California Accountancy Regulations

 The California Board of Accountancy is responsible for implementing the California Accountancy Act.  The Board regulates the practice of public accounting by issuing and enforcing rules and regulations.  This week we will review the California Board of Accountancy Regulations.  To help understand the regulations we will also examine several disciplinary actions taken by the board against those who have violated the regulations.

Introduction to the Board of Accountancy Regulations:

The regulations issued by the Board are extensive (see link to full regulations above), currently encompassing:

Obviously it would not be reasonable or practical to read all 96 pages of regulations in the time allotted for this class.  Nevertheless, everyone who practices public accountancy in California is subject to these regulations and is expected to understand and comply.  The goal of this chapter is to become aware of the general content of the regulations, explore more important topics in detail, and then examine the Board’s activities to enforce these regulations.

Revisions of the Regulations

The Board makes additions and changes to these regulations frequently as needed to best protect the public. If you are practicing public accounting, it is important that you be aware of proposed and adopted changes.  The Board makes great effort to advise all CPA’s of proposed changes and invite comments and suggestions.  The Board publishes proposed Regulation changes on their website and by mail to all licensees through a publication called “UPDATE.”

How to Proceed with this Chapter

• Become familiar with the regulations – Review the index to the Regulations.  Notice the general content of each article.  Explore any items that you find particularly interesting.  Don’t try to read the entire set of regulations, just become familiar with the types of items in the regulations.  Then read the instructor’s summary of the more notable regulations in the remainder of this chapter.
• What’s new with the Board of Accountancy? – After becoming familiar with the regulations we will explore a few disciplinary/enforcement actions of the Board of Accountancy.  Read the latest issue of the “UPDATE” published by the Board of Accountancy.  What issues are discussed in this edition?  Were there any disciplinary/enforcement actions?
• Examine the full list of disciplinary/enforcement actions – The California Board of Accountancy’s website contains a cumulative list of disciplinary/enforcements actions.  Review some of the disciplinary actions to get a broad view of the types of violations and how the Board responded to them.  Just for fun, look up the CPAs you know to see if they have ever been subject to a Board action!

Regulations not covered in this Course

Our focus is on ethics and professional conduct.  Therefore we will not be covering many of the administrative regulations.  These include topics such as the CPA exam and various board fees.  Students who will be taking the CPA exam may wish to review Article 2 of the regulations.

regulations to focus on

Below are the articles we will be focusing on in this chapter.  Please review the summaries below.  For more information or to review the article in length, please visit the Board of Accountancy Regulations website.

Article 3 – Practice Privileges

Article 3 allows someone who is licensed as a CPA in another state to practice public accountancy in California.  There are strings attached.  Section 27 of Article 4 establishes certain criteria which must be met.  In addition, the person with the out-of-state CPA must register with the Board of Accountancy by submitting a 6-page form.  The form typically does not require approval and the person can begin practicing public accountancy as soon as they file the form.  There are some cases where a person must get board approval before practicing public accountancy – the mere filing of the form is not adequate.  Those cases are as follows:

• Prior conviction of a crime
• Prior discipline against the practitioner
• Any open investigations involving the practitioner
• Any prior civil judgments against the practitioner over $30,000 that were related to professional conduct
• Several other administrative causes

The important thing to remember about Article 3 is that if you have a CPA license from another state, you cannot just begin practicing public accountancy in California.  Anyone in such a situation should contact the California Board of Accountancy and become familiar with Article 3.

Beginning July 1, 2013, the California Board of Accountancy recognizes certain states that have CPA licensing requirements similar to those of California.  A CPA from those specific states can perform work in California for their clients who have operations in California. However, if the client is headquartered in California the CPA firm must be registered with the California Board of Accountancy.  As of July 1, 2013, all the regulations list all states as having licensing requirements similar to California.  The regulations also identify Washington D.C. and two U.S. territories (Guam and Northern Mariana Islands) as having substantially equivalent licensing requirements.

If the CPA firm is not from one of the states that have been identified to have CPA licensing requirements similar to California, the firm must first obtain practice privileges from the California Board of Accountancy.

