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August 1994

The business of public accounting. (includes related article) (Cover Story)

by Craig, James L., Jr.

    Abstract- Competitive pressures have forced many public accounting firms to downsize, mainly through attrition and reduced hiring. The economic slowdown of the early 1990s, together with the increasing use of technology to automate many accounting tasks, spurred this shakeout in the profession. As a result, public accounting firms today are leaner, more specialized and more quality- and customer-oriented than before. Eight managing partners from practices of various sizes and specializations were convened to allow an exchange of views on the issues confronting the profession. All panel participants agreed that productivity, increased revenues and salary realignments were the principal concerns of their firms during the downsizing wave. They also identified accountant's liability, audit billing, retraining, and non-CPA ownership of firms as key issues that required attention.

Yet the services the profession offers are still considered essential to a stable and viable capitalistic system. The assurance function, which some label the compliance aspect of what it offers, is still respected and requested by users of financial information. And the business community highly regards tax compliance and consulting services, management consulting, and similar services performed within the context of a self-regulated environment.

Quality, value-added services, can only be, in the long run, delivered within the context of a profitable, successful business operation, a business operation that is effectively and efficiently managed.

Economics of the last few years have put severe pressures on the best of businesses. Downsizing and re-engineering are commonplace. Public accounting has not been exempted from the economic downturn.

The CPA Journal asked managing partners of eight practice unlts of varying sizes to discuss the economic issues and consequences facing the profession, not only because of the economy, but also because of the dominant role technology plays and the rapidly changing needs of users of financial information. The panelists were Larry Cinquegrana, R. D. Hunter & Co.; Neil Gibgot, Gibgot, Willenbacher & Co; Gerry Golub, Goldstein, Golub, Kessler & Co.; Richard Hecht, Charles Hecht & Co.; Bert Mitchell, Mitchell/Titus & Company; Herbert Morse, KPMG Peat Marwick; Stanley Nasberg, M.R. Weiser & Co.; and Maryann Winters, Baash, Winters & Breen, P.C.

The CPA Journal: As managers of firms and practice units, what actions did you take to minimize the effects of the downturn in the economy?

Gerry Golub: The weak economy created a flurry of merger activity as firms sought to consolidate and obtain economies of size. The idea has been to spread existing overhead over a broader income base. In our case, over the past three years, we had three groups join our organization. As a result we have been able to increase our billings and increase our bottom line notwithstanding the economic crunch--notwith- standing that many existing clients cut back on special work and put pressure on us to reduce fees for the basic compliance work of audit and tax returns.

Stanley Nasberg: Our approach was two-fold: reduce overhead and increase productivity of our professional staff, which we accomplished quite successfully. On the revenue side, we concentrated on developing niche or boutique practice areas. We encouraged our partners to develop specialties, with the intent of increasing market share.

Just as Gerry experienced some shrinkage for existing clients, we have had a decline in hours for many clients. But it wasn't just because of the economy. Technology gains have been an important factor operating during this period. But even with shrinkage for some existing clients and technologydriven efficiencies, through sales and marketing efforts, we have been able to increase collectible hours.

CPAJ: Stan, did you reduce staff during this period? Did downsizing occur?

Nasberg: Without question. We absolutely decreased the size of our staff and pushed the existing staff to increase collectible hours.

CPAJ: Gerry, you focused on increasing revenue through an expanded practice. Did you also do some downsizing of staff?

Golub: Not really. Our staff had been giving us the kind of effort we expected.

CPAJ: Did you cut back on salary increases during this time?

Golub: The professional staff of the firm performs at or above acceptable levels in what I consider to be a tough profession with night and weekend hours and demanding clients. To try to squeeze a few thousand dollars of salary out of them is not the answer. We want a highly motivated staff that operates at high productivity levels.

Bert Mitchell: During this period we actually experienced some undesirable turnover so that trimming of staff was not necessary. Companies had been furloughing older, more experienced people whose salary had crept above market levels. Those excessed were replaced with younger, less experienced people at lower salary levels. My staff was a prime target as a source for those replacements. Also, more recently, the Big Six firms have experienced shortages in middle levels--because of underhiring a few years ago and turnover to growing industries primarily in the financial area--and have gone to middle-tier firms such as mine to attract people.

Neil Gibgot: The recent upturn in the economy has created a need for middle-level accountants. And the senior people Bert talks about that lost jobs will never find comparable work. They are out of the marketplace.

