STATE OF FLORIDA

DIVISION OF ADMINISTRATIVE HEARINGS

DEPARTMENT OF PROFESSIONAL ) REGULATION, BOARD OF ACCOUNTANCY, )

)

Petitioner, )

)

vs. ) CASE NO. 89-3717

)

FLANAGAN & BAKER, P.A., )

)

Respondent. )

)

RECOMMENDED ORDER

Pursuant to notice, the above matter was heard before the Division of Administrative Hearings by its duly designated Hearing Officer, Donald R. Alexander, on September 26, 1989, in Sarasota, Florida.

APPEARANCES

For Petitioner: Tobi C. Pam, Esquire

1940 North Monroe Street, Suite 60

Tallahassee, Florida 32399-0792

For Respondent: John R. Flanagan, pro se

2831 Ringling Boulevard, Suite E-118 Sarasota, Florida 34237

STATEMENT OF THE ISSUES

The issue is whether respondent's certified public accountant's license should be disciplined for the alleged violations set forth in the administrative complaint.

PRELIMINARY STATEMENT

This matter began on September 9, 1988, when petitioner, Department of Professional Regulation, Board of Accountancy, issued an administrative complaint charging that respondent, Flanagan and Baker, P. A., a certified public accounting firm, had violated in various respects Section 473.323, Florida Statutes (1987) and Rules 21A-22.001, 21A-22.002 and 21A-22.003, Florida Administrative Code (1987), when it prepared annual financial statements for a client in 1987. Thereafter, respondent requested a formal hearing to contest the agency's action. The matter was referred by petitioner to the Division of Administrative Hearings on July 11, 1989, with a request that a hearing officer be assigned to conduct a hearing.

By notice of hearing dated August 3, 1989, a final hearing was scheduled on September 26, 1989, in Sarasota, Florida.

At final hearing, petitioner presented the testimony of Marlyn D. Felsing and Thomas F. Reilley, both certified public accountants and accepted as experts in accounting. It also offered petitioner's exhibits 1-14. All exhibits were received in evidence. Respondent was represented by one of its partners, John

R. Flanagan, who testified on its behalf. It also presented the testimony of its junior partner, Thomas A. Menchinger, and offered respondent's exhibits 1-

1. All exhibits were received in evidence.

   
   

   The transcript of hearing was filed on October 10, 1989. Proposed findings of fact and conclusions of law were timely filed by petitioner on October 25, 1989. A ruling on each proposed finding is made in the Appendix attached to this order.

   
   

   FINDINGS OF FACT

   
   

   Based upon all of the evidence, the following findings of fact are determined:

   
   

   1. Respondent, Flanagan & Baker, P. A. (respondent or firm), was a certified public accounting firm having been issued license number AD 0006179 by petitioner, Department of Professional Regulation, Board of Accountancy (Board). When the events herein occurred, the firm's offices were located at 2831 Ringling Boulevard, Suite E-118, Sarasota, Florida, and John R. Flanagan and Michael L. Baker, both certified public accountants (CPA), were partners in the firm. In addition, Thomas A. Menchinger, also a CPA, was a junior partner. The firm has since been dissolved, and Flanagan and Menchinger have now formed a new firm known as Flanagan & Menchinger, P. A., at the same address. It is noted that Flanagan, Baker and Menchinger are not named as individual respondents in this proceeding, and at hearing respondent's representative assumed that only the firm's license was at risk. Whether license number AD 0006179 is still active or valid is not of record.

      
      

   2. In 1987, respondent, through its partner, Flanagan, accepted an engagement to prepare the 1986 calendar year financial statements for Ballantroe Condominium Association, Inc. (BCA or association), an owners' association for a fifty unit condominium in Sarasota. Financial statements are a historical accounting of what transpired for an entity during a particular period of time as well as the status of its assets, liabilities and equity on a given date. They are prepared for a variety of persons who rely upon them to see what transpired during that time period. If the statements are not properly prepared, the possibility exists that harm or other problems may accrue to the users of the statements.

      
      

   3. After the statements were prepared and issued, a unit owner made inquiry with respondent in August 1987 concerning two items in the statements. When he did not receive the desired response, the owner wrote the Department in September 1987 and asked for assistance in obtaining an opinion regarding the two items. Eventually, the matter was turned over to a Board consultant, Marlyn

      D. Felsing, and he reviewed the statements in question. Although Felsing found no problems with the two items raised by the owner, he noted what he perceived to be other errors or irregularities in the statements. This led to the issuance of an administrative complaint on September 29, 1988 charging the firm of Flanagan & Baker, P. A., with negligence in the preparation of the statements and the violation of three Board rules. That precipitated the instant controversy.

