Auditing Basics: How to Assess a Potential Client’s Reliability

By Maire Loughran from Auditing For Dummies

You have to judge a client’s accounting competence and integrity before accepting an auditing engagement. If the client lacks accounting skills and integrity, you should seriously consider not accepting the job. The process for sizing up a potential client can be involved. Just as you wouldn’t want to start a business with someone you don’t trust, you don’t want to accept an auditing engagement from a company whose management ethics seem a little shaky. If a client lacks integrity, your job becomes a whole lot more complicated.

Here are some red flags to look for when evaluating a company’s integrity:

Turnover: High turnover — especially in key management or financial positions — can indicate business practice disagreements that may be ethical in nature. Asking management members how long they’ve been employed by the company and examining payroll reports are two ways to find data on employee turnover.
Reputation: Consider whether the potential client has a poor reputation in the community. Keep in mind that you’re known by the company you keep — it may be smart to walk away from such a client.
Lawsuits: Check out any lawsuits currently pending among the owners of the business. Talking to the parties of the lawsuits may lead you to vast amounts of insider info that will affect your decision.
Attitude: Ask yourself this: Do the client’s management personnel have a reasonable attitude toward being audited, or do they seem overly resentful or apprehensive? Most companies with nothing to hide have a very casual attitude toward an audit, even if they consider it an inconvenience. And if management has a bad attitude toward paying taxes, as evidenced by interviews with the management or by income tax changes either proposed or made by the government, it’s possible that revenues have been understated to lower the company’s tax burden.
Compensation: Check to see whether members of upper management are paying themselves appropriate compensation. Lack of W-2 income can indicate disguised compensation in the form of inappropriate loans from the company or diversions of cash receipts. In other words, if the manager is living in a million-dollar gated community on $50,000 a year, you have to wonder how she’s pulling off this trick.

Keep in mind that if you identify a lack of management values in one area, such as compensation, you’ll likely find ethical issues in other areas as well.

Think twice about accepting an engagement if the company management seems inept. If management is extremely inexperienced in its industry, for example, you have to wonder about the company’s future prospects. This situation brings into play the issue of going concern: the likelihood that the business will be in operation for the foreseeable future (usually one year after the balance sheet date), which you evaluate as part of each audit.

If the company doesn’t have a knowledgeable financial person supervising the preparation of the financial statements, chances are that the financial statements aren’t reflective of appropriate accounting principles. This situation makes your job harder and may ultimately cause you to have to quit the job prior to finishing the audit.