Accounting firm in crisis

Grant Lincoln is the newly appointed managing partner of the local

accounting firm of BVD Knox ("BVD"). Lincoln is a talented

but quiet young CPA who has garnered the admiration and respect of clients and staff alike in his tenure at BVD. When the BVD partners were considering a replacement for their long serving managing partner, Lincoln was the natural choice. He began his career with BVD in 2005 after graduating from the University of Central Arkansas with both a bachelor and a master's degree in accounting. Lately, Lincoln had been rethinking his choice of firms and careers given

the headaches of guiding his firm through some tremendous challenges.

Background

BVD was founded in 1987 by three individuals whose accounting

careers began at the same national accounting firm. The founding partners, John Bush, Betty Villines, and Jim Dimon were rising stars in the 1980s and had established themselves as experts in assurance and management consulting within their accounting firm.

When it was apparent to them that they would be forced to relocate in order to advance further at their firm, they took bold action. These three accounting & auditing prodigies decided the time was right to leave the confining world of national accounting firms and hang out their own shingle. The three BVD partners organized and managed their firm like a national accounting firm, but without much of the red tape and overhead. BVD grew and thrived in the 1990s and gained the reputation as a local accounting firm with talented professional staff delivering high quality work to their clients.BVD's focus remained on assurance work for small businesses as well as small

business consulting. They had difficulty hiring and retaining professionals dedicated to their income tax practice. When their former national accounting firm decided to close its local office, the BVD partners seized an opportunity. Jim Dimon made contact with Bill Knox, a tax partner at that firm, and inquired if their former colleague would like to bring his tax expertise (along with his impressive client list) to join BVD. After much negotiation, BVD accepted Knox as a senior partner and the firm name was changed to BVD Knox. BVD continued to grow in the 2000s. At its peak, BVD was comprised of six partners along with a professional staff of around 75 individuals. The firm had the reputation of providing services equal in quality to those provided by a national firm, but with costs more in line with the local market.

In 2013, Jim Dimon decided the pressures of building and growing a successful accounting firm had taken a toll on the quality of his life and health. He decided to retire and adopt a more relaxed lifestyle. Jim would still be available for consultations and counsel but would leave the world of day-to-day management along with its inherent stresses behind. He consented to continue to associate his name with the firm along with his sizeable partnership investment.

At that time, John Bush became the managing partner of BVD.

Storm Clouds

The tide began to turn for BVD in early 2018. The firm was ill prepared for what came next. Its sterling reputation would soon become tarnished. The first storm cloud on the horizon concerned BVD's oldest and largest client, Acme Industries ("Acme"). Acme was in business to manufacture and market furniture and furnishings for schools.Over the years, Acme had become the market leader in school furniture. Acme made the decision to go public in 2010 in order to access the capital to finance its growth. Since the company did not possess any expertise with public reporting to the Securities and Exchange Commission ("SEC"), they had to rely on their accounting firm to guide them through the process. John Bush had been the engagement partner on the Acme audit for over ten years.

In a routine review of Acme's filings, the SEC's Division of Corporation Finance uncovered some accounting irregularities. Acme had been improperly recording revenue when an order for furniture was received, even though the process of making and delivering the furniture often took several months to complete. Further, some of these orders had been cancelled, although that revenue was never reversed. Additionally, it was discovered that there was a significant amount of bad debts that had not been recognized by Acme.

Acme's audit committee hired its own law firm and accounting firm (collectively "the investigators") to investigate these SEC findings. When the investigators confronted John Bush about the accounting short comings at Acme, he stated that he did not know about any of these nefarious activities. They had apparently flown under the radar of the BVD auditors.

He further explained to the investigators that his firm had not been hired to find fraud, only to perform a financial audit. As the investigators began digging into the company records, they began to apply more and more pressure to Acme's controller, Wendy Buffet. When she could bear their scrutiny no more, Buffet admitted that she began to get more aggressive with the revenue recognition at Acme in order to meet Wall Street expectations for earnings and net income. The lack of bad debt recognition was also instituted in order to keep Acme's expense ratio in line with expectations.