For most students, this will never be an issue because you will become a California CPA, not another state.  However, you may someday wish to practice public accountancy in another state and will now be aware that the other state also has regulations that may affect you.

Article 6 – Peer Review

The purpose of article 6 is to enhance the quality of accounting services by requiring a “peer review” of the accountant’s work.  All CPA firms and sole proprietorships that perform accounting and auditing services are required to have an independent review and report completed every three years.  A CPA firm or sole proprietor is subject to this requirement if they perform any accounting or auditing work that is subject to the following professional standards:

• Statements on Auditing Standards (SAS) issued by the AICPA’s Auditing Standards Board (ASB) or the Public Company Accounting Oversight Board (PCAOB)
• Statements on Standards for Accounting and Review Services (SSARS) issued by the AICPA’s Accounting and Review Services Committee (ARSC)
• Statements on Standards on Attestation Engagements (SSAE) issued by the AICPA
• Government Auditing Standards issued by the U.S. Government Accountability Office
• Audits of non-Security Exchange Commission (SEC) issuers, using PCAOB audit standards

There are two exclusions where a CPA is not subject to peer review:

1. If the firm’s engagements are subject to the PCAOBs inspection program.
2. If the firm does not perform any attestations work beyond a compilation.

Peer reviews can only be conducted by an independent board-approved peer reviewer.

Even if a CPA has only one small engagement subject to the above professional standards, the CPA must undergo a peer review.  Given the cost of peer reviews, small CPA firms may find it impractical to provide services that are subject to the above professional standards.

If the CPA receives a substandard peer review, the CPA must report the review to the Board of Accountancy within 45 days of receipt.   In addition to the substandard peer review report and related materials, the CPA should also submit documentation that the CPA has corrected the deficiencies listed in the peer review.

Article 9 – Professional Conduct

This article includes many of the most important practice requirements and is the primary focus of the regulations for this course.  The list below summarizes some of the important regulations regarding professional conduct.

Section 50: Client notification

Requires the CPA to advise their clients that the CPA is licensed by the California Board of Accountancy.  This effectively lets the client know that there is a regulatory agency that they can access to verify a license, check for disciplinary actions, or file complaints.

Section 54: Confidential Information 

Establishes confidentiality requirements.  To some extent this is common sense.  A CPA is held in a position of trust and should protect all client information.  Client information should not be shared without the express permission of the client.  However, it is important to note that there is no accountant-client privilege similar to attorney-client privilege.  Unlike attorneys, accountants must comply with all subpoenas and regulatory requests.  For this reason, accountants should be aware when a client’s situation may lead to litigation.  In those cases, the client may wish to engage an attorney and then have the attorney engage the accountant.  This will result in the accountant’s information being protected under the attorney-client privilege.

Section 56: Commissions

Provides regulations for CPAs who work on a commission basis.  Historically CPAs were not allowed to be paid on a commission basis.  The theory was that a commission may result in the CPA having financial interests that are not consistent with the client’s interests and the CPA’s objectivity may be impaired.  The regulations now allow CPAs to be paid on a commission basis, but we must take care to ensure that we are serving the client’s interest.  If a CPA will be paid a commission, the regulations require the following:

• The client must be advised in writing of any commission paid by a third party, who the third party is, and the CPA’s relationship with the third party
• CPAs cannot accept referral fees simply for recommending a third party to the client
• No commission can be accepted if it impairs the CPA’s independence, objectivity, or creates a conflict of interest

Section 57: Incompatible Occupations/Conflict of Interest

Prohibits a CPA from participating in any other occupation which would impair their independence, objectivity, or create a conflict of interest.

Section 58: Compliance with Standards

Requires CPAs to comply with Generally Accepted Accounting Principles, Generally Accepted Auditing Standards, and any other applicable professional standards.  This section effectively gives the Board of Accountancy the authority to discipline any CPA who does not comply with GAAP or GAAS in cases where those standards apply.

