Sally Jones is preparing for next month's partner retreat in Phoenix. Sally is one of three founding partners and is currently the lead partner for the Assurance Services unit of Smith & Jones LLP. She worries about the performance of her unit, and that of the rm as a whole, because there has been no bottom-line growth, and revenues increased by only 2 percent in 2007 (see Appendix 1). There are a number of other issues that she is sure will dominate discussions at the partner meeting: the prot available for partners is below industry average, and in the past year her rm has lost several larger audit clients to rival audit rms and to clients' bankruptcies and mergers. Although the audit partners have stepped up their eorts to win new clients, the rm has not yet won any signicant new audits. Things have not gone well on the staff front either her unit has lost a number of staff CAs and students as well as two partners. Further still, her unit, Assurance Services, has the lowest billable hours and realization rate,1 due to client miscommunications that led to les being redone. Smith & Jones has rapidly grown from a small, local rm to a medium, regional rm through organic growth and mergers. When her own rm was small, it was easy to see whether everyone was on the same page they all worked within 10 feet of each other in the same, cramped ofce. But now with 16 partners and 96 professional staff divided between four ofces in western Canada, Sally is unsure whether her staff understand the vision and whether they are living the rm's core values. Sally knows the Business Advisory Services unit of Smith &J ones regularly helps clients to improve their performance, but wonders whether what was \"good for the patient\" is also \"good for the doctor\". She invites you, Morgan Jaille, to her ofce to discuss what is ailing Smith & Jones, and to ask whether you can provide recommendations to improve the rm's performance. You have been with the rm since your graduation and are almost nished your CASB coursework. You enjoy the people you work with and the camaraderie, and al- though you have shown a talent for assurance work, your heart is set on working as a business consultant Your objective, once you receive your professional designation, is to work in the Business Advisory unit, helping rms to improve their bottom lines.You see this assignment as a chance to impress Smith & Jones' Business Advisory partners with your consulting abilities. Sally limits the scope of the assignment by asking you to focus your efforts on the Assurance Services unit of Smith & Jones. Your goal is to make recommendations that will increase her unit's protability, and thus increase the partners' take-home pay. SMITH 8: JONES' STRATEGY At the 2006 partner retreat, Sally and the other partners sat down and formalized Smith & Jones' strategy, vision, and core values (see Figure 1). To reinforce this message, the rm had its strategy and vision printed on the back of each staff members' business card. THE PAST AND FUTURE OF SMITH 8: JONES After graduating from the University of Saskatchewan in the late 1930s, Sally Jones started her career with, and earned her CA designation while working for, one of the Big 8 audit rms in Calgary. She decided to move back home to Saskatoon and strike out on her own in 1996 because she was tired of working long hours without adequate compensation, and the long commutes in Calgary. She was extremely competent and personable and soon grew For example, it is estimated that in 2003 PotashCorp of Saskatchewan paid approximately $1.2 million for its audit and $0.6 million for its rst year of SOX compliance work. Almost overnight the fortunes of audit units improved. In fact, in the wake of the introduc- tion of SOX, most of the Big 4 accounting rms struggled to meet the demand for assurance services. In response to this increased demand and the prohibitive cost of a bad audit, some larger CA rms cut loose higher-risk clients and increased the audit fees for their remaining clients. Because of this, Smith & Jones was able to pick up a number of clients in the areas in which they specialized: small business, credit unions, and agribusiness. Although their revenues rebounded in the wake of SOX, a signicant issue for Smith & Jones was the hiring and retaining of staff. In the past couple of years, Smith & Jones lost over 10 percent of its staff and two partners to industry or rival audit rms. Sally had reasons to believe that the demand for CAs would not recede in the near future. As more baby boomers reach retirement age, the number of CAs leaving the profession is increasing. Unfortunately, the number of students entering the profession is not enough to offset these retirements. Even with UFE (uniform evaluation) pass rates at unprecedented high levels, the supply of GAS is inadequate to meet demand. To make the profession even more attractive to prospec- tive university students, the Canadian Institute of Chartered Accountants (CICA) now allows students to become CAs without working in an audit rm and performing any assurance work as part of their professional work experience requirement. Unfortunately, this will further reduce the number of audit hours available to rms like Smith & Jones, because all CA students currently have to complete a minimum of 600 audit hours as part of their pro- fessional work experience. Another issue is that fewer than 40 percent of CAs remain in public practice after qualifying for their CA designation. The majority of CAs leave public practice to work in industry, where many enjoy larger compensation packages after taking into account stock-based incentives. As a result of the increased competition for CAs, their salaries have been bid up, especially in areas where the economy is booming. Sally knows that Smith & Jones is not well equipped to win the CA talent war. Smith & Jones offers a mentorship program, exible hours, and a broad variety of audit assignments. However, the Big 4 accounting rms offer higher wages, signing bonuses, international assignments, subsidized child care, concierge services, superb in-house training programs, exible benet packages, and a UFE passing bonus. To get a better handle on why Smith & Jones is losing its staff members, Sally reviewed the exit interviews from sta who had recently left the rm. Specic complaints from CAs and students included long hours, many of which were uncompensated, and because of all the work, they were often denied time off for training and development Sally was disappointed to read this because all Smith & Jones' sta are entitled to 150 hours of training