   4. The engagement in question represented the first occasion that the firm had performed work for BCA. The association's annual financial statements from its inception in 1980 through calendar year 1983 had been prepared by Touche Ross & Company, a national accounting firm, and for the years 1984 and 1985 by Mercurio and Bridgford, P. A., a Sarasota accounting firm. Some of these statements have been received in evidence.

      
      

   5. As a part of the Board investigation which culminated in the issuance of a complaint, Felsing visited respondent's firm, interviewed its principals, and reviewed the work papers and financial statements. A formal report reflecting the results of his investigation was prepared in June 1988 and has been received in evidence as petitioner's exhibit 1. In preparing his report, Felsing relied upon a number of authoritative pronouncements in the accounting profession which underlie the concept of generally accepted accounting principles (GAAP). These included various opinions issued by the Accounting Principles Board (APB), Statements on Auditing Standards (SAS) issued by the Auditing Standards Board, and Accounting Research Bulletins (ARB) issued by the Committee on Accounting Procedure. The three organizations are a part of the American Institute of Certified Public Accountants (AICPA). With regard to the concept of materiality, which requires an accountant to consider the relative importance of any event, accounting procedure or change in procedure that affects items on the statements, Felsing did not exclude any matters on the ground they were immaterial. Rather, he included all possible irregularities, regardless of their materiality, on the theory that the probable cause panel (for which the report was initially prepared) should consider all items in the aggregate.

      
      

   6. According to Felsing, a number of irregularities or errors were found in the financial statements prepared by respondent. These are discussed separately in the findings below. The first alleged deficiency noted by Felsing concerned a change by the association from accelerated to the straight-line method of depreciation. According to APB 20, such a change is considered to be significant, and "the cumulative effect of changing to a new accounting principle on the amount of retained earnings at the beginning of the period in which the change is made should be included in net income of the period of the change." In other words, APB 20 requires the cumulative effect of the change to be reported in the net income of the current year. However, respondent accounted for the change as a prior period adjustment on the statement of members' equity. Respondent justified its treatment of the item on the ground the prior year's statements prepared by Mercurio and Bridgford, P. A., did not show any accumulated depreciation. Thus, respondent asserted it was merely correcting an error because the other firm had not reported depreciation on the balance sheet. In addition, respondent noted that the effect on the balance sheet was only $721, deemed the item to be immaterial, and concluded its treatment of the item was appropriate. However, APB 20 requires the auditor to address the cumulative effect of the change ($2,072) rather than the effect of only the current year ($721), and therefore the cumulative effect should have been reported in current income. By failing to do so, respondent deviated from GAAP.

      
      

   7. The association had designated several cash accounts as being reserve accounts for deferred maintenance and replacements. Under ARB 43, such accounts must be segregated in the balance sheet from other cash accounts that are available for current operations. This would normally be done in a separate classification called "other assets" so that the user of the statements would be aware of the fact that the reserves were not available for current operations. However, the statements reflect that three such reserve accounts were placed

      under the classification of current assets. It is noted that these accounts totaled $25,514, $18,550 and $30,927, respectively. While respondent recognized the difference between cash available for current operations and reserves for future use, and the requirements of ARB 43, it noted that the association's minute book reflected the association regularly withdrew funds from the accounts throughout the year to cover current operations. Also, the prior year's statements prepared by Mercurio and Bridgford, P. A., had classified the item in the same fashion. Even so, if respondent was justified in classifying the accounts as current assets, it erred by identifying those accounts as "reserves" under the current assets portion of the balance sheet. Therefore, a deviation from GAAP occurred.

      
      

   8. One of the most important items in a condominium association's financial statements is how it accounts for the accumulation and expenditure of reserves, an item that is typically significant in terms of amount. The accounting profession does not recommend any one methodology but permits an association to choose from a number of alternative methods. In this regard, APB

      22 requires that an entity disclose all significant accounting policies, including the choice made for this item. This disclosure is normally made in the footnotes to the financial statements. In this case, no such disclosure was made. Respondent conceded that it failed to include a footnote but pointed out that when the statements were prepared by Touche Ross & Company, one of the world's largest accounting firms, that firm had made no disclosure on the basis of immateriality. However, reliance on a prior year's statements is not justification for a deviation from GAAP. It is accordingly found that APB 22 is controlling, and footnote disclosure should have been made.