On a quarterly basis, the managing partners of firms in my region gather to talk about business problems. About 50 managing partners participate, with probably 25 at any one meeting. Many of these firms gave smaller raises than in past years, and some gave no raises at all. These are not just small firms.

As far as my firm is concerned, we have a niche practice, specializing in the precious stones and jewelry business. A number of clients called upon us to help them work through operating problems the economy created for them. We tried to watch our expenses and computerize every aspect of our work to increase efficiency. All tax returns are done in house on the computer. Our accountant/auditor types all have laptop computers, which they take into the field.

Larry Cinquegrana: We are at about the same volume as we were at the end of 1990, but we have 10% less people. In the late '80s our salary increases were significant. When tough times came, we revised our salary structure to become more realistic, with raises in the 3% to 7% range. This was very different from the late '80s when we couldn't get enough of the people we wanted.

We did not fire people, we reduced our staffing by attrition. Right now we have a more experienced staff able to get the work done more expeditiously, albeit sometimes by using technology. Clients like to see the same people doing their work.

We have also had shrinkage as clients sought to reduce our involvement to reduce their costs--changing from monthly to quarterly visits, from quarterly to annual, and changing from audits to reviews or even compilations.

In the compliance area of tax returns, audits, and reviews, we are feeling competitive pressures from other firms. Clients don't seem to care who does this type of work.

On balance, our fees have been holding and our profits have been holding. But this is after a period of rapid growth--double digit in some years--we experienced in the early and mid eighties.

We cut our expenses wherever we could and we became very serious and focused on our marketing efforts. In the past we sought clients the old fashioned way--golf, Rotary club membership, and the like. But now we have two marketing people on board. We haven't seen the fruits of that effort yet, but we are serious about it.

Our receivables are older and larger now and we are struggling with that. But ultimately we are being paid. We are working with our clients through their tough times.

Herbert Morse: There are two very powerful forces at work. Clients are being squeezed; their businesses are changing dramatically. The second is technology. We have been forced to look at all our costs, whether it be in the office or the productivity of our people. While we retained our rate of salary increases pretty consistently, we flat out were working with fewer people. Like our clients, we sought to push staff to higher levels of productivity.

The firm has invested enormously in technology, as obviously everybody has, to gain further productivity increases. We are much quicker, more productive, much more responsive to clients. The combination of all these factors has made the last few years one of the most challenging periods from a practice management point of view than any of us have experienced.

CPAJ: Has the result been fundamental change in the way firms do things? And are these changes permanent?

Richard Hecht: Professional staff members are doing their work differently. The computer is doing the mechanical part of the task-- footing, posting, making changes to subtotals and totals. Now we expect staff to be more analytical. Some have found it difficult to make the change, to identify areas of risk. We need people with higher levels of skill.

Morse: The shape of the pyramid is changing dramatically. We used to be very wide at the bottom. But our leverage model is shrinking.

Golub: How do you get the staff up to the required levels and skills?

Morse: Internally, we are rolling around on the floor on this one. We have achieved significant, almost drastic, reductions in the number of hours to perform audit engagements because of our research and developmental activities. But the ramifications are huge. How do you attract and retain younger professionals? How quickly can they get up to speed. The recruiting and training consequences are enormous.

Nasberg: Will you have to restructure your billing approach to compensate for the change in leverage?

Morse: So many of our internal measurements used to be based on chargeable hours--chargeable hours at each staff level, hours managed for partners and managers. We continue to look at that, but now we focus more on revenue per staff, per partner. Through training and a change in mind set, we are trying to get our people, especially the auditors, to do more things for clients. This is a major initiative.

CPAJ: Is the "hour" as a unit of work performed still the fundamental measure for billing?

Several: It is for us. Absolutely.

Gibgot: The hours are less, but the people performing the work are more experienced and carry a higher billing rate.

CPAJ: So you adjust for technology with higher billing rates?

Morse: Because of the multiple forces at work, that may not necessarily be happening at the moment. Our realization rates have declined over the past few years.

Nasberg: The challenge of the '90s is to convert the auditors of the '90s to consultants. Clients have to feel we have delivered value beyond just the compliance aspects of what we do. That requires highly trained people.

Hecht: Are clients going to pay more for this added value? How do you get the client to appreciate the "more" that you have brought to the audit?

