CPA Exam AUD: Engagement Acceptance and Continuance

Engagement Acceptance and Continuance: CPA Exam Guide

The decision to accept a new client or continue with an existing one is one of the most important professional judgments an auditor makes. AU-C Section 210 (Terms of Engagement) and AU-C Section 220 (Quality Control for an Engagement Performed in Accordance with Generally Accepted Auditing Standards) address the auditor's responsibilities in accepting and continuing engagements. This topic tests the candidate's understanding of the preconditions for an audit, predecessor-successor auditor communications, and engagement letters.

Preconditions for an Audit

Before accepting an audit engagement, the auditor must establish whether the preconditions for an audit are present. These preconditions include management's use of an acceptable financial reporting framework in the preparation of the financial statements and management's agreement to the premise on which the audit is conducted. This premise requires management to acknowledge and understand its responsibility for the preparation and fair presentation of the financial statements, for the design, implementation, and maintenance of internal control relevant to the preparation of the financial statements, and for providing the auditor with access to all information relevant to the preparation of the financial statements, additional information that the auditor may request, and unrestricted access to persons within the entity from whom the auditor determines it is necessary to obtain audit evidence.

If these preconditions are not present, the auditor should not accept the engagement. If the applicable legal or regulatory framework prescribes the layout or wording of the financial statements, the auditor must still determine whether the framework is acceptable.

Communication Between Predecessor and Successor Auditors

When a change of auditors occurs, AU-C Section 210 and AU-C Section 510 (Opening Balances) address the successor auditor's responsibilities. Before accepting the engagement, the successor auditor is required to communicate with the predecessor auditor. This communication helps the successor auditor understand the reasons for the change of auditors, the integrity of management, and any disagreements between the predecessor and management about accounting policies, audit procedures, or other significant matters.

The successor auditor should request to review the predecessor auditor's workpapers. The predecessor auditor may allow the successor to review the workpapers; however, the predecessor has no obligation to allow access and may limit the review. Client consent is typically required for the predecessor to respond to the successor's inquiries. If the predecessor does not respond or if the client refuses to authorize the predecessor to respond, the successor should consider the implications for accepting the engagement.

Matters the successor auditor should inquire about include disagreements with management about accounting principles or audit procedures, the predecessor's understanding of the reasons for the change of auditors, communications to management and those charged with governance regarding fraud and noncompliance, and communications regarding significant deficiencies and material weaknesses.

The Engagement Letter

The engagement letter establishes the terms of the engagement between the auditor and the entity. AU-C 210 requires that the agreed-upon terms be recorded in an engagement letter or other suitable form of written agreement. The engagement letter should include the objective and scope of the audit, the responsibilities of the auditor, the responsibilities of management (including the preconditions), identification of the applicable financial reporting framework, a reference to the expected form and content of any reports to be issued, and a statement that there is an unavoidable risk that some material misstatements may remain undetected due to the inherent limitations of an audit.

For recurring audits, the auditor must assess whether the terms of the engagement need to be revised and whether the client needs to be reminded of the existing terms. A new engagement letter is not necessarily required every year, but the auditor should consider issuing a new letter when there are changes in the engagement scope, new legal or regulatory requirements, changes in management, significant changes in the nature or size of the entity, or a misunderstanding about the terms.

Accepting an Engagement to Audit Special Purpose Financial Statements

When the financial statements are prepared using a special-purpose framework (such as cash basis, tax basis, regulatory basis, or contractual basis), the auditor must consider whether the framework is acceptable for the intended purpose. The engagement letter should identify the applicable special-purpose framework and its purpose, and the auditor should consider whether users may misunderstand the purpose of the financial statements.

Client Acceptance and Continuance Evaluation

The firm's quality control policies should include procedures for evaluating prospective and existing clients. Factors to consider include the integrity and reputation of the principal owners, key management, and those charged with governance. The auditor should consider whether the entity is involved in money laundering, illegal activities, or questionable financial reporting practices. The firm must consider whether it has the competence, time, and resources to adequately serve the client and whether accepting or continuing the engagement would create any conflicts of interest or independence issues.

For continuing clients, the firm should evaluate whether any events have occurred that would have caused the firm to decline the engagement had they been known at the time of the initial acceptance. These events might include management integrity issues discovered during the prior audit, persistent unresolved disagreements, material scope limitations imposed by management, or changes in the entity's operations that strain the firm's resources or expertise.

Limitations on Scope Before Engagement Acceptance

If management or those charged with governance impose a scope limitation during the terms of a proposed engagement, the auditor should consider whether the limitation will result in disclaiming an opinion. If a disclaimer is likely, the auditor ordinarily should not accept the engagement. However, if law or regulation requires the auditor to accept the engagement, the auditor should perform the audit to the extent possible and disclaim an opinion.

Exam Tips for Engagement Acceptance and Continuance

• Communication with the predecessor auditor is required before accepting a new audit engagement.
• The predecessor auditor has no obligation to allow workpaper access but typically requires client consent to respond to inquiries.
• The engagement letter must be signed before the audit begins and should cover the objectives, responsibilities, and scope.
• Preconditions for the audit include management's agreement to its responsibilities and use of an acceptable framework.
• If a scope limitation before acceptance would likely lead to a disclaimer, the auditor should ordinarily decline the engagement.