Sections 59 through 61: Reporting of Restatements, Investigations, and Settlements

Requires a CPA to notify the Board of Accountancy if certain events have occurred including:

• Certain audited financial statements that have been restated to correct material errors in previously issued reports
• Any investigations of the practitioner by the Securities and Exchange Commission (SEC) or the Public Company Accounting Oversight Board (PCAOB)
• Certain civil settlements, arbitration awards, or judgments against the CPA

Section 62: Contingent Fees

Generally prohibits contingent fees where the practitioner will be paid only if a certain outcome is reached.  For example, a CPA could not accept a contingent fee if a bank loan is approved based on financial statements created by the CPA.  Also, when preparing tax returns, CPAs cannot charge a contingent fee.  In both cases the contingent fee might impair the practitioner’s independence and objectivity with regard to the work they are performing.

Section 63: Advertising

Prohibits false, fraudulent, or misleading advertising.

Section 65: Independence

Establishes independence as a cornerstone of a practitioner’s work.  This section is short, but extremely important.

Section 67: Approval of Use of Fictitious Name

Effectively requires a sole proprietor CPA to do business only under their name.  For example, John Smith would operate his business as “John Smith, CPA” or “John Smith, Certified Public Accountant.”  Fictitious names are not allowed without approval of the Board of Accountancy.  A name such as “Smith Accountancy” would require approval of the Board of Accountancy.  As we learned in our last unit, the name cannot imply there is more than one accountant if that is not the case.  For example, Mr. Smith could not do business as “John Smith, CPAs” as this implies more than one CPA.

Section 68: Retention of Working Papers

This is an important section dealing with client’s records.  The client’s records must be returned to the client.  They cannot be withheld because the client has not paid.  Withholding client records has been cause for numerous complaints to the Board of Accountancy and resulting discipline against practitioners.

Sections 68.1 through 68.5: Working Papers and Audit Documentation

Require a CPA to keep appropriate documentation of their work and to retain that work for as long as needed.  For audit work papers, this is at least seven years.  This may seem a simple item, but destruction of records was a key factor in the conviction of Arthur Andersen.

Article 12 – Continuing Education

Article 12 (sections 80 – 94) establishes continuing education requirements for CPAs.  Here is a brief summary of the requirements:

• A CPA may place their license on “inactive status.”  Inactive licenses are not required to complete continuing education, but they cannot use their license to practice public accountancy.  A CPA can move their license back to active status, but they must complete all continuing education requirements.
• All California CPAs must complete a total of 80 hours of continuing education every two years (the license renewal cycle), with at least 20 hours completed each year.
• Any practitioner involved in governmental audits must complete 24 hours (of the 80 required) of continuing education in governmental accounting or auditing every two years.
• Any CPA involved in audits, reviews, compilations, or other attestation services must complete 24 hours (of the 80 required) in financial statement preparation, industry accounting, and related attestation services every two years
• Any licensee involved in audits must complete 8 hours (of the 80 required) in the areas of detecting and reporting financial statement fraud.
• Any CPA with an active license must obtain at least four hours of ethics education (of the 80 required during that two-year licensing cycle).
• Any CPA with an active license must obtain at least 2 hours of regulatory review education every six years.
• Practitioners may be ordered by the Board of Accountancy to do additional continuing education.  This is a common disciplinary requirement.

 Article 12.5 – Citations and Fines

Article 12.5 gives the Board of Accountancy to impose administrative penalties for lesser offenses.  The Board issues citations to the person violating the regulations and levies a fine.  Fines range from $100 to $5,000 or more, depending on:

• The gravity of the violation.
• The good or bad faith of the cited person or entity.
• The history of previous violations.
• Evidence that the violation was or was not willful.
• The extent to which the cited person or entity has cooperated with the board’s investigation.
• The extent to which the cited person or entity has mitigated or attempted to mitigate any damage or injury caused by the violation (From Regulation section 95.2).

If the person or firm that was cited does not comply with the citation and pay the fine, the Board may suspend or revoke their CPA license.