Mitchell: The issue that confounds us is who is the client. As long as management is the client, a fundamental problem exists. The best audit from management's perspective is "no" audit.

CPAJ: A cheap audit that finds nothing?

Mitchell: Until we can refocus and redirect who is the client, we will constantly have problems with who is paying for what. We will get nowhere on the pricing dilemma until we are independent of the auditee. When our client is not the management of the company being audited, but its stockholders, it will be easy to demonstrate the added value of the audit process.

Gibgot: Bert, you are talking about the public sector--SEC registered companies, governments, recipients of government funds. In my practice the important ingredient is to recognize what the client wants and needs. Anyone around this table can deliver a audit. The audit is a necessary evil in the client's mind. It is finding what else the client needs and will gladly pay for.

Golub: We have been our own worst enemy. Several years ago, someone came up with the concept the audit is a commodity. We convey the idea to ourselves and our clients that the audit has minimal value, what really matters is the additional things we can do for clients. Not too many years ago we would sit with our clients and interpret the financial results for them--how much they earned, the need to focus on getting receivables down, and the like. Now clients are more sophisticated. The public has caused us to separate auditing from consulting. Our services have become unbundled. We now call the things we used to do--advice how to cut overhead, discussions on reducing inventory levels--as consulting. That has weakened the value of the audit.

But how do we develop the people we need to be able to consult with the client, who understand the industry, who can help the client run the business better? That used to come out of the audit. Where are we headed? Will we be like the lawyers, with a staff to partner ratio of one or one and one/half to one? Some day we will come to our senses and sell the value of the audit process, not the piece of paper, but of knowing the business by having spent time working through its operations and problems.

Gibgot: I don't think its reselling the audit process. I think its reselling what the CPA does. What the audit is.

Hecht: We as a profession have to find a way to make the audit more valuable. We have made the audit a loss leader to get access to a client. What would happen if we said to clients, we will do an audit, but we won't do consulting? The idea of knowing the client form having done the audit, and being in a better position to do the consulting is not relevant today. The consultants are specialists who do not interact with the audit team. If the audit aspect of services were a separate profit center, standing on its own, it would be properly priced.

Morse: One of the fundamental forces at work, at least among the largest firms, is overcapacity on the audit side. As long as that exists, there will be enormous pricing pressure. As far as offering a wide range of services, what I still see is that our clients want us, expect us, to have specialists available to help them run their businesses. Clients expect us to provide them with ideas and solutions across a range of issues specific to their industries. We are stressing integration of services rather than separation. My firm is undergoing a major change in the way it runs its business. Previously we were organized by function. I used to have a P&L for the audit department, the tax department, and the consulting practice. We are now running the business, even our own internal financial statements, by industry.

CPAJ: So is the best strategy to undervalue the audit in order to get a foot in the door to sell these other services?

Morse: Whether we are talking about audits or tax services, the market says we are not going to reward compliance activities. They have to be done, everybody understands that. To compete, you must become the low- cost producer of the compliance services. But none of us can settle for that--personally, professionally, or financially. The management challenge is what else we can do. How can we position ourselves, our people, to do more?

CPAJ: I hear two concepts. The first is the audit as the loss leader to other services. The other says let's get the audit priced right. If we give it away, the public will think it isn't worth very much. If we properly price it, its worth will be better recognized.

Mitchell: If you price the audit properly, you will get none of the business.

CPAJ: That's because of the overcapacity Herb spoke of?

Morse: I don't think we are going to go back to the '70s or early '80s where we could pass through our costs the way we used to.

Mitchell: At some point we must address the issue of "who is the client?" If we don't do it, the government will. We have to redefine the issue of independence as to the auditor and the operation being audited. The reason we are not getting paid well enough for the audit is that we are not marketing to the need. If we could provide assurance to a stockholder that management is doing the best it can do, the stockholder couldn't pay us enough.

Nasberg: I think we are making a major mistake if we think we can be successful by selling strictly on our ability to do an audit. If I see a scenario where I am one of six or ten firms bidding on an engagement, I will walk away. I believe in the concept of niche specialization where you compete on bringing industry knowledge and expertise, added value, where the client wants you because you know what is important and can bring ideas to help.

Maryann Winters: In our up-state market, we compete with a wide range of firms including four of the Big Six. We compete on the basis of the attention and level of service we provide that the big firms can not. We are cheaper also because we do not have the overhead structure. But the client knows if we are engaged they will deal consistently with the same people, who have the authority to make decisions. You have to sell your strengths. I don't believe it is in our best interest to low-ball a bid. If there are a large number of firms in the bidding, I will decline.

