A certified, professional accountant can be a valuable partner to a small business at all stages, from formation, to financials, to the sale of the business. Handling your own accounting might seem like a money-saving strategy, but it may not be the best use of your time. Aside from that, do-it-yourself accounting can sometimes result in expensive mistakes.
Paying a professional can have benefits that far outweigh the added costs. But if an accountant makes an error or gives advice that has financial consequences for your business, it can create the sort of setback you were hoping to avoid by hiring a pro in the first place.
As the business owner, you may incur liabilities or suffer losses that stem from an accountant’s negligence. If this happens, you may be able to hold the accountant legally responsible for financial losses that their actions (or failure to take action) result in.
Suing isn’t always the first, best, or only course of action. But if your accountant made a costly error and is unwilling to set things right, you should understand your legal rights and options.
An accountant’s role in a small business
Partnering with an accounting professional can be beneficial for your business before you are even up and running. When putting together a business plan, an accountant can help you to prepare financial statements such as startup budget and costs, projected profit and loss statements, and sources and uses of funds. Lenders will look carefully at these statements, so accuracy is critical.
An accountant can also provide valuable advice about business formation. Choice of entity (C corporation, S corporation, or a limited liability company) may affect how the company’s earnings will be taxed and how your assets are protected. Other important tax issues tied to the formation of a business entity include pass-through taxation and founder property and services contributed to the company in exchange for equity.
Once your business is up and running, there are numerous issues that you may elect to have an accountant handle or advise you on.
Some of the most important ones are:
- Sales tax
- Payroll tax
- Employee versus independent contractor issues
- Setting up financial software that tracks income and deductible expenses
- Establishing a budget
- Strategic financial planning for growth
- Preparing tax forms
As your company grows, an accountant can take on a variety of roles in its operations. They might develop, implement, and maintain financial databases, establish and monitor control procedures, analyze data to assist in business decisions, provide strategic recommendations, prepare financial reports, make sure you are up to date on tax laws, and deal with third parties such as vendors and financial institutions.
Partnering with a professional who takes care of these matters frees up your time to be used in other areas of the business. You also avoid the stress of wondering whether your accounting and taxes are aboveboard.
By helping you to keep more of your hard-earned money and avoiding expensive mistakes, the return on investment of hiring an accountant should more than outweigh the costs of paying one. But if your accountant makes an error that costs you money, the situation gets more complicated.
Steps to take when you spot accounting errors
When you suspect your accountant has made an error, it’s important to get all the facts straight before assuming negligence.
- Speak with your accountant. They may have an explanation for why you aren’t seeing what you expected. While these conversations are essential when you spot errors, reviewing your financials and talking with your accountant throughout the year can help prevent errors from happening in the first place.
- Account for ambiguities. Even though accountants work with numbers, not everything is straightforward. This is especially true when accountants are working in the dark. It’s critical that you disclose all of the information pertaining to your financials and the intricacies of your business.
- Ask for a second opinion. If the numbers still aren’t adding up, have another accountant review your financials.
- Amend the error. Some errors can be fixed if caught quickly enough. For example, your accountant may be able to file an amended tax return.
Accounting malpractice: When something goes wrong
If your accountant made an error and is in the wrong, it may be malpractice.
Most people are familiar with the concept of malpractice as it relates to physicians and healthcare providers, but malpractice can be committed by many types of professionals—including accountants.
A number of different theories of liability can be asserted against an accountant for malpractice. The most common is negligence.
Accounting negligence occurs when an accountant does not provide services at a level that would be reasonably expected of an accounting professional under similar circumstances.
More specifically, a successful claim for accountant malpractice must satisfy the following elements:
- The accountant owed the client a duty to use reasonable care. This duty is based on the professional relationship between the accountant and the client (that is, the client hired the accountant to provide accounting services).
- The accountant breached their duty to the client. To show that a breach of duty occurred, the client must demonstrate that the accountant failed to use that degree of professional skill normally possessed by accountants performing similar work, such as failure to follow the law, Generally Accepted Accounting Principles (GAAP), or other standards. In many cases, the testimony of an expert witness is used to show a breach of duty.
- Harm must have occurred. You must have suffered financial losses (“damages”) as a result of an accountant’s alleged mistake. If an accountant committed an error, but no harm resulted, you do not have a case.
- The accountant’s negligence was the cause of the client’s damages. There must be a causal nexus between the asserted breach of duty and damages. Causation is often shown by using the “but-for” test. This test seeks to establish that but for the existence of X (the accountant’s error or omission), then Y (the client’s damages) would not have occurred.
In some cases, it is possible to sue an accountant even when you did not hire them directly. For example, if you relied on a third party accountant’s negligently prepared financial statements in connection with a business transaction—and lost money on that transaction—you might have a case. This type of claim is typically called negligent misrepresentation (rather than simple negligence).
A small business that sues an accountant for professional negligence is entitled to recover all damages resulting from the accountant’s breach of duty. The damages available depend on the circumstances of each case.
For example, if an accountant makes an error that results in overpaid taxes, the business can likely recover the overpaid taxes and related penalties, as well as professional fees incurred as a result of defending against an IRS examination. The business might also be able to claim that an accounting error caused them not to receive an income tax refund. Experts are often hired to determine the full scope of damages.
What is not considered accounting malpractice
Even if your accountant made an error, they may not be liable.
Errors that are not considered to be malpractice include:
- Errors made by an accountant that you had yet to enter into a formal professional relationship with.
- Errors that fall outside of the accountant’s specified duties, as outlined in the engagement letter or other formal agreement.
- Errors that do not result in a financial loss.
- Bad outcomes, not errors. When you have to pay more taxes than you expected or an investment goes south, these may not be incidents of malpractice if your accountant acted in your best interests and followed the law and professional standards.
Examples of accounting malpractice
The two biggest types of accounting errors our attorneys see are:
- Tax reporting errors, resulting in additional tax liability to the IRS; and
- Errors in an accountant’s financial statements in the context of a purchase or sale of a business.
Many other types of errors are possible. Other common examples of accountant misconduct that can lead to a lawsuit include:
- Failure to recommend an audit
- Errors made during an audit, such as failure to identify fraud or embezzlement
- Preparing inaccurate business reports or financial statements
- Mistakes in evaluating a financial statement or transaction
- Keeping inaccurate financial records
- Errors involving inventory, accounts payable, or accounts receivable
- Giving bad investment advice
- Overbilling, embezzlement, license fraud, conflicts of interest, and other types of fraud
How to handle suspected accounting malpractice
Keep in mind that any deviation from professional accounting standards can constitute malpractice—as long as you suffered financial losses from the alleged misconduct.
If you suspect malpractice, save all documents and statements related to your losses and consider consulting an accounting malpractice attorney. Most firms offer free consultations and will let you know whether you have a meritorious case. If you do have a case, an attorney can also advise you what steps to take next. Filing a lawsuit does not mean that you’ll have to go to trial. Often, filing suit motivates the other party to settle the claim.
It’s understandable that you may wish to avoid getting involved in a lawsuit. It can be expensive and time-consuming. But experience has taught us that while many accountants hold themselves to high ethical standards and are committed to resolving mistakes, unfortunately, some don’t take responsibility for their mistakes without legal pressure.
Small business owners must hold themselves accountable for their successes—and for their failures. It’s only fair that you hold the professionals working for you to the same standard.