Article 13 – Denial, Suspension, and Revocation of Certificates, Permits, or License

This article gives the Board authority to levy significant punishments for more substantial offenses including:

• Dishonesty, fraud, or breach of fiduciary responsibility of any kind;
• Fraud or deceit in obtaining a certified public accountant’s certificate or a public accountant’s permit under Chapter 1, Division III of the Business and Professions Code;
• Gross negligence in the practice of public accountancy or in the performance of the
• bookkeeping operations described in Section 5052 of the code;
• Violation of any of the provisions of Chapter 1, Division III of the Business and Professions Code or willful violation of any rule or regulation of the board (From Regulation section 99).

When determining the appropriate penalty, the Board considers:

• Nature and severity of the act(s) or offense(s).
• Criminal record and evidence of any act(s) committed subsequent to the act(s) or offense(s) under consideration which also could be considered as grounds for denial, suspension or revocation.
• The time that has elapsed since commission of the act(s) or offense(s) referred to in subdivision (1) or (2).
• The extent to which the applicant or licensee has complied with any terms of parole, probation, restitution, or any other sanctions lawfully imposed against the applicant or licensee.
• If applicable, evidence of expungement proceedings pursuant to Section 1203.4 of the Penal Code.
• Evidence, if any, of rehabilitation submitted by the applicant or licensee (From Regulation section 99.1).

Discipline

The California Board of Accountancy has the authority to discipline anyone who violates the California Accountancy Act or the Board Regulations.  Discipline may include lesser punishments such as imposing smaller fines or requiring additional continuing education.  The Board can also impose significant punishments such as suspending or revoking the CPA license of an individual or firm education and imposing fines in the millions of dollars.

The Board of Accountancy has skilled investigative accountants on staff, and utilizes additional outside investigators as needed.  If the investigators determine that there has been a violation of the California Accountancy Act or Regulations, an administrative process will determine and apply the appropriate discipline, while providing due process to the defending person or firm.

Now that we have reviewed the regulations, we will examine some cases where the Board of Accountancy has enforced the laws and regulations.

Who can be subject to enforcement?

Anyone can be subject to the jurisdiction of the Board of Accountancy – not just CPAs.  If a person or firm is practicing public accountancy, with or without a license, that person is subject to the laws and regulations and the Board can take action against them.

Enforcement and Discipline are Public

While complaints and investigations are not published, any cases that conclude disciplinary actions are public information.  All recent disciplinary actions are published in the “UPDATE” publication published by the Board of Accountancy.  An example of the UPDATE publication can be found in the appendix to this chapter.  A cumulative summary of all disciplinary actions is available on the Board of Accountancy website.  The summaries published in “UPDATE” and the website are brief, but adequate.  The details of any particular case can be obtained by contacting the Board of Accountancy.

Examples of Disciplinary Actions

Let’s examine some recent discipline cases and one older case of some significance. Review the “UPDATE” publication in the chapter appendix.  The disciplinary cases are divided into two categories (1) revocation of a CPA certificate and (2) other enforcement actions.

1. How many CPAs had their license revoked during the period?
2. How many other enforcement actions were there?
3. What were the violation and penalties assessed in each case?
4. Do you think the penalties were appropriate for the violation?

Now let’s examine an older, yet well-known case.  Arthur Andersen was one of the largest CPA firms in the world.  Yet the firm no longer exists due to the conduct of a few people in the firm.  We will examine Arthur Andersen and Enron later. For now, let’s see how the California Board of Accountancy handled this matter. Visit the Board of Accountancy website for the cumulative list of enforcement actions.  Click on the letter “A” on the alphabetical list of cases.  On the list of all enforcement cases involving those with the letter “A” you will find Arthur Andersen.

1. What was Arthur Andersen disciplined for?
2. Was the violation in California?
3. What penalty was assessed against Arthur Andersen for the violation?
4. Do you think the penalty was fair?

Summary

The above review of the accountancy regulations highlights some of the more important regulations relating to professional conduct.  If you are faced with any of these issues you should become more familiar with the specific regulations that affect your situation.