Golub: Neil Gibgot, suppose you are in a competitive situation for a new diamond distributor client. Your fee proposal is for $35,000, and two others have made proposals for $23,000. What do you say?

Gibgot: Clients come to me because I know the precious-stone business. Normally we don't even talk price. My reputation for confidentiality and knowledge of the industry, precedes me. I'm a diamontologist, the only CPA in the country to hold that designation.

Golub: The point is, you don't care who the competition is, you have the confidence and the market presence to refuse to get into a bidding war. Let's assume we all want the diamond client. We can't compete with Neil on knowledge, so we bid the $23,000. But suppose it is for a client in an industry with which we are all familiar. If we all bid $23,000 that is what the client will pay. But if we all bid $35,000, that is what the fee will be. We beat ourselves up. Why do we do it?

CPAJ: Gerry, you ask a question that the profession should answer. But on a practical level, how will firms develop the people they need to do the kind of work required?

Golub: Perhaps the college graduates will move directly into employment in industry, become knowledgeable in that industry, and then be recruited into public accounting.

Morse: We intend to do a lot more experienced-level recruiting. New entrants cannot spend the amount of time on clients that we did growing up in the ranks. The on-the-job training that served us so well is not there, and we will have to devise new ways to train and prepare staff for the work we expect them to perform.

CPAJ: None of you have spoken about the possibility of performing additional assurance type functions for clients. For example, we now have an attestation standard for expressing an opinion on management's assertion about the effectiveness of the internal control system. Aren't new services like this an opportunity for additional fees?

Golub: All that means is the next time the job is bid, the client will say the engagement includes an audit of the financial statements, a management letter, and a report on internal control. And all the firms will bid the same $25,000 they bid the last time.

Winters: We have all been talking as if it is essential that growth occur. What about the possibility of providing services efficiently and effectively for a reasonable profit. Is growth always essential?

Golub: You have to fund technology and the ability to provide additional services your clients may need. You have talented, productive people who want to join the partnership ranks. You want to demonstrate opportunity for all your good people to keep them motivated. The potential for advancement has slowed, but growth provides additional opportunity.

Winters: The growth will be dependent on increasing market share. In a stagnant economy that means taking clients from others.

Hecht: There were a number of small firms that sprang up between World War II and the Korean War which will be looking for merger or other form of combination over the next 10 years. Firms no doubt will be looking to grow in that fashion. That may be a window of opportunity.

Winters: Firms get together to talk in my city as they do where Neil's office is located. I see firms willing to do more sharing and cooperative ventures than mergers. I see sharing computer knowledge, library resources, and other capital items.

CPAJ: To summarize the discussion on the economics of the profession, firms have become leaner, through attrition and less hiring in reaction to the downturn in the economy. In addition, technology has played a dominant role. However, the people now doing the work require greater skills. To grow a practice and obtain more market share, firms must demonstrate specialized skills and knowledge and compete on the basis of bringing more to the audit table. And some firms are able to bring other disciplines and skills--consulting capability--that clients need and feel comfortable obtaining from CPA firms.

Moving on, accountant's liability seems to be the number one topic of conversation where two or more CPAs are gathered. How has the accountant's liability risks affected you and the conduct of your practice?

Winters: One of the services I provide is litigation support for an insurance company's attornys relating to attorneys' and accountants' malpractice suits.

Morse: Talk about growth opportunities.

Winters: I get to see some of the problems firms find themselves in and how they got there...mostly small firms. What I have learned is the importance of knowing your client. You cannot protect yourself from the unscrupulous client. If the client is doing something, which in the long run will create a problem for you, you have to be willing to walk away from that client, if you can't reform them.

CPAJ: You have been able to avoid the problem by avoiding risky client situations.

Gibgot: The whole profession is damaged when news of one audit failure is publicized. We all lose standing in the eyes of the public and our clients. Because of the liability exposure, our firm decided not to do audit work for public companies. Also our work is mainly review engagements and not audits. At this point we are very careful and selective of the clients we choose to handle.

Morse: We have a harsh and difficult marketplace in what is now the most hostile liability environment that most of us could have ever imagined. It is incumbent upon us to show absolute leadership of when to say "no." My firm cannot associate with a risky situation in spite of pressure for growth and new business.