      
      

   9. The financial statements contain a schedule of sources and uses of cash for the current fiscal year. According to APB 19, all transactions in this schedule should be reported at gross amounts irrespective of whether they utilize cash. However, respondent reported all transactions in the schedule at their net amount. In justifying its action, respondent again relied upon the prior years' statements of Touche Ross & Company and Mercurio and Bridgford, P. A., who reported the transactions in the same manner. It also contended the item was immaterial and that a detailed explanation of the item is found in the statement of members' equity. Despite these mitigating factors, it is found that the schedule was inconsistent with APB 19, and a deviation from GAAP occurred.

      
      

   10. Felsing's next concern involved the language used by respondent in footnote 6 to the statements. That footnote pertained to the unfunded reserve and read as follows:

       
       

       NOTE VI - UNFUNDED RESERVE

       
       

       As of December 31, 1986, the Association reserves amounted to $103,953 consisting of

       $18,931 as a reserve for depreciation and statutory reserves of $85,022. The amount funded was $95,422 leaving an unfunded balance of $8,531 due to the reserves from the operating funds.

       
       

       Felsing characterized the footnote as "confusing" because it referred to depreciation as a part of a future reserve for replacements. Felsing maintained the footnote contained inappropriate wording since depreciation relates to assets already placed in service and not to their replacements. Respondent

       agreed that the footnote, taken by itself, might be confusing. However, it contended that if the user read the preceding footnote, which he should, there would be no possible confusion. That footnote read as follows:

       
       

       NOTE V - RESERVE FOR DEPRECIATION

       
       

       The Association funds the reserves for depreciation through its operating budget. These funds are to be used for the replacement of property and equipment as the need arises. As previously noted, the Association changed its method of computing depreciation to conform with generally accepted accounting principles. As of December 31, 1986, the reserve for depreciation totaled $18,931.

       
       

       According to respondent, the above footnote made clear to the user that the firm was not referring to depreciation as a reserve but rather was setting aside funds equal to depreciation in an effort to have sufficient cash to purchase assets in the future. While the deficiency here is highly technical and minute in nature, it is found that the footnote is not sufficiently clear and that the user might be confused.

       
       

   11. Felsing next observed that the footnotes did not disclose how the association accounted for lawn equipment or other capital assets. According to APB 22, such a choice is considered a significant accounting policy and, whatever policy is utilized, the same must be disclosed in the footnotes to the statements. In response, Flanagan pointed to a footnote in Note I of the statements which read in part as follows:

       
       

       Property and Equipment and Depreciation

       
       

       Property and equipment capitalized by the Association is stated at cost. During 1986, the Association changed its method of depreciation from the accelerated cost recovery method to a straight line method in which property and equipment is depreciated over its estimated useful life in accordance with generally accepted accounting principles.

       
       

       According to respondent, this footnote was adequate in terms of explaining the method of depreciation. Also, a number of other statements were introduced into evidence to show that other entities routinely used a corresponding footnote.

       Flanagan's testimony is accepted as being the most credible and persuasive evidence on this issue, and the footnote is accordingly deemed to be adequate disclosure on this policy.

       
       

   12. In the statement of members' equity, there is an item in the amount of

       $1,730 described as "capitalization of lawn equipment expensed in previous year." Although Felsing did not question the amount shown, he faulted respondent for not properly describing whether the item was a change in accounting principle or an error correction. According to APB 20, the disclosure of an error correction is required in the period in which the error was discovered and corrected. Although respondent considered the footnote

       described in finding of fact 11 to constitute adequate disclosure, it is found that such disclosure falls short of the requirements of APB 20.

       
       

   13. Work papers are records and documentary evidence kept by the accountant of the procedures applied, tests performed, information obtained and pertinent conclusions reached in the engagement. They serve the purpose of documenting the work performed and provide verification for the accountant. In addition, another important, required tool is the audit program, a written plan for how the auditor intends to perform the audit. The plan serves the purpose of documenting the accountant's mental process of deciding what procedures are necessary to perform the audit and to communicate those procedures to the persons actually conducting the audit. The audit plan should include in reasonable detail all of the audit procedures necessary for the accountant to perform the audit and express an opinion on the financial statements. Although a variety of checklists have been prepared by the AICPA and other organizations, each audit program must be tailored to fit the needs of a particular client.