Buffet informed the investigators that the CFO and CEO of Acme were well aware of the questionable accounting at Acme. When the investigators inquired as to BVD's knowledge of the accounting, Buffet broke down. She stated that BVD knew all about the accounting schemes at Acme but looked the other way in order to keep Acme's auditing and consulting business. Furthermore, Buffet stated that she and John Bush had been involved in an "inappropriate

relationship" for over five years. After receiving the report from the investigators, Acme's audit committee summarily terminated their business relationship with BVD. Acme would soon be required to report their change of auditors to the SEC. Details of the dark underbellies of both Acme and BVD would soon hit the street.

Radial Technologies ("Radial"), another BVD client, was a privately held software and web hosting company. Radial's growth over the past decade was nothing short of meteoric.Radial's founder and CEO, Harold Wickes, had a keen intellect with an ego to match. After leading a successful company, Wickes' only remaining goal was for Radial to become a public company so that he could cash out his significant holdings in order to enable him to buy his own island. Betty Villines, the engagement partner for Radial, had been able to reason with Wickes and to delay Radial's initial public offering of stock. Nobody understood Wickes' temperament and personality better than Villines, who was able to explain to him the headaches of being the CEO of a public company.

When it was apparent that Wickes would not stop until Radial was a public company, Villines devised a plan. It was well known in the technology sector that the founders of Sigma Inc. ("Sigma") were ready to retire and were willing sell their small public company to someone who would continue their legacy. Villines facilitated a meeting of the Sigma management and Wickes in order to hammer out a deal. The businesses of Radial and Sigma would complement each another to form an even more successful combined company. The plan was 1) for Wickes to buy the majority of the shares of Sigma, 2) merge Radial into Sigma, 3) change the name of Sigma to Radial and 4) have Wickes cash out some of his shares of the newly named public company in a secondary offering. Villines was justifiably proud of her plan when both sides were able to agree in principle to this complicated arrangement. She left her brainchild in the hands of the attorneys for Radial and Sigma and began her celebration of a job well done (with some great client billing numbers to show for it). This story had a happy ending for Harold Wickes, who was able to complete this complicated transaction and monetize a significant portion of his holdings. All the while, he became the darling of Wall Street with his photograph splashed across the covers of both Fortune and Forbes magazines.The above market premium that he paid for the Sigma stock was a paltry sum, given the much higher valuation that Wall Street had awarded his combined companies.

A few months after the closing of the Radial/Sigma deal, an analyst with the SEC's Enforcement Division discovered some unusual trading activity in Sigma stock in the days leading up to the announcement of the Radial/Sigma transaction. Upon the receipt of the detailed trading records, the analyst began investigating activity in the account of Buddy Villines. Further investigation, revealed that Mr. Villines had been married to prominent CPA, Betty Villines for a number of

years. When the SEC learned of Mrs. Villines' involvement in crafting the Radial/Sigma deal, subpoenas were issued to both Mr. and Mrs. Villines.

In the Bunker

After both John Bush and Betty Villines tendered their resignations from the firm, the Executive Committee of BVD had been reduced to one member, Bill Knox. Knox, a tax man to the core, had never truly involved himself with the management of BVD, relegating those duties to Bush and Villines. Knox called on his old friend and former partner, Jim Dimon for assistance.Knox and Dimon began meeting every day in order to devise a plan to save their firm.

Knox and Dimon knew that they did not have any time to spare if they were going to save their accounting firm. Since they did not have the skill or the energy to perform an adequate investigation and knowing they would need expert representation, they hired a law firm to

investigate the allegations against BVD. The law firm would also interview all BVD personnel as well as the key people at every BVD client in order to provide the information the partners would need in making decisions about the future of BVD. While they were waiting on the report, they first had to concern themselves with appointing the next managing partner to replace the now departed John Bush.

"Bill, you are the natural choice for managing partner," Dimon stated. "You have been here forever, and you are well thought of by your clients and the staff alike." "Jim, I was hoping you would come out of retirement to lead this firm," Knox replied. "I just don't have the energy or the drive to succeed John. In fact, I was considering retirement

myself before all this mess hit the fan." "That is out of the question, Bill! I've been gone way too long." Dimon brightened, "We need one of those young and energetic partners. I think Grant Lincoln is the one. He is smart as hell and everybody loves him.He may be too smart to accept the job though. These next few years could make an old man out of him." "I can't think of a better candidate than young Lincoln! Let's call him up and give him the good news before word of John & Betty hits the wire," replied Knox.

The Report

The news of indiscretions of Bush & Villines soon became public and BVD was vilified in boththe business press and the tabloids.

