Thoma v. Barnes, Dennig & Company, 784 N.E.2d 1207 (Ohio 2003)
Background. Can an employer sue its accountants for failing to discover that a bookkeeper was embezzling large sums of money over a 6-year period? This is the question addressed by an Ohio court in a recent case. While the case involved a for-profit business, the court's conclusions are equally relevant to churches and other nonprofit organizations.
For twelve years a company used a local CPA firm to perform yearly "reviews." In a review, the CPAs review the client's financial documents (including bank statements), speak with the client's employees, and create financial statements for the client. During a review, a CPA firm would also perform "analytical tests" on account balances to verify that those figures were calculated using generally accepted accounting principles. A review is more thorough than a "compilation," which only requires the CPA to place the client's internal income statement and balance sheet into a financial-statement format, but less thorough than an audit, which requires the accountant to verify the financial information (account balances) it received from the client by contacting the appropriate financial institutions.
Over the course of six years, the company's internal bookkeeper ("Sarah") embezzled more than $120,000 from its corporate accounts. The embezzlement was finally discovered by employees of the company's bank. To accomplish her thefts, Sarah either changed the payee's name on the company's checks or wrote in her own name as the payee when the officers signed corporate checks in blank.
After learning of the embezzlement, the company sued its CPA firm for professional negligence in failing to discover Sarah's thefts while conducting the annual reviews. The company asserted that its CPA firm negligently relied on Sarah's "verbal assurances" that the cash reported on the company's internal balance sheet each year was the same as the balance on its year-ending bank statement. The company claimed that if the CPAs had requested a copy of the year-end bank statements each year, they would have discovered Sarah's thefts.
To support these claims, the company relied on the testimony of an accounting expert who stated that there was no requirement that an accountant performing a review obtain the client's year-end bank statement. Instead, this was a matter committed to the accountant's professional judgment. The expert also testified that the person responsible for writing checks and recording them in the corporate ledger should not have been the same person who reconciled the bank account. In other words, one person should have been "controlling the cash," and a different person should have been "recording the cash." The evidence presented at trial indicated that under the company's internal accounting system Sarah performed both of these jobs.
In its defense, the CPA firm claimed that it was up to an accountant's professional judgment whether to seek a complete year-end bank statement, and that the company's own negligence in failing to discover Sarah's thefts had contributed to its losses. Specifically, the CPA firm presented evidence that the company knew that Sarah had experienced emotional problems that had hampered her job performance, and knew that she had purchased a large amount of consumer goods, such as new cars and expensive clothing. The company also knew that many of its vendors had not been paid.
A jury concluded that the embezzlement was due to the company's own negligence rather than to the negligence of its CPA firm. The company appealed.
The court's ruling. An appeals court affirmed the trial court's ruling in favor of the CPA firm. It concluded that there was ample evidence that the company's own negligence was the main reason that Sarah was able to embezzle funds. It cited the company's "failure to adequately supervise and evaluate Sarah, its failure to monitor internal accounting controls, and its awareness of signs of Sarah's mental and emotional instability."
What this means for churches
This case is important for the following two reasons.
First, it illustrates that CPA firms can perform a number of services besides a full audit. These "limited engagements" include compilations and reviews. Limited engagements may not be adequate to detect embezzlement and other financial fraud in a church. While they are cheaper, any cost savings comes at a price. The CPA firm undoubtedly would have detected Sarah's embezzlement in this case had it been hired to perform an audit. Because it only performed a review, the embezzlement was not detected.
Second, the case demonstrates that a church may not be able to blame its CPA firm for financial fraud that is made possible by the church's own negligence. The negligent acts in this case that prevented the company from transferring fault to its CPA firm included "its failure to adequately supervise and evaluate Sarah, its failure to monitor internal accounting controls, and its awareness of signs of Sarah's mental and emotional instability."
One more point. It is common for churches' governing documents (e.g., bylaws) to require an "annual audit." Many churches with such a provision in their bylaws elect to have a CPA firm perform a limited engagement (review or compilation), usually to reduce the cost. This would constitute a violation of the church bylaws. Either the bylaws should be amended to allow limited engagements instead of audits, or full audits should be performed.
If your church is not required to have an audit, there are still compelling reasons why you should consider having one. These include the following:
- An audit promotes an environment of accountability in which opportunities for embezzlement (and therefore the risk of embezzlement) are reduced.
- The CPA (or CPAs) who conducts the audit will provide the church leadership with a "management letter" that points out weaknesses and inefficiencies in the church's accounting and financial procedures. This information can be valuable to church leaders.
- An audit contributes to the integrity and reputation of church leaders and staff members who handle funds.