       
       

   14. Felsing noted what he believed to be a number of deficiencies with respect to respondent's work papers, audit program, and engagement planning. In reaching that conclusion, Felsing relied upon various SAS pronouncements which govern that phase of an auditor's work. Those pronouncements have been received in evidence as petitioner's exhibits 7-14. Although the work papers themselves were not introduced into evidence, Felsing stated that his review of them reflected they were "deficient" in several respects. For example, he did not find a planning memorandum, time budget, checklist or other evidence that planning procedures were performed as required by SAS 22. In this regard, Flanagan corroborated the fact that no formal planning memorandum to the file was prepared. Although respondent's audit program was written for a condominium association, Felsing found it "extremely brief" and was not tailored to this particular client. He opined that such a program should have included reasonable detail of all audit procedures necessary to accomplish the audit and to express an opinion on the financial statements. In particular, it was noted that some required procedures were not on the list while some procedures actually used by respondent were not included. Through conversations with respondent's members, Felsing learned that much of the audit work was performed by Menchinger, the junior partner in the firm. In addition, "a few" other work papers were prepared by an unknown assistant. Although Menchinger reviewed all work performed by the assistant, Felsing found no evidence that the papers were reviewed by the supervising partner, Flanagan. Such review, which is a required step in the audit process, is generally evidenced by the supervising partner placing check marks or initials on the individual work papers. Felsing noted further that the decision to rely on the testing of internal controls was not documented in the work papers by respondent. He added that the amount of time budgeted by respondent for this engagement (around thirty hours) was inadequate given the fact that it was the first year the firm had prepared this client's statements. Finally, Felsing concluded that the violations were not peculiar to a condominium association but were applicable to all enterprises.

       
       

   15. Respondent pointed out that the association was a small client with less than five hundred line items, and the audit program and engagement planning were planned within that context. Respondent introduced into evidence its audit program which contained the steps taken by the firm in planning for the engagement. Testimony that all steps contained therein were followed was not contradicted. Similarly, Flanagan testified without contradiction that he reviewed all work performed by Menchinger but did not evidence his review with tick marks on each page. According to Flanagan, on a small audit such as this, he considered the signing of the tax return and opinion letter evidence that he

       had reviewed the work papers. However, Flanagan acknowledged that someone examining the papers would not know they had been reviewed by the supervising partner. Based upon the above findings, and after reconciling the conflicting testimony, it is found that respondent violated GAAP by failing to have a planning memorandum, time budget, and evidence of testing of internal controls within its work papers. All other alleged violations are found to without merit.

       
       

   16. Respondent has continued to represent the association since the Board issued its complaint. Indeed, Flanagan noted that the association is pleased with the firm's work, and this was corroborated by a letter from the association's board of directors attesting to its satisfaction with the firm. There was no evidence that the association or any other third party user of the statements was injured or misled by relying on the statements.

       
       

       CONCLUSIONS OF LAW

       
       

   17. The Division of Administrative Hearings has jurisdiction over the subject matter and the parties thereto pursuant to Subsection 120.57(1), Florida Statutes (1987).

       
       

   18. Since respondent's professional license is at risk, the agency must prove the allegations in the administrative complaint by clear and convincing evidence. See, e.g., Evans Packing Co. v. Department of Agriculture and Consumer Affairs, 14 FLW 2326, 2327 (Fla. 1st DCA, October 3, 1989).

       
       

   19. The administrative complaint names the accounting firm of Flanagan and Baker, P. A., as the respondent in this cause, and all allegations are directed towards the firm. Under the licensing scheme in chapter 473 for certified public accountants, both the accounting firm and its individual members are issued licenses. Petitioner contended at hearing and in its proposed order that in addition to the firm, its individual members are also subject to disciplinary action in this proceeding. To support its position, petitioner relied upon the Uniform Partnership Act, and more specifically Sections 620.60(1) and 620.63, Florida Statutes (1987), which hold that every partner is an agent of the partnership, and all partners are liable jointly and severally for any penalty incurred by a wrongful act or omission of a partner acting in the normal course of the business of the partnership. It is true, of course, that agency principles can apply in disciplinary proceedings and the wrongful conduct of an agent imputed to his principal. 1/ However, for this to occur, all attendant due process requirements must be met. More specifically, at a minimum the licensee to whom the illicit conduct is to be imputed must be put on notice that his license is at risk. In the case at bar, the complaint failed to name the individual members as respondents and alert them to the fact that the agency intended to subject their licenses to disciplinary action. Moreover, Flanagan and Menchinger were not formally served individually with a copy of the complaint and were under the impression that the proceeding involved only the license of the firm. Because of these procedural infirmities, it is concluded that the only license subject to disciplinary action is that of the now dissolved accounting firm of Flanagan and Baker, P. A. Cf. Arthritis Medical Center, Inc. v. DHRS, 543 So. 2d 1304 (Fla. 4th DCA 1989) (defendant is entitled to personal service of original process before an administrative board acquires personal jurisdiction).