The newly constituted Executive Committee of Knox, Dimon & Lincoln soon received a detailed report from their law firm (the report is summarized below): Legal Issues

While Acme was threatening to sue BVD over its audit failures, this action would be covered by arbitration (as outlined in BVD's engagement letter to Acme). The good news was that by going to arbitration (as opposed to litigation) BVD could avoid the negative publicity that litigation would necessarily bring.Due to the complicity of Acme's CEO, CFO and Controller, it is highly unlikely that arbitrator would grant Acme any type of arbitration award.

BVD would be facing certain litigation in the form of a shareholder derivative lawsuit involving Acme shareholders who were harmed by the accounting schemes at Acme. Most of the cost of this litigation will be covered by BVD's errors and omissions insurance policy. However, the policy has limits in what it will pay. Therefore, if the ultimate litigation award were high enough, the firm might have to fund a portion of the award. Additionally, BVD's insurer had begun discussing the possibility of a premium increase on this insurance policy.

The accounting firm cannot be held legally culpablein the Radial/Sigma insider trading case. The legal responsibility in this case rests squarely on the shoulders of Mr. &Mrs. Villines. However, BVD's reputation will necessarily suffer since Mrs. Villines actions were related to her role as a senior partner with the firm.

Both Mr. Bush and Mrs. Villines will be subjected to endless a barrage of personal litigation regarding their indiscretions. These former partners will undoubtedly need to withdraw their BVD partnership investment in order to defend themselves.Their

withdrawals are allowed under the partnership agreement.However, these withdrawals may result in BVD being undercapitalized in the near future.

Client Issues

Most of BVD's clients were in shock over the news about the firm's transgressions. The law firm interviewed client personnel as well as audit committee chairs at BVD clients.With the reputation of BVD in decline, there was a common theme among those interviewed. Many were discussing the necessity of switching their accounting firm to a less controversial choice.

Client personnel also discussed the necessity to renegotiate the fees being paid to BVD, if the decision was made not to change accounting firms.

The law firm found that a lot of the clients were extremely loyal to the older partners (Bush, Villines and Dimon). They were uncertain of the abilities of the younger management of the firm.

The clients uniformly expressed disgust that they received the news of BVD's problems through the rumor mill or the press. A personal visit or at least a phone call from the firm's management would have softened the blow of this bad news.

Staff Issues

Upon interviewing the staff at BVD, the law firm uncovered pervasive and serious personnel issues which would need to be solved if BVD were to survive.

The staff uniformly expressed concern that their voice was not being heard by the firm's management. They viewed themselves as highly trained and highly functioning professionals but felt like their progressive ideas in how to perform the work or manage the client projects were dismissed without any consideration on the part of management.

While it was possible to earn bonuses for exceptional work, the staff were generally disgusted with how the bonus system worked. While the bonus system included stated objectives and goals, the staff felt the bonus system was inconsistently managed. Most felt that the bonus awards had more to do with politics than with performance.

The staff felt that communication from the management of the firm was inconsistent and often conflicting. The amount and type of firm communication often depended on the personal preference and/or current mood of each partner or senior manager. Certain staff noted that they often received word of what was happening at BVD through clients or news reports instead of from their management. The unanimous sentiment among staff was that they needed more communication.

When surveyed under the promise of anonymity, approximately three quarters of the staff expressed concern about ability of BVD to survive.The majority of staff interviewed stated that they were in the process of updating their rsum.

Many of the female staff members expressed concern regarding their potential for advancement. With the departure of Mrs. Villines, a female senior manager represented the sole female above the rank of seniorthere are no female managers. These staffers felt that the "good old boy" system was alive and well at BVD.

The latest teamwork initiative at BVD was laughable in the eyes of the staff. The rumor was that BVD had expended a significant amount of funds on a management consultant contract in order to form this initiative (they felt these funds would have been better spent

in the bonus pool, if they could ever understand how bonus awards were determined). While the idea of teamwork was accepted by the staff, they felt like teamwork was just another buzzword their management used. The staff felt that they were teams in name

only, with the work still being perform in the traditional manner.

