Secrets to a successful on-site peer review

By Raymond M. Nowicki

In Brief

Opportunities for Excellence

After more than 20 years of peer and quality reviews, leading firms have developed techniques that assure they will receive at least an unmodified (clean) report, and many have eliminated the risk of a letter of comments. The strategies and techniques of these leaders are applicable to even the smallest CPA firm. Myths about peer review standards abound, but understanding the system and following sound management principles can bring review costs down and assure a successful peer review. The author presents the "secrets" that the leaders use for successful peer reviews.

Secret No. 1: Firm Philosophy

The key to a good quality control system—and a good peer review—is the desire to achieve quality, itself. A firm’s philosophy is paramount. “Quality is a way of living and practicing,” says David Pitcher, a member of the NYSSCPA Peer Review Committee. “You can’t imitate a quality firm for a day.” A successful quality control system must start with the partners, in their thoughts, words, and deeds. Staff will generally imitate the partners’ attitudes and behavior. On the other hand, too many small CPA firms struggle through the triennial peer review process, hoping to achieve a passing grade. Why? Although the specific reasons vary, the truth is, many small firm practitioners tolerate the process as an intrusion rather than integrate it into their business plan. These practitioners think they need peer review for reasons other than quality professional service:

  • To maintain AICPA membership and continue as part of its insurance program.
  • To qualify as an auditor under Yellow Book or similar standards.
  • To maintain a license, because some states require a peer review as a condition for continued licensure.

    While certainly practical considerations, these motives actually indicate that the firm is on a road to self-destruction. Embracing the desire for quality itself, and leveraging the peer review process toward this goal, is the first secret of leading firms. Desired behavior is conditioned on the attitude that pursues quality in these firms.

    Secret No. 2: A System That Works

    The nature of a firm and its client base is the first consideration when developing a quality control system: One size does not fit all. Neither Big Five, AICPA, nor peer reviewer defines the right approach to serving a client’s accounting and auditing needs. That must be done by the practitioner. There are some minimum requirements in documentation; however, audit approaches may otherwise differ between large firms and small firms, while both meet the needs of an appropriate quality control system. For example, a large firm can provide an independent review of each financial statement (cold partner review) in order to assure that disclosure and documentation requirements are all met. Conversely, a sole practitioner can achieve a similar quality level by waiting a few days after completing the job, and then doing a last detailed look at the working papers and financial statements and disclosures.

    Secret No. 3: Cover All the Standards

    A firm’s peer review system needs to cover all of the following elements:

  • Independence
  • Personnel management
  • Acceptance and continuance
  • Engagement performance
  • Monitoring.

    In most small CPA firms, independence, personnel management, and acceptance and continuance issues can be handled adequately with minimal documentation. Annual written personnel evaluations and the review of CPE files will normally satisfy quality control standards. Independence, objectivity, and integrity issues in these firms typically result from uncollected receivables from clients, a problem that most partners recognize. However, the occasional granting of “check-signing authority” by a client could lead to a very severe letter of comment.

    Client acceptance and continuation issues are often handled through the local grapevine of bankers, lawyers, and other referral sources. For quality control purposes, it helps to include a form in the permanent file to update regularly acceptance and continuation documentation. (It is a sound idea to review clients that create the most aggravation and consider whether they are worth serving.)

    There is a second issue associated with engagement acceptance. Most small firms know their limitations and the types of engagements they can professionally complete. Although documentation of these matters does not need to be extensive, a firm needs to have a systematic means of demonstrating its satisfaction that all partners are equally concerned with these areas and committed to these standards.

    Secret No. 4: Engagement Performance, an Easy Target

    Engagement performance deficiencies are easily identified by the peer review team upon inspection of a firm’s files. The following are areas where frequent errors are uncovered:

  • Failure to implement newer standards, disclosures, or audit techniques. These could be identified and implemented if the firm attended recent audit and accounting updates. (Solution: Check CPE files and look carefully at the annual audit, compilation, and review risk alerts prepared by the AICPA.)
  • Failure to use complete and current guidance material. Some firms still attempt to develop their own programs, which is neither efficient nor cost-effective and typically results in outdated and incomplete checklists. (Solution: Invest in the well-known program packages. These programs are usually prereviewed, thus saving the cost of having the reviewer inspect them closely.)
  • Failure of staff and partners to understand issues required by the firm’s guidance material. Both staff and partners will inadvertently pass over a recent addition to a program because they do not understand its relevance to this engagement. (Solution: Ask the firm’s quality control partner to hold a briefing on recent changes to the programs, so that the relevant changes are noted and addressed by all.)
  • Failure to address and sign off on completed program steps. This simple mandate should be constantly hammered home by partners. (Solution: In final review, a partner should be concerned that all staff have taken responsibility for their work by signing off.)
  • Failure of the firm to address findings from its prior peer review. The AICPA now requires the state peer review committees to consider whether repeated errors are an indication of the firm’s unwillingness to cooperate with the process. More importantly, why would a firm not implement such an obvious measure when aiming for a clean report?