       
       

   20. Respondent is charged with negligence in the preparation of the association's financial statements within the meaning of Subsection 473.323(1)(g), Florida Statutes (1987). If true, that would also constitute a

       violation of subsection 473.323(1)(a), which makes it unlawful for a licensee to violate any provision within chapter 473. In addition, respondent is charged with violating subsection 473.323(1)(h), which makes it unlawful for a licensee to violate any rule adopted under the act. This latter charge is based upon further allegations that respondent violated Rules 21A-22.001, 21A-22.002 and 21A-22.003, Florida Administrative Code (1987). Although the complaint does not identify which portions of the cited rules are alleged to have been violated, it is noted that the first rule requires, among other things, that a licensee comply with the general standards of professional competence and due professional care, both of which standards are cited in the complaint. The second rule requires an accountant to comply with generally accepted auditing standards while the final rule generally prohibits an accountant from expressing an opinion that statements are in conformity with GAAP if such statements contain any departure from such principles.

       
       

   21. By clear and convincing evidence petitioner has shown, as to the statements, that respondent did not comply with GAAP in six respects. As to the work papers, there is clear and convincing evidence that respondent deviated from GAAP in three respects. The remaining charges have not been sustained. By failing to conform with GAAP, respondent was negligent within the meaning of Subsection 473.323(1)(g), Florida Statutes (1987). This also constituted a violation of Subsection 473.323(1)(a), Florida Statutes (1987), which makes it unlawful to violate any provision within chapter 473. Paragraph 3 of the complaint refers to a lack of "professional competence" and "due professional care" on the part of respondent, both of which are referred to in Rule 21A- 22.001, Florida Administrative Code (1987). Since respondent clearly had the competence to accept the engagement, the charge that it violated this portion of the rule must fail. As to the charge that it did not exercise due professional care in the performance of the engagement, the charge has been sustained. The complaint also alleges that respondent's conduct violated rule 21A-22.002 which prohibits an accountant from using his name on statements that do not comply with GAAP. Since respondent used its name on the statements, and there were deviations from GAAP, the rule has been violated. Finally, rule 21A-22.003 prohibits a licensee from expressing an opinion on statements that depart from GAAP unless the licensee can "demonstrate that due to unusual circumstances that financial statements would otherwise have been misleading" and the report describes "the departure", its effects and the reasons why compliance would result in misleading statements. Since the firm did not follow the dictates of this rule, a violation has occurred.

       
       

   22. Rule 21A-36.004, Florida Administrative Code (1987) sets forth suggested disciplinary guidelines to be used in this type of proceeding. Although petitioner has not recommended a penalty for the firm's license, which is the only licensee subject to disciplinary action in this proceeding, a reprimand is deemed to be a sufficient penalty within the guidelines of the above rule. This is because the violations were not serious, and the evidence did not reflect that the deviations caused harm to the statement's users. 122

RECOMMENDATION

Based on the foregoing findings of fact and conclusions of law, it is RECOMMENDED that respondent be found guilty of the violations discussed in

the conclusions of law portion of this Recommended Order, and that license

number AD 0006179 be given a reprimand. All other charges should be dismissed.

DONE and ENTERED this 30th day of October 1989, in Tallahassee, Leon County, Florida.

DONALD R. ALEXANDER

Hearing Officer

Division of Administrative Hearings The DeSoto Building

1230 Apalachee Parkway

Tallahassee, Florida 32399-1550

(904) 488-9675

Filed with the Clerk of the Division of Administrative Hearings this 30th day of October 1989.

ENDNOTE

1/ For example, it is a common practice in administrative proceedings to charge a real estate broker or insurance agent with the acts of his salesmen by imputing their guilt to the licensee. However, in each case the broker or agent has been named a respondent in the cause, made aware of the fact that his license is in jeopardy, and served with a copy of the complaint.

APPENDIX

Petitioner:

46. Rejected as being subordinate to other findings. 47-48. Used in finding of fact 14.

49-50. Used in finding of fact 15. 51-53. Used in finding of fact 14.

1. Rejected as being subordinate to other findings.

2. Used in finding of fact 5. 56-57. Used in finding of fact 1.

COPIES FURNISHED:

TOBI C. PAM, ESQUIRE

1940 NORTH MONROE STREET, SUITE 60

TALLAHASSEE, FL 32399-0792

MR. JOHN R. FLANAGAN

2831 RINGLING BOULEVARD, SUITE E-118 SARASOTA, FL 34237

MS. MARTHA WILLIS, EXECUTIVE DIRECTOR BOARD OF ACCOUNTANCY

4001 NORTHWEST 43RD STREET, SUITE 16

GAINESVILLE, FL 32606

KENNETH D. EASLEY, ESQUIRE

1940 NORTH MONROE STREET, SUITE 60

TALLAHASSEE, FL 32399-0792

Docket for Case No: 89-003717

Orders for Case No: 89-003717