Another cause of stress among the staff was the strife between BVD's two senior managers, Michael Copper ("Copper") and Rebecca Marks ("Marks"). Copper and Marks made no effort to disguise the bad blood between them. Their disagreements over staffing and the management of client projects often deteriorated into shouting matches in front of the staff. Copper was recently hired away from a national firm in order to fill a management void while Marks had risen through the ranks at BVD. While both were talented accountants, Marks often resented Copper with his new ideas on how to run things at "her firm. " Marks felt that Copper should spend some time demonstrating his loyalty to BVD before trying to make wholesale changes.

The staff were frustrated with the leadership style at BVD.Most applauded the departure of Bush & Villines. However, they expressed reservations that the new leaders would be any less autocratic.The perception among the staff is that BVD is a stodgy old firm being run by leaders who did not want to change with the times.

When specifically asked about the capabilities of Grant Lincoln, the perception of the staff were "mixed." Most felt that Mr. Lincoln was a great technician and highly capable in his area of expertise. However, many expressed their reservations at his ability to lead the firm through a crisis.Some quotes from the interviews follow: "Mr. Lincoln is just so quiet." "I never know what is going on inside his head." "I'm not sure Grant can handle the public relations aspect of running BVD."

Report Summary

BVD is facing a dire situation. The firm is at the crossroads and action needs to be taken now in order to salvage the firm.

Numerous organizational changes need to be made. The culture at BVD is suffering and the firm may not survive the current onslaught.

BVD needs to update its strategic focus. Particular attention needs to be given to client & staff retention. The firm may need to focus its efforts to become a niche player in the accounting services area.

With the departure of two senior partners, BVD needs to determine if there is room in the budget to admit another individual to the partnership.This may be necessarily in order to recapitalize the firm.

The firm needs to formalize its succession planning. The sudden departure of two senior partners brought this issue to the forefront.

The management culture of the firm needs to be transformed. The current crisis may provide the opportunity the firm needs in order to accomplish this.

The Executive Committee Deliberates

After reviewing the report individually, the Executive Committee (the "committee") convened to discuss it and determine their next steps. Their deliberations are summarized below:

They decide that the time is right to admit one of the senior managers to the partner ranks but cannot decide on which one. Copper has a lot of new ideas, seems to be very outgoing,

and is humble to a fault but self-confident at the same time.He is very

enthusiastic and optimistic and is great at developing the staff members assigned to his projects. On the other hand, Marks is the highest-ranking female. Promoting her would go a long way towards appeasing the female staff members.She has a wealth of institutional knowledge since she has grown up at BVD. However, she can be cold at times-a criticism of her that has recently surfaced from the staff. The leadership styles of the two senior managers could not be more differentCopper seems to respect the staff more and lets them work out their problems, only stepping in when needed. On the other

hand, Marks seems to be more "old school" and autocratic, her directive style often bordering on micromanagement.

The committee recognizes the need to retain old clients while investigating new sources of revenue. The partners have met with all of the BVD clients with varying levels of interest in retaining BVD. At worst, BVD could lose half of their client base before the dust settles. Dimon noted that the Controller from one of his old clients had approached him with a scheme. If the Controller could talk his employer into retaining the services of BVD, then Dimon would agree to "kick back" a portion of the fee to the Controller.

With the departure of two named partners, a serious discussion ensued about whether to change the name of the firm. Lincoln expressed his enthusiasm for this idea and thought that the rebranding might give new life to the firm. Resistance was offered by the two old-timers.

The committee thought that some of the issues brought forward by the staff of BVD were petty and meaningless. They see no reason to change the management style at the firm.

BVD has long been a major contributor to the philanthropic activities in their area.With the stress on capital and earnings brought about by the recent crisis, the committee considered whether to discontinue their philanthropic activities. After many long hours of deliberation without any progress toward an agreement among the partners, Lincoln decided to approach the problem in a different manner. Lincoln, ever the proud UCA Bear, remembered with fondness his time spent in his accounting leadership class (though he had difficulty remembering any of the principles he learned in class). He proposed to his partners a plan to engage those young and energetic students in the current Seminar in Accounting Leadership to provide some free ("Hey, this firm is in financial distress!") leadership consulting to BVD.

Questions

1. How a leader can save BVD from its dire situation?

2. The culture at BVD is suffering and the firm may not survive the current onslaught. What strategies will be applied to change the culture at BVD? What proper actions is needed regarding BVD's clients, Acme industry and Radial Technology?

3. The firm may need to focus its efforts to become a niche player in the accounting services area. How BVD will update its strategic focus and pay attention needs to be given toclient & staff retention.