store "while one of our CPAs prepares your tax return."
Ultimately, the survival of the small CPA firm is up to the marketplace. Will small businesses and other users of small businesses' financial statements continue to value receiving compilations and reviews from a licensed firm? Will they be more inclined to consider the reputation of the unlicensed firm and decide that the financial statement issued by a large, well-known company is just as satisfactory as the SSARS statement from a small firm?
The local accounting firms are going to be targeted not by the Big Five accounting firms but by these organizations, which will be structured specifically to go after their clients with similar and perhaps expanded services. The competition will be more intense than it has been in the past.
What Can a Firm Do?
State laws were written to define the practice of public accounting during a different era and do not provide for the exclusive rights to most of the work that we do as CPAs. The Supreme Court decision in Ibanez eliminated the restriction on holding out as being a CPA. The Miller decision seems to seal the inevitable. The new UAA concedes the issue. The adoption of the new UAA will recognize that we have to accept the challenge that unlicensed firms bring to the marketplace. It will, however, be the small firm's responsibility to provide services to their clients in a way that will produce loyalty, satisfaction, and retention. Hopefully, the small, local CPA firm will not become extinct due to increased competition from the marketplace. *
Nicholas J. Mastracchio, Jr., PhD, CPA, is an associate professor at the State University of New York at Albany and a consultant on business
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