Who's afraid of their annual inspection?

Nobody should be — it's an important tool for improvement

By Harvey I. Milhiser, CPA

More fearful than Jason, Freddy Krueger or The Thing. Harder than hitting a Sandy Koufax curveball. Meets with more resistance than a Ray Lewis tackle.

What brings such fear and apprehension to an accounting firm?

We have all settled down after busy season. Our staffs are beginning to get back on a regular work schedule. We are no longer working 50 to 60 hours per week — not on a regular basis, anyway. Vacations are being taken. The birds are singing. Life is good.

... And then the quality control partner wants to schedule the firm's annual inspection.

What a bummer! What a killjoy! Get outta here we have no time or need to do an inspection!

I perform many peer reviews each year and the single biggest complaint I receive is about the requirement that firms must perform annual inspections. Many CPA firms believe that since all of their engagements are reviewed by staff, a manager, a quality control department and a partner, that should be enough.

Well, maybe it should be — but then why does the peer reviewer turn up incorrect or incomplete financial statements and workpaper documents? True, this can and does happen on engagements that went through the inspection process. Why? Maybe it has to do with the CPA firm's dedication and enthusiasm (or lack thereof) for the inspection process.

Why is it important?

All firms, no matter the size, must do an annual practice monitoring / inspection process. The AICPA's Peer Review Program Manual includes PRP Section 10,000, which is devoted to monitoring guidance. This section is complete with how-to areas, explanations, checklists and examples. In my opinion, every firm should obtain and review this section of the manual.

The thrust of this article is to explain why the annual practice monitoring process is important to each firm. I also want to explain how to perform a practice monitoring / inspection program for your firm.

A practice monitoring review encompasses basically all aspects of a firm's A&A practice. When my firm has its practice monitoring review, I get all new independence forms completed and resolve any issues that may come up. I make sure all of the firm's professional reference materials are in place and updated regularly. This is much easier now that all of our auditing and accounting (A&A) and tax reference materials are obtained either through the Internet or by CD. I also have our firm administrator review all personnel files to make sure they have been updated with any current information and evaluations.

In addition, I review all CPE on a quarterly basis to be sure that the firm, partners and staff members are in compliance with AICPA, MACPA, Yellow Book and any other requirements. Also, I do not want a lot of firm personnel to have to take many hours of CPE in the last two or three months of their CPE year. I make sure that all in-house CPE is properly documented.

In selecting the firm's engagements for our inspection process, we select a cross section of our practice. We select initial-year engagements first, whether they are compilations, reviews or audits. We then continue to select a cross section of our engagements representing all of the firm's levels of service, industries, managers and partners.

For our review of the selected engagements, I have always used the applicable current peer review checklists. I assign the A&A partners, managers and various levels of staff to review the applicable selected engagements. No one is assigned to review an engagement that they have performed or reviewed or on which they have consulted. I always try to include all members of the professional A&A staff to the inspection process.

In doing the inspection in this manner, I believe I am making all members feel they are part of the process. In addition, I am cutting down on the time that each person needs to contribute to the inspection. No person (other than myself) spends more than four to five hours in the process. A staff person with one year of A&A experience can perform an inspection on a compilation without disclosures engagement. The reviewers go over any item with a "no" answer, a documentation question, a financial statement typo or a question as to why something was done in a certain manner.

I believe a person who helps perform a review in the practice monitoring process benefits from a great deal of valuable training.

After the review of the engagements is completed, I go through the checklists, notes, comments and files, as needed. I prepare a report to the partners and a seminar for the staff. We review all aspects of the inspection findings and how we will correct the problem areas. I find that we are much harder on ourselves than the peer reviewer. We try to be — we live with the engagements every day, not just once every three years.

A one- or two-person firm can perform a meaningful inspection. A one-person firm can look over a cross section of the prior year's engagements. This post issuance review can reveal some things that were not done during the initial processing. A two-person firm can have the people review each other's engagements. I peer review many one- and two-person firms that perform excellent inspections.

Think positively

Remember that all annual practice monitoring reviews and inspections must be documented. The documentation must indicate the scope of your practice, the scope of the inspection, the findings and any corrective action needed and undertaken. The same type of documentation is needed in the areas of CPE, independence, personnel files, reference materials, etc. Inspections are required in all years between the firm's peer reviews.

If you do not schedule ahead of time and plan for your firm's annual inspection as you would a client's closing, it will not get done. If you and your personnel perform the inspection with a positive attitude, you will be amazed what can be accomplished.

Harvey I. Milhiser, CPA, of Gorfine, Schiller & Gardyn, P.A., is a member of the MACPA's Peer Review Committee.