Mitchell: Everyone practicing in the profession faces the liability question every day, whether it be for a review engagement or even a tax return. A large part of our work is in the not-for-profit sector, and we have had a liability issue pop up there. No area is immune. If we were to get the client/auditee situation resolved, the liability exposure would decline.

Morse: Contrast this again with the earlier discussion. Intense competition, all of us seeking in our own ways to increase market share and become more efficient and competitive. But when it comes to liability matters, we as a group of firms and a profession must stand together and seek to push through reforms to bring sanity to the liability system. Always present is the possibility that something could happen that could be catastrophic to a firm's existence.

Golub: Prior to the deluge of claims against firms, human nature sometimes led firms to look the other way in highrisk situations and with demanding clients. But that has changed. We just extricated ourselves from what we considered a high-risk engagement involving a client that was not willing to pay a fair price for our services. Rather than resign, we priced ourselves out of the engagement. A major firm came in and took the engagement for a significantly lower fee, fixed for three years. And they didn't speak with us.

Cinquegrana: We have become very serious about our client acceptance procedures. Five years ago, if a warm body came to the office seeking services, we were happy for the work. Now we check with the attorney, the bankers.

Another major factor relating to liability exposures is the documentation now being created on audits to mitigate damages in the event we are sued. But the bottom line is knowing the client. A good crook can fool a good auditor every day of the week.

Golub: Larry said his workpapers are getting thicker? I thought because of technology and new approaches the workpapers were getting thinner?

Mitchell: Instead of detailed account analysis and lists of transactions, there are checklists and memorandums of conclusions. They are reminders.

Cinquegrana: Even with the technological advances, the amount of hours to do an audit are more than they were five years ago because of the increased documentation.

Morse: The kind of checklists and documentation I envision in today's audit are not the rote kind. They explain the basis for the judgments arrived at. How did we conclude the loan-loss reserve was adequate? The papers and documentation must be free standing and bullet proof when challenged. Technology allows us to analyze and seek relationships within financial information.

CPAJ: What about non-CPA ownership of firms?

Mitchell: With the range of services we offer we definitely have to go that route. To recruit and retain the high-powered people necessary to perform specialized services, you have to hold out the carrot of potential ownership.

Golub: Limit the percentage non-CPAs can own to a rational amount, keep control of the audit out of the non-CPA owners, and that's how a business should operate. Professionals who make a major contribution to a firm's success and profitability should have the potential to be owners.

Gibgot: Its not clear to me why we need it. Why do we have to provide services that a CPA would not be competent to perform?

Mitchell: Firms offer a wide range of services and expertise. It is quite common for firms to employ actuaries, engineers, and valuation specialists to satisfy client needs. But these services must be differentiated from audit services. Accounting firms are more than audit firms.

Morse: It is critically important to us. We have a large number of principals who in every respect are treated as partners. Twenty percent of our "partner" complement are principals now.

Hecht: The argument is being debated at the wrong level. The fact is there are non-CPA owners now. The question is the role they should play in management of the firm.

CPAJ: A last question. Public accounting is a stressful, demanding business. Are the rewards of quality of life, compensation, group problem solving there. Is it fun any more?

Golub: It is fun, exciting, and very rewarding financially.

Morse: I think all of us still enjoy being with clients, being involved with issues that matter to them, and bringing ideas and advice to the table that benefit them. And make a buck at it. We have been able to adjust to the rapidly occurring changes, and we are still doing OK. There is also a great deal of enjoyment from dealing with and interacting with my partners.

Winters: We have changed along with the environment and have managed to remain successful. I love what I am doing!

Nasberg: We have arrived because we no longer think of ourselves as merely a profession. We are a business, we are entrepreneurs who react to change and make the most of it, even thrive on it.

Golub: I would say it differently. We are professionals operating in a business environment. If anything, I think we are more professional in the way we address issues, evaluate risks, and understand our clients. In operating our firms, we focus on the business aspects.

Mitchell: I don't think we are any different than any other business. Our product happens to be professional services. We have to operate as business people. If you don't make profits, there will be no professional services.

Gibgot: The most successful professionals give back the most to the community, the profession and its organizations such as the AICPA and state societies, and to others in the firm.

CPAJ: Lady and gentlemen, we have run out of time. There is much more that I would have liked to have covered, but we will have to save that for another day. Thank you for participating.

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