The first audit of a new client takes longer than the second, and not only because the team is learning the business. The auditor must also be satisfied about the opening balances, balances the auditor did not audit, because misstatements in them can carry into the current period. The standard is AU-C section 510, Opening Balances — Initial Audit Engagements, Including Reaudit Engagements.
This guide follows the engagement from acceptance to the report. For the engagement letter itself, see the audit engagement letter guide.
Before accepting: communicate with the predecessor
For a deeper treatment of the predecessor and successor exchange, see predecessor and successor auditor communications.
AU-C 210 covers communication with the predecessor auditor on initial engagements. Before accepting, the successor auditor asks management for permission to communicate with the predecessor auditor. If management refuses, the successor inquires why and considers the implications for acceptance. Where permission is given, the successor makes inquiries of the predecessor about matters relevant to the decision to accept, which include:
- information about management's integrity
- disagreements with management about accounting principles, audit procedures or other significant matters
- the predecessor's understanding of the reasons for the change of auditors
- communications to those charged with governance about fraud, noncompliance and significant deficiencies or material weaknesses
- under SAS 147 (audits of periods beginning on or after June 30, 2023), the inquiries about fraud and noncompliance with laws and regulations, whose results the successor documents
The inquiry is not a formality. Document the call, who took part and what was said, and any limits the predecessor placed on the answers.
Ask for access to workpapers
After acceptance, the successor typically asks the predecessor for access to its workpapers, with the client's written authorization. The predecessor decides which workpapers it will make available, and it may require the successor to sign an access letter. Ask early, because the work to review them has to be planned.
Quality management also applies to acceptance. The firm's system under SQMS No. 1 sets criteria for accepting engagements, and SAS No. 146 puts responsibility on the engagement partner for determining that acceptance and continuance policies were followed. See the SQMS 1 guide.
Plan for the initial engagement
AU-C 300 requires planning activities specific to an initial audit, including the AU-C 510 procedures and the communication with the predecessor. Budget more time for understanding the entity and its controls, for the opening balance work, and for any problems the client's books may have. For a client on QuickBooks, add time for reviewing the reports.
The planning memo should record that this is an initial engagement, the opening balance approach, the predecessor's report, whether the prior period was audited, reviewed, compiled or unaudited, and the effect on planned procedures. See the audit planning memo guide.
What AU-C 510 requires
The requirements are about evidence on opening balances, which include balances that exist at the start of the period and balances that depend on prior events, such as contingencies and commitments. In summary, the auditor should:
- Read the most recent financial statements and the predecessor's report, if any, for information relevant to the opening balances, including disclosures.
- Determine whether prior-period closing balances were correctly brought forward, or where appropriate restated.
- Determine whether the opening balances reflect the application of appropriate accounting policies, consistent with those in the current period, or whether changes were properly accounted for and disclosed.
- Obtain sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the current period's financial statements, by one or more of the following:
- where the prior-period statements were audited, reviewing the predecessor's working papers
- evaluating whether audit procedures performed in the current period provide evidence relevant to opening balances
- performing specific procedures on the opening balances
The standard also covers inventory, noncurrent assets and liabilities, and other items where current-period procedures provide little evidence about the opening balance, and it sets specific procedures for them.
Reviewing predecessor workpapers
Reviewing the predecessor's workpapers can provide evidence if the auditor is satisfied about the predecessor's competence and independence. The successor needs to decide how much reliance is appropriate. Things to consider:
- The predecessor's professional reputation, and whether it was a firm with a peer review.
- The nature of the work: workpapers that show confirmations, count results and recalculations are worth more than a summary of conclusions.
- The materiality and risk of the balances the successor wants to rely on.
- Whether the workpapers provide a basis for the opening balance as of the end of the prior year and are not only for balances at an interim date.
Reviewing the predecessor's papers does not mean the successor takes responsibility for the predecessor's report. The successor's report is on the current period, and the successor does not refer to the predecessor's work as a basis for the opinion on that period.
Keep an access letter on file. Record what was reviewed, the date, who reviewed it and what was concluded. Where the predecessor refuses access, the successor has to obtain evidence another way.
Procedures by balance type
Most of the evidence on opening balances comes from the current period's work. The following patterns are common.
| Area | Typical approach to opening balances |
|---|---|
| Cash | Agree to prior-year bank reconciliation and bank confirmation or statements; current-year testing of reconciling items |
| Receivables | Subsequent collections in the current year; review of the prior-year aging and allowance |
| Inventory | Predecessor count workpapers; testing of current-year count with a rollback of movements; analytical review of gross margin for reasonableness |
| Fixed assets | Roll back additions and disposals; test prior-year additions; recompute depreciation |
| Payables and accruals | Subsequent payments; search for unrecorded liabilities of the prior period |
| Debt | Lender statements and agreements; amortization recomputation |
| Equity | Agree to prior-year statements and the equity records |
| Contingencies and commitments | Legal letters; discussion with management; review of minutes |
| Revenue and deferred revenue | Contract review; testing of opening contract liabilities against current-year recognition |
Inventory is a common problem area in a first-year audit. If the client did not take a count at the start of the year and no one else did, the auditor may not be able to obtain sufficient appropriate evidence about opening inventory by other means. See inventory observation procedures.
