1.12 Legal and Organizational Structure of the Firm

In most states, any organization providing public accounting services must register as a business organization. This requirement generally exists to protect the public by providing oversight and licensing certification for firms purporting to perform public accounting services.

Legal Structure of the Firm

Because professionals in an accounting firm may be eager to reduce their legal liability by establishing the firm as a corporation with limited liability for its partners and professionals, state regulators can prescribe the types of business organizations that accounting firms may register as. Although some states allow accounting firms to register as virtually any type of business organization, other states impose limits on the types of organization an accounting firm can choose. The following table describes the most common organization forms used by accounting firms in the United States:

Table 1.2

Common Forms of Business Organization

Type of Organization	Description
Sole Proprietorship	A non-incorporated entity with no legal liability protection or separation of income; the business and the owner are treated as a single entity. This is a common form of business for a single-person organization (i.e., contractor, consultant).
General Partnership	A partnership extends the ownership structure of a sole proprietorship to multiple owners. Partners share income and losses according to their partnership interests. Partners can be liable for the other partners’ actions.
Limited Liability Partnership (LLP)	A business structure providing partners limited liability protection wherein individual partners are not legally liable for the misconduct of other partners. As in an LLC, income from an LLP flows through to the individual partners.
Corporation	A corporation is created as a separate entity owned by one or more shareholders. In general, corporations provide liability protection for their owners, but income is taxed at the corporate level and again when profits are distributed to the owners. Although most states do not allow accounting firms to register as corporations, some states allow firms to register as professional services corporations (PCs) that provide some liability protection with a corporate income and tax structure.
Limited Liability Company (LLC)	A business structure owned by members that provides limited legal liability protection while allowing company profits to flow through to the members as individual income.
For more information on each type of business entity, you can click on the organization type to view a more detailed discussion at the U.S. Small Business Administration’s website: www.SBA.gov.

Because it represents an organizational hybrid offering benefits of both partnerships and corporations, each of the Big 4 accounting firms and most of the other accounting firms with a global or national presence in the United States is organized as limited liability partnerships (LLPs).

Organizational Structure of the Firm

Except for relatively small clients whose needs can be met by an individual accountant, public accounting firms generally consist of a group of professionals who work as teams to fulfill specific service engagements for a particular client. These teams are made up of public accountants at various ranks and experience levels who possess the necessary skill and expertise to meet the client’s needs.

Although titles and position names can vary by firm, they generally follow a hierarchy based on experience and expertise. The following table illustrates the hierarchical organization found within most public accounting firms:

Table 1.3

Organizational Structure of a Typical CPA Firm

Staff Level	Experience	Responsibilities
Partner	10+ Years	Ultimate oversight responsibility on audit work High-level judgments and client negotiations Responsible for attracting and retaining clients Responsible for multiple clients and engagements
Manager	5—10 Years	Responsible for planning and overseeing audit procedures Reviews work and oversight of senior (i.e., in-charge) auditor Responsible for managing client relationships Often responsible for multiple clients and engagements
Senior (In-charge)	2—5 Years	Works closely with the manager to plan and carry out the audit Responsible for carrying out and supervising field work Reviews work of associates auditors Generally responsible (i.e., in-charge) for 1–2 engagements
Associate (Staff)	0—2 Years	Performs detailed audit procedures Works closely with senior auditor to complete field work Lowest-level judgments and decisions Generally assigned to multiple engagements

In order to be cost efficient and to ensure clearly defined lines of responsibility, a typical engagement team employs a pyramid hierarchy of professionals to meet a client’s needs. Although larger audit clients may require more professionals at each experience level, an engagement team generally includes a partner, a manager, an in-charge senior auditor, and several associate auditors. As discussed in greater detail in Topic 4, to ensure quality, an independent review of the audit is performed by a partner or manager who is not assigned to the engagement team. This partner is often called the concurring partner, or the engagement review partner.

Because costs are allocated to an audit engagement based on time spent working on the engagement, the pyramid hierarchy also allows for a more cost-efficient audit. Most of the time spent performing audit procedures is assigned to lower cost associates and seniors who can perform tasks requiring relatively less professional judgment. Generally, only the more complex tasks and significant decisions are passed up the pyramid, where they are addressed by more experienced, and therefore costly, professionals (e.g., managers and partners). This pyramid model also has the benefit of providing built-in training and mentoring relationships. For example, as professionals perform audit tasks, at least one professional on the engagement team at a level above them reviews their work and provides feedback regarding strengths and weaknesses. This prepares an auditor for taking on future supervisory roles as well as giving them on-the-job training in conducting the audits.

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