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AU-C Original Pronouncement

Applicability

This section states the requirements and provides application guidance on the auditor's responsibilities in agreeing upon terms of engagement with management and those charged with governance. It establishes preconditions for an audit, for which management is responsible. AU-C 220, Quality Control for an Engagement Conducted in Accordance with Generally Accepted Auditing Standards, addresses those aspects of engagement acceptance that the auditor can control. AU-C 580, Written Representations, discusses management's responsibilities. (AU-C 210.01)

AU-C 210 Definitions of Terms

Source: AU-C 210.04

Preconditions for an audit. The use by management of an acceptable financial reporting framework in the preparation and fair presentation 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.

Recurring audit. An audit engagement for an existing audit client for whom the auditor performed the preceding audit.

Objectives

AU-C Section 210.03 states that:

…the objective of the auditor 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

a. establishing whether the preconditions for an audit are present and

b. 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.

Fundamental Requirements

Engagement Acceptance

Preconditions

Unless required to do so by law or regulation, an auditor should not accept an engagement when the preconditions (see “Definitions of Terms” section above) are not met. (AU-C 210.08) To assess whether those preconditions are met, the auditor should:

a. determine whether the financial reporting framework4 to be applied in the preparation of the financial statements is acceptable and

b. obtain the agreement of management that it acknowledges and understands its responsibility

i. for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework;

ii. for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; and

iii. to provide the auditor with

1. access to all information of which management is aware that is relevant to the preparation and fair presentation of the financial statements, such as records, documentation, and other matters;

2. additional information that the auditor may request from management for the purpose of the audit; and

3. unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence.

(AU-C 210.06)

Limitation of Scope

If management limits the scope of the auditor's work so that the auditor will have to disclaim an opinion, the auditor should not accept the engagement. The exception to this is when management is required by law or regulation to have an audit and the disclaimer of opinion is acceptable under law or regulation, for example with audits of employee benefit plans. Then the auditor can accept the engagement, but is not required to do so. (AU-C 210.07)

Agreement on Terms

The auditor should establish an understanding with management or those charged with governance5 about the services to be performed for each audit, review of a public company's financial statements, or agreed-upon procedures engagement. The understanding should include:

1. The engagement's objectives and scope

2. Management's responsibilities

3. Auditor's responsibilities

4. The audit's limitations, the inherent limitations of internal control, and the risk that some misstatements may not be detected

5. Financial reporting framework

6. Expected form and content of the report

In addition, the auditor may want to:

● Elaborate on the scope of the audit by referencing regulations, laws, GAAS, ethical codes, and pronouncements of professional bodies, as applicable.

● Identify any communications in addition to the auditor's report.

● Discuss audit planning and performance, including composition of the audit team.

● Remind management about the expectation of written representation, the agreement to make available draft financial statements on a timely basis, and the agreement for management to inform the auditor of subsequent events or facts discovered after the date of the financial statements that may affect the financial statements.

● Detail fees and billing arrangements.

● Request management to acknowledge receipt of the engagement letter and to agree to the terms by signing the letter.

The auditor may also choose to address arrangements concerning the involvement of other auditors, specialists, internal auditors and other entity staff, and predecessor auditors. Restrictions on auditor's liability, when not prohibited, audit documentation to be provided to other parties, additional services, arrangements with component auditors, and any other agreements with the entity may be included in the engagement letter. (AU-C 210.A23-.A26)

The auditor should document the understanding in writing. If the auditor fails to establish an understanding, the auditor should decline the engagement. (AU-C 210.09-.10) A sample engagement letter is included at the end of this chapter.

Initial Audits, Including Reaudits

Inquiry of the predecessor auditor is required because the predecessor may provide information that will assist the successor auditor in deciding whether to accept the engagement. The communication may be either written or oral. Both the predecessor and successor auditors should treat any information obtained from each other as confidential information. The successor auditor should request permission from the prospective client to make an inquiry of the predecessor prior to final acceptance of the engagement. However, the successor auditor may make a proposal for an audit engagement before having permission to inquire of the predecessor auditor.

The successor auditor should ask the prospective client to authorize the predecessor to respond fully to the successor auditor's inquiries. If a prospective client refuses to permit the predecessor auditor to respond or limits the response, the successor auditor should inquire as to the reasons and consider the implications of that refusal in deciding whether to accept the engagement. (AU-C 210.11) The successor auditor should make specific and reasonable inquiries of the predecessor about the following four matters:

1. Information about management's integrity

2. Disagreements with management about accounting principles, auditing procedures, or other significant matters

3. Communications to those charged with governance and responsibility regarding fraud, noncompliance with laws or regulations, and matters related to internal control

4. The predecessor auditor's understanding of the reasons for the change of auditors

(AU-C 210.A31)

The predecessor auditor should respond promptly, fully, and factually. However, if the predecessor decides, due to unusual circumstances such as impending, threatened, or potential litigation; disciplinary proceedings; or other unusual circumstances, not to respond fully, he or she should indicate that the response is limited. Also, if more than one auditor is considering accepting the audit, the predecessor auditor does not have to respond to inquiries until an auditor has been selected by the entity and has accepted the engagement. Any information exchanged between the predecessor and successor auditors should be considered confidential. (AU-C 210.A28-A30)

If the successor auditor receives a limited response, that auditor should consider the implications of the limited response in deciding whether to accept the engagement.

Recurring Audits

For a recurring audit, the auditor should evaluate whether the terms of the engagement need to be changed. The auditor should also remind the client about the existing terms of engagement.

Change in Terms

If the client requests a change in the terms, the auditor must ensure that there is a reasonable justification for the change. So, too, if prior to completion of an audit, the client requests a change to an engagement with a lower level of assurance, the auditor must be satisfied that a reasonable justification for doing so exists.

Certain factors may warrant a change in the terms of engagement for a recurring engagement. These might include, for example, changes in management or ownership, in legal or regulatory requirements, in the size of the entity, or in the financial reporting framework. (AU-C 210.A33) If the terms are changed, the auditor and management should document in writing the mutually agreed-upon change. (AU-C 210.13-16) If, however, the auditor concludes there is no reasonable justification for a change in terms and management does not allow the auditor to continue the original audit, the auditor must take these three steps:

1. Withdraw from the engagement.

2. Communicate the situation to those charged with governance.

3. Determine whether the auditor has any legal, contractual, or other obligation to report the circumstances to owners, regulators, or other parties.

(AU-C 210.17)

Illustration

Illustration 1. Example of an Audit Engagement Letter (from AU-C 210.A42)

4

Acceptable reporting frameworks contain established accounting principles promulgated by a body designated by the Council of the AICPA under Rule 203 in the AICPA Code of Professional Conduct. These bodies include FASB, FASAB, IFRS, GASB, AICPA, and PCAOB.

5

In this chapter, references to management should be read as “management and, when appropriate, those charged with governance,” unless the context suggests otherwise. Those charged with governance are those “with responsibility for overseeing the strategic direction of the entity and obligations related to the accountability of the entity,” including the financial reporting process. (AU-C Glossary of Terms)