    Secret No. 5: Anticipate Problem Engagements

    Problem engagements typically occur with high visibility or high exposure clients.

    High visibility engagements primarily relate to clients that serve the public, such as governments, school districts, banks or credit unions, and pension plans. Typically, these entities are subject to specialized accounting principles and reporting requirements. They receive an inordinate amount of attention from regulators, such as the Pension Benefit Guarantee Corporation (PBGC), federal and state oversight or regulatory agencies, and the AICPA Peer Review Program, as well as the general public.

    Historical evidence from the PBGC, supported by AICPA peer review statistics, indicates that as many as 85% of the pension reports issued by CPAs have serious flaws. As a result, the PBGC has warned that it will conduct a study of the 1999–2000 pension reports (Form 5500) in the year 2002 and report its findings to Congress. It has been this author’s experience that most small CPA firms have one large client with a 401(k) or pension plan audit requirement. Unfortunately, they treat it as an add-on service performed at a low price without adequate consideration to the extent of exposure they are facing from regulators.

    Governments and other entities subject to Yellow Book reporting require auditors to maintain minimum levels of CPE. Since Yellow Book requirements have been widely disseminated, most firms are aware of their minimum CPE requirements and in compliance.

    The following are other exposures that may require extra service and analysis:

  • Going concern issues
  • Environmental problems (such as the neighborhood gas station)
  • Weak management ethics (such as clients that openly brag about unreported sales and questionable deductions)
  • Litigation, especially from unfulfilled contracts and employee suits.

    Leader firms consider the intrinsic cost to maintain these high visibility clients and have the means to document their considerations and the decisions they make concerning client continuance.

    Secret No. 6: Monitoring (Inspections)

    The revision of the Peer Review Elements reduced the number of standards from nine to five and changed the inspection element, renaming it monitoring. Because of this change, many firms stopped doing the complete, annual inspections that had been the norm. Although it is possible, in theory, to substitute a pre- or postissuance review for an annual inspection, in reality, leading firms have found there is no substitute for a specific period of thorough self-evaluation.

    Sole practitioners have a unique problem in addressing monitoring issues, because an error will not be caught during an inspection if the practitioner was unaware of the problem when the work was done. Simply put, the sole practitioner usually does not know what he does not know. Therefore, self-inspection has little or no value. For this reason, it is wise for sole practitioners to request that other professionals inspect their work, at least in the year prior to peer review.

    This problem is not exclusive to small firms, however. In larger, multipartner firms, managers sometimes perform the annual inspection. This arrangement frequently fails to achieve maximum benefit, because the manager—

  • fears that an inspection critical of an important partner might damage the inspector’s own chances for partnership;
  • does not want to identify a colleague as a nonperformer;
  • may not have access to all information, such as personnel files or independence confirmations, and may hesitate to pry into partners’ affairs;
  • may not be experienced in all aspects of the peer review process; and
  • may have commitments to billable client projects that interfere with the timely planning and completion of the annual inspection.

    Although self-inspection satisfies the intent of the standard, it usually does not result in a thorough, comprehensive solution. Such a solution would include asking a reviewer other than the firm’s regular peer reviewer to quote the cost of an inspection. These outside inspections provide insights into the work of others and a fresh perspective on the quality control system.

    Secret No. 7: Preparing Firm Statistics

    In preparation for a review, each firm is required to compile a list of client engagements subject to the peer review process. The format of the summary requires the following data for each engagement:

  • An identification number or name
  • The number of audit and accounting hours dedicated to it, excluding bookkeeping, tax services, and management advisory service hours
  • The engagement’s fiscal year end
  • The engagement partner
  • The type of industry.

    It is a simple form, yet many small firms fail to complete it properly—a costly and unnecessary failure.

