AU-C 510 Opening Balances: Initial Audit Engagements and Predecessor Auditors

AU-C section 510, Opening Balances — Initial Audit Engagements, Including Reaudit Engagements, applies when a firm audits an entity for the first time, or audits a period that was unaudited or audited by another firm. Opening balances are the account balances that exist at the start of the period, which are the closing balances of the prior period adjusted for any restatement. The firm cannot sign an opinion on the current-year statements without being satisfied that those starting balances do not distort them.

This page paraphrases the standard. Read AU-C 510 in AICPA Professional Standards before relying on any point here.

What is the objective of AU-C 510?

The auditor's objective is to obtain sufficient appropriate audit evidence about whether opening balances contain misstatements that materially affect the current period's financial statements, and whether the prior period's closing balances were correctly brought forward or restated, and whether appropriate accounting policies are consistently applied or any change is properly accounted for and disclosed.

Opening balances matter because they flow into the current year. A misstated opening inventory changes cost of sales. A misstated opening receivable can hide in current-year collections. A misstated opening equity balance carries into every statement.

Where does AU-C 510 fit in an initial engagement?

Three sections touch an initial audit.

• Acceptance. Communicating with the predecessor auditor before accepting the engagement is an acceptance matter. It sits with the terms-of-engagement requirements in AU-C 210, not in AU-C 510, and includes the SAS 147 inquiries about fraud and noncompliance.
• Opening balances. AU-C 510 covers the audit work on balances brought forward.
• Reporting. AU-C 700, 705 and 706 govern how the report reflects the predecessor's role or any modification arising from opening balances.

What audit procedures does AU-C 510 require?

The auditor reads the most recent financial statements and, where there is one, the predecessor auditor's report. The auditor then obtains evidence on the following.

1. Brought forward correctly. Whether the prior period's closing balances were correctly brought forward to the current period, or restated where appropriate.
2. Accounting policies. Whether opening balances reflect the application of appropriate accounting policies.
3. Evidence on the balances themselves. One or more of the following, depending on the circumstances:
   • where the prior-period statements were audited, reviewing the predecessor auditor's working papers to obtain evidence about the opening balances
   • evaluating whether audit procedures performed in the current period provide evidence about the opening balances
   • performing specific audit procedures to obtain evidence about the opening balances

The