When the prior period was not audited
If the prior period was reviewed, compiled or unaudited, there is no predecessor audit report or audit workpapers. The successor performs the opening balance procedures on its own. A separate case is a reaudit, where the auditor is engaged to audit a period that was previously audited by someone else; AU-C 510 covers reaudit engagements too. When the client wants comparative statements with an unaudited prior year, the prior year is labeled unaudited and the audit report addresses it, as described below.
For a first-year audit where the prior year was reviewed, the working papers of the reviewing accountant are not audit evidence of the same character as audit workpapers. Treat them as information, not evidence of the same weight.
Misstatements in opening balances
If the auditor finds that the opening balances contain a misstatement that could materially affect the current period, the auditor performs additional procedures to determine the effect on the current period and communicates the misstatement to the appropriate level of management and those charged with governance. If the effect on the current period is not properly accounted for and disclosed, the auditor expresses a qualified or adverse opinion as appropriate.
Where the auditor learns from the work that the predecessor's financial statements were misstated, the successor asks management to inform the predecessor, and AU-C 510 and AU-C 210 address the further steps.
Comparative statements and the report
When the predecessor's report is not reissued
If the current-period statements are presented with comparatives that were audited by a predecessor whose report is not reissued, the successor's report includes an other-matter paragraph. The comparative-information requirements in AU-C 700 govern this; older sources cite AU-C 710. The paragraph states that the prior-period statements were audited by another auditor, gives the date of the predecessor's report and the type of opinion it expressed, describes any modification, and describes the nature of any emphasis-of-matter or other-matter paragraph in that report.
Unaudited prior period
If the comparative statements were not audited, whether they were reviewed, compiled or received no service, the statements are marked unaudited and the auditor's report includes an other-matter paragraph stating that the prior-period statements were not audited. That statement does not relieve the auditor of the need to obtain evidence on opening balances under AU-C 510.
When you cannot obtain evidence
If the auditor cannot obtain sufficient appropriate audit evidence about the opening balances, the auditor expresses a qualified opinion or disclaims an opinion, as appropriate. The usual example is inventory: with no evidence on opening inventory, the auditor may be able to give an opinion on the balance sheet but not on results of operations and cash flows. See types of audit opinions.
If the auditor concludes that the opening balances contain a misstatement that materially affects the current-period statements and the effect is not properly accounted for, a qualified or adverse opinion follows. A change in accounting policy that is not consistently applied or properly disclosed has the same result.
Practical tips
- Ask the client at the proposal stage for the last audited or reviewed statements and the auditor's report, so the cost of the first year can be set realistically.
- Schedule the predecessor call before the engagement letter is signed.
- Start with the balances that carry the most risk, usually inventory, receivables, deferred revenue and debt.
- Use the prior-year trial balance as the starting point for the lead schedules, and agree it to the prior-year statements.
- Leave time at the end for subsequent events and for resolving opening balance questions, which can surface late.
Frequently asked questions
What is AU-C 510?
AU-C 510 sets out the auditor's responsibility for opening balances in an initial audit engagement, including a reaudit. It requires evidence that the opening balances do not contain misstatements that materially affect the current period.
Do I have to review the predecessor's workpapers?
It is one of the options in AU-C 510. The auditor can also rely on current-period procedures that provide evidence about opening balances or perform specific procedures. The right mix depends on risk.
Do I need the client's permission to contact the predecessor?
Yes. The successor asks management for permission to communicate with the predecessor, and if management refuses, the successor inquires why and considers whether to accept.
How do I report on comparatives audited by a predecessor?
If the predecessor's report is not reissued, the successor's report includes an other-matter paragraph that refers to the predecessor's audit. The comparative-information paragraphs of AU-C 700 set out the required content.
What if I cannot get evidence on opening inventory?
A qualified opinion or a disclaimer of opinion on the affected statements may be needed. Inventory is a typical example.
Sources
- AICPA, AU-C Section 510, Opening Balances - Initial Audit Engagements, Including Reaudit Engagements
- AICPA, AU-C Section 210, Terms of Engagement (communication with the predecessor auditor)
- AICPA, SAS No. 147, Inquiries of the Predecessor Auditor Regarding Fraud and Noncompliance With Laws and Regulations (effective for audits of financial statements for periods beginning on or after June 30, 2023)
- AICPA, AU-C Section 300, Planning an Audit (initial audit engagements)
- AICPA, AU-C Section 700, Forming an Opinion and Reporting on Financial Statements (comparative information)
- AICPA, SAS No. 146, Quality Management for an Engagement Conducted in Accordance With Generally Accepted Auditing Standards (acceptance and continuance)
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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error