    First, this form helps identify areas of specialization. Firms that concentrate 10% or more of their practice in a specific area will need a peer reviewer with current experience in that area. The more specialized areas, the more engagement team members may be required to participate, increasing the cost of the review.

    Second, firms often include bookkeeping, tax preparation, and other nonaudit or accounting hours in this summary. When a reviewer identifies this error, the statistics must be reworked. If the error is noted when the reviewer is on site, this error may delay an efficient review.

    This type of error in the preparation of statistical information adds dollars to the cost of a review. Firms that take this phase of preparation seriously will use this as an opportunity to further analyze their client base and the profitability of each engagement.

    Secret No. 8: Selecting the Reviewer

    The peer review process has been around for a long time, and some firms have become “comfortable” with their reviewers. Over time, firms have identified reviewers that demonstrate technical competence, good communication skills, and sound philosophies from similar-sized firms. In other words, the reviewers are now true peers of their reviewed firms. This is one reason why the statistics show that more firms are achieving clean reports. A long-term reviewer is capable of differentiating between systemic, recurring issues and transitory matters that can be addressed informally.

    Unfortunately, some firms believe that they can achieve the same result by hiring a reviewer who demonstrates lighter technical skills and a willingness to gloss over issues: an easy grader. The NYSSCPA Peer Review Committee has committed new efforts to inspecting the work of reviewers in the field. This process, called oversight, is designed to ensure that both the process and its outcomes are credible. During an oversight, a reviewer’s working papers will be inspected and compared to the firm’s engagement work and financial statements. In cases where the reviewer has failed to identify obvious problems in the reviewed firm’s quality control system, the Peer Review Committee may take any number of actions to correct the problem, including requiring a new review and expanding the findings or work of the present review.

    The committee considers the following criteria when selecting reviewers for oversight:

  • Reviewers that do a large number of reviews
  • Reviewers that show a pattern of unprofessional work due to lack of timeliness, incomplete reports, letters of comment, or other deficiencies
  • Random selection
  • Referral from the technical manager or the committee.

    If a review or reviewer is selected for oversight, this does not necessarily signal a problem. The author was one of the first peer reviewers to be subjected to oversight. Though the notification did give me butterflies, the experience itself proved that oversight did not increase the time required for the review and gave me and my peer review clients the comfort of knowing that work was being performed according to the standards.

    Secret No. 9: The End Game, and Dealing with the Reviewer

    The following are approaches to achieve a clean report with no letter of comments. Some may be controversial, but all are effective when used appropriately:

  • Housecleaning. Typically, a peer reviewer will provide an advance list of files likely to be reviewed. If you do not receive the list, you can assume that the reviewer will pick a pension audit, Yellow Book engagement, or first-time engagement. Fatal errors include—
  • multiple engagements that do not meet professional standards.

    Prepare the staff. If everyone has not recently read the firm’s quality control policies, encourage them to do so. If the firm does not have a written quality control document, review unwritten policies with all staff.

    Never assume the reviewer is perfect. If a reviewer issues a finding that seems inappropriate, ask to see the standards that describe the issue. Sometimes, reviewers substitute personal preference for professional standards.

    Are findings systemic or isolated? Everyone makes an occasional mistake. If a deficiency is noted on one engagement, offer the reviewer one or two examples where the firm handled a similar matter properly.

    The final debate. If the firm is down to one or two findings and can argue that they are neither pervasive nor significant, challenge the reviewer by asking for a second opinion on the gravity of the issues and their impact on the review. This decision should be made by the best accounting and audit partner in the firm; it requires the combined skills of debate, technical knowledge, and knowledge of the peer review process. It can result in convincing your peer reviewer to issue a clean report without a letter of comments. However, it can also backfire for firms that have failed to properly recognize a serious deficiency.

    Don’t believe the myths. Some peer reviewers believe that the NYSSCPA Peer Review Committee “almost always expects the reviewer to find some deficiency.” This is untrue. The truth is that New York State’s 1999 review statistics showed that 51% of all firms achieved a clean report with no letter of comments. The majority of the firms achieving this favorable result had less than 10 professionals.

    Over the past 20 years, there has been a significant change in the way CPA firms perform their work. There is a focus on quality and consistency, and the degree of effort is virtually identical across all firms. This demonstrates the profession’s ability to regulate itself with little interference from the outside. With a little guidance and a commitment to quality, every firm can achieve a clean report.

    Raymond M. Nowicki, CPA, is a partner of Nowicki & Company CPAs LLP, Buffalo, N.Y.

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