each year. Staff also complained that the number of hours budgeted for les was often insufcient, so they had to work extra unpaid hours just to make budget. The partners who left observed that not everyone lived the rm's stated values, commenting that some partners refused to help when another partner or manager had requested it. One partner, who volunteered many hours on the executive of the United Way and the Rotary Club, grumbled that this contribution was not recognized, as did another who coached several children's sports teams. Finally, a partner harped on a perennial bone of contention at the partner meetings: the rm has several partners who are outstanding \"rainmakers\". However, while these partners were adept at bringing in new clients, they sometimes subsequently lost the business because they did not effectively manage their staff or adequately service clients. Partners who had a better bedside manner with clients and effectively managed their staff, but were less effective in bringing in new engagements, wanted some of these clients assigned to them. While you are meeting with Sally, an audit partner interrupts to ask her whether she has had time to read the proposed new audit standard. Sally sighs while thinking about the continuous stream of new audit standards. Like many of her colleagues, she has become \"standard-fatigued\": it seems like every week a new accounting or auditing standard must be read, understood, and incorporated into Smith & Jones' standard audit procedures. Smith & Jones can sometimes use the introduction of new auditing regulations to justify higher audit fees to its clients. Most of the time, however, the new regulations only reduce its audit margins. In addition, changes in professional practice rules have increased the volume of documentation required for the audit, and for demonstrating adherence to stricter independence rules. Unfortunately, these changes have a larger cost per employee for smaller accounting rms than larger rms. In fact, Sally has heard that several smaller CA rms stopped perform- ing statutory audits because the investment needed to maintain their practice was outstripping the benet. The coming introduction of international reporting nancial standards (IFRS) also weighs heavily on smaller audit rms. While IFRS remain a bright spot for larger audit rms with clients forced to adopt IFRS, because of the higher fees that will ensue, the picture is not as positive for smaller audit rms that may only have few or no clients who will imple- ment the new standards. For these smaller audit rms, it may not be worth the cost to train employees and update audit practices to IFRS. Indeed, one reason why the two smaller audit rms, one in Brandon and the other in Lethbridge, sought to merge with Smith & Jones was that these rms were struggling to keep up with the new professional practice standards. Before adjourning the meeting, Sally shares with you her concern about the potential risk of a failed audit. If a client company experiences nancial distress and it is subsequently determined that Smith & Jones had failed to detect a violation of generally accepted ac- counting principles (GAAP), Smith & Jones' reputation would suffer, driving away current and future clients. Sally tells you that Smith & Jones is scheduled to be scrutinized by the Canadian Public Accountability Board (CPAB) in the coming year.3 PRACTICE AREAS Smith & Jones has three practice units: - Assurance Services undertakes notice to readersi' compilations, nancial reviews, and audit engagements. Sally Jones is the lead partner for Assurance Services. Ten partners, 16 audit managers, and 50 full-time professional staff report to Sally. - Tax Services assists clients with preparing and ling corporate and personal tax re- turns, tax planning, succession and estate planning, sales taxes, and payroll lings. 3. Complete and review audit I review contingent liabilities and subsequent events; I evaluation of audit results by the engagement partner; I review of audit le and statements by the risk partner; I complete and issue auditor's report; and I meet with audit committee and management to inform them of any weaknesses and to suggest improvements. THE PARTNER INCENTIVE PLAN Sally shares some benchmark gures for other similar-sized Canadian public-practice rms she has just received, noting that Smith & Jones is underperforming in a number of key areas. According to the survey, similar-sized CA rms reported that their gross revenues were up 9 percent, the average prot margin before partner distributions for CA rms was 35 percent, realization rates were 94 percent of billings, salaries were the largest expense at 33 percent of gross billings, and partners in rms with over 50 full-time staff took home, on average, over $300,000 a year. Before you leave, Sally reviews the rm's incentive plan for partners. She wonders whether she needs to tweak this as well. Currently, partners are evaluated in three areas, each worth 50 points. For a partner to earn a full bonus, he or she needs to earn 135150 points. The rst area examines the partner's average hourly billings (target of $150fhour in 2008 dollars), and the number of chargeable hours per year (target of 1,200 per year). Hitting both targets earns 50 points, and earning anything less is prorated. The second area evaluates the partner's administrative load. Partners with additional administrative responsibilities re- ceive higher ratings. For example, lead partners get the highest rating (50 points), then partners that are in charge of an ofce (40 points), then someone who is in charge of a functional area, like tax (30 points), or an area expert, such as estate taxation (20 points). The third area is the amount of client billings that are managed by the partner. The partner with the highest amount of client billings in the year is awarded 50 points; the remaining partners receive a prorated amount based on their billings as a percentage of the highest partner's total (e.g., a partner with half the client billings of the partner with the highest client billings would receive 25 points). The bonus pool is set at 20 percent of the net pre-tax prot (prot available to partners).4 The rm uses the total for the three areas to help calculate the yearly bonus for each partner. 4. The remaining 80 percent of net pre-tax prots are distributed to partners on the basis outlined in each partner's partnership agreement. Typically, partners draw between 75 and 80 percent of their anticipated earnings throughout the year, with the remainder paid out after the year-end results are nalized