Clarified Auditing Standard--Terms of Engagement, Part 2 (AU-C 210)

In my last article, the objectives and content of engagement letters was discussed.  Following are some additional issues from AU-C Section 210 and a discussion of planning issues that an engagement leader may wish to discuss with management and/or persons charged with governance when the engagement letter is delivered.

As a reminder, the auditor’s objective is to accept an audit engagement for a new or existing audit client only when the basis upon which it is to be performed has been agreed upon through:

·      Establishing whether the preconditions for an audit are present and

·      Confirming that a common understanding of the terms of the audit engagement exists between the auditor and management and, when appropriate, those charged with governance.

Preconditions for an audit include the use by management of an acceptable financial reporting framework in the preparation of the financial statements and the agreement of management and, when appropriate, those charged with governance, to the premise on which an audit is conducted.

Additional Issues in Engagement Letters

·      Initial audits, including reaudit engagements –Covers steps the auditor should take before accepting an engagement for an initial audit (or a reaudit engagement) including requesting:

o       Management to authorize the predecessor auditor to respond fully to the auditor’s inquiries regarding matters that will assist the auditor in determining whether to accept the engagement.

§         Should management refuse to authorize the predecessor auditor to respond, or limits the response, the auditor should inquire about the reasons and consider the implications of that refusal in deciding whether to accept the engagement.

§         The auditor should evaluate the predecessor auditor’s response, or consider the implications if the predecessor auditor provides no response or a limited response, in determining whether to accept the engagement.

·      Recurring Audits –Covers requirements in assessing whether circumstances require the terms of the audit engagement to be revised. 

o       Acceptance of a change in the terms of the audit engagement--Covers the auditor’s consideration of changes to the terms of the audit engagement when no reasonable justification for doing so exists.

§         If the terms of the audit engagement are changed by agreement, the auditor and management should agree on and document the new terms of the engagement in an engagement letter or other suitable form of written agreement.

o       If the auditor concludes that no reasonable justification for a change of the terms of the audit engagement exists and is not permitted by management to continue the original audit engagement, the auditor should:

§         Withdraw from the audit engagement when possible under applicable law or regulation.

§         Communicate the circumstances to those charged with governance, and

§         Determine whether any obligation, legal, contractual, or otherwise, exists to report the circumstances to other parties, such as owners, or regulators.

·      Additional considerations in engagement acceptance

o       Auditor’s report prescribed by law or regulation

§         If law or regulation prescribes a specific layout, form, or wording of the auditor’s report that significantly differs from the requirements of GAAS, the auditor should evaluate:

ü      Whether users might misunderstand the auditor’s report and, if so,

ü      Whether the auditor would be permitted to reword the prescribed form to be in accordance with the requirements of GAAS or attach a separate report.

§         If the auditor determines that rewording the prescribed form or attaching a separate report would not be permitted or would not mitigate the risk of users misunderstanding the auditor’s report,

ü      The auditor should not accept the audit engagement unless the auditor is required by law or regulation to do so.

ü      When audit performed in accordance with such law or regulation does not comply with GAAS, the auditor should not include any reference to the audit having been performed in accordance with GAAS within the auditor’s report.

Practical Note

Because an engagement letter forms a contract between the reporting entity and the auditor, and because both parties to the contract must understand its contents for it to be valid, the letter should be delivered by the engagement leader or partner.  In addition to the contents of the letter, other important planning considerations should be discussed and documented when the letter is delivered. Following are some specific items that should be discussed:

·      Reach an understanding about the nature of the engagement, as well as client and CPA firm responsibilities.

·      Discuss management’s responsibilities for selecting the most appropriate financial reporting framework, designing and maintaining internal control systems and preparing financial statements and footnotes.

·      Discuss current client issues, including any affects of economic climate.

·      Request management to contact the predecessor auditor (if prior period statements were audited) to obtain permission for review of the prior year audit documentation or discuss the necessary additional audit procedures applicable to opening balances.

·      Make fraud inquiries.

·      Arrange for proper workspace.

·      Arrange for client assistance.

·      Finalize dates for interim and year end fieldwork.

·      Discuss target dates.

·      Discuss range of audit fees and affects of variables (problems, no client assistance, etc.).

·      Document discussions in partner participation memo.

·      Discuss financial statements and footnotes. If possible, prepare a rough draft or block out financial statements and footnotes for discussion.

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