Risk management in accounting: A step-by-step guide

On the surface, accounting may seem like the definition of a “safe” career path. A calculator, a desk plant, and an open tab of spreadsheets sure don’t seem to be the backdrop of a risky environment. That said, just because accounting doesn’t have as many obvious threats as other industries doesn’t mean it’s free of occupational hazards. In fact, there are many hidden risks associated with accounting.

In this article, we’ll walk you through some of the main risks in the accounting industry and discuss why it’s essential for any accounting firm — small or large — to have a risk management plan in place. By the end of this post, you’ll have a complete understanding of the ins and outs of risk management in accounting.

What’s risk management?

Risk management is a process used to identify and assess threats to a business. For the accounting industry, this means taking steps to mitigate risks that could impact your firm’s legal standing, financial stability, or cybersecurity.

It’s important for businesses in every industry to invest in risk management. Without a solid plan, in fact, you won’t be prepared to face possible risks, leaving your company vulnerable.

You can think of a risk management plan as your playbook for handling different threats to your accounting business. The plan will outline your approach to all types of risks your company could possibly face, whether they’re internal operational errors, or unavoidable external risks such as economic downturns and regulatory changes. An effective risk management plan will create clear, actionable steps to prepare your business for the worst-case scenario.

So, what’s at risk for accountants?

You may be wondering, “What’s so risky about accounting?” While accountants certainly aren’t putting their lives at risk daily, the industry still comes with a list of potential threats.

In general, accounting risks can be organized into three main categories: preventable risks, strategy risks, and external risks.

The 3 categories of risk

1. Preventable risks: These are risks that arise within your accounting business that won’t generate any strategic benefits. As the name suggests, these risks are avoidable. They generally stem from errors, mismanagement, negligence, or poor choices. Example: An accountant accidentally inputs the wrong financial information on a client’s tax return, resulting in IRS penalties. The result would likely be a lawsuit.
2. Strategy risks: These risks are anticipated and intentionally taken for superior strategic returns. For example, your firm may expand its services to include international tax advising. This comes with many more regulatory hurdles and may require hiring international tax experts.
3. External risks: This kind of risk is described as uncontrollable and takes place outside of your accounting business. External threats include regulatory changes and economic downturns. A prime example of an external risk in the accounting industry is the U.S. Tax Cuts and Jobs Act (TCJA) of 2017, which was one of the largest tax code changes in modern American history. The regulatory change made it very difficult for accountants to advise clients correctly, which led to many compliance issues.

Common risks for accountants

Now that we’ve covered the idea of general risks to pretty much any business, let’s take a closer look at the risks more related to accounting.

Professional mistakes

Without a doubt, the biggest risk in the accounting industry stems from professional errors or mistakes when carrying out a professional service. Accounting is extremely detail-orientated work, and even the smallest mistake can have major consequences for a client.

A mistake as simple as filing a document at the wrong time can cost a client thousands of dollars in penalties, which can quickly become grounds for a professional liability lawsuit. If an accounting error is viewed as negligent, your firm could face damaging litigation and regulatory fines.

Cybercrime

Any industry that stores sensitive customer or client information is considered high risk when it comes to data breaches. Accounting firms routinely use highly sensitive financial information such as social security numbers, pay slips, and bank account numbers — meaning data breaches can be especially threatening to accountants.

In recent years, cybercrime has been on the rise, and no business is out of reach. No matter how many safeguards your accounting firm has in place, a cyber attack is always a real possibility.

Reputational damage

Accounting is generally viewed as a relatively safe bet when it comes to market demand. After all, as long as we have to pay taxes, there will be a need for accountants. Having said that, accounting is a competitive field, and if your firm’s reputation suffers, you’ll risk losing potential clients. Online reviews are one of the most important ways to build trust in today’s digital-first world. People rely on reviews to help them make decisions, and a single bad review can turn off a slew of potential new clients.

Regulatory changes

Every industry deals with regulatory compliance issues, but few industries have it as hard as accountants. Accounting regulations and tax laws are constantly changing, and it can be a major challenge to stay ahead of it all.

New reporting requirements and adjustments to tax codes can disrupt workflows, causing you to miss deadlines and increase the risk of errors.

Fraudulent activity by clients

This is a risk that is unique to accounting. An accountant may become inadvertently implicated in a crime if clients engage in fraudulent activities and the accountant fails to identify red flags. Even if the accountant is directly involved in committing the fraud, the simple act of being negligent, failing to identify, or not reporting the fraud can cause the accountant to be partially liable for the crime.

Risk management in accounting: 8 steps

Now that you understand the different types of risks that may affect your accounting business, let’s look at a step-by-step plan to tackle these dangers. A risk management plan is your key to preventing risks from occurring and minimizing their impact. 

Step 1: Risk identification

The first step in creating a risk management plan involves identifying areas of vulnerability within your accounting business. You will identify all of the potential risks and threats your company could face. Create a long list of any and all possible risks that pose a threat to your accounting business — include everything from a minor employee error to economic downturns, a data breach, and bad customer reviews, just to name a few.

Step 2: Analysis

Next, you’ll want to estimate the potential severity of each risk and the likelihood that it might happen. In doing this exercise, you can rank the risks according to their degree of severity. 

During this step, you’ll assess the different threats to your organization and define how probable the risk is to occur, as well as the potential damage the risk could cause. Identifying your accounting firm’s risks is a complex process and involves using a risk matrix to define the threat level of each risk. Doing so allows you to prioritize the most harmful and likely risks. 

For example, a minor professional error is a pretty likely occurrence, but the implications would be a much less severe threat than a major data breach.

Step 3: Risk avoidance

If possible, your best defense against certain risks is to avoid them entirely. The good news? In many cases, the biggest threats to your business are completely avoidable. So, when possible, your accounting firm should steer clear of risks that pose significant threats. There are certain threats that simply are not worth rolling the dice on, and you’ll want to implement measures to prevent them from occurring.

Here are some examples of risks that you should steer clear of:

• Taking on a client with a history of fraud
• Bypassing cybersecurity measures
• Assisting clients outside of your area of expertise

Step 4: Risk reduction

Certain risks may be necessary to take on as an accountant, such as working with clients in industries prone to regulatory changes or handling large volumes of sensitive financial data that could be targeted by cybercriminals.

Not all risks are avoidable, so in these cases, it’s best to understand how to mitigate the worst-case scenario for each risk. With careful planning, you can minimize the level of risk so as not to jeopardize your business.

For example, to prevent a data breach from occurring, you can implement advanced cybersecurity measures such as data encryption and multifactor authentication. You can also lessen the severity of a data breach by limiting the amount of sensitive information your firm retains and deleting any non-essential data.

Step 5: Risk acceptance

No business can grow without taking some risks, and while most threats can be avoided or minimized, some risks are simply worth taking. Risk acceptance involves recognizing a potential threat, understanding its impact, and deciding to proceed without taking specific actions to prevent or mitigate it. In accounting, this might mean accepting the possibility of minor errors in non-critical financial reports due to tight deadlines rather than investing in complicated additional review processes. However, this approach should be used sparingly and only when the potential consequences are minimal and outweigh the cost or effort of mitigation. 

Step 6: Communication

Be sure to loop in your staff if you didn’t consult them throughout the planning process and train them in the risk management procedures you established in the plan. You want each and every accountant in your firm to be aware and involved in your risk management plan. It takes just one error or misstep for a major incident to occur.

Step 7: Risk monitoring

Risks can arise at any moment, and even if you invest heavily in an effective risk management plan, new risks can arise that weren’t previously on your radar. This is why it’s important to update your risk management plan often. Identify potential risks before they escalate and work to create safeguards for the newly identified areas of concern.

Step 8: Risk transfer

One of the best ways to shield your accounting firm against potential threats is to transfer the risk to a third party, such as an insurance company. Purchasing insurance transfers much of the financial burdens associated with the risks to your insurance provider, which allows you to continue running your accounting business without the fear of going bankrupt due to a liability claim.

Coverage like professional liability insurance can help your accounting firm withstand the risks of professional errors and omissions. 

To avoid the financial impacts of a data breach or cyber attack, you can also purchase a cyber liability insurance policy. 

The fact of the matter is that the best way to avoid liability as an accountant is to transfer the risk to an insurance provider.

Manage your risk effectively as an accountant

While there are so many elements to running a business that you can’t control, it’s important to focus on what you can. While risks are an inevitable part of life, you can do your best to plan and prepare for them. Risk management comes with the territory of an accountant, and with a proper plan in place, you can avoid and mitigate threats to your business.

Read about all the insurance policies that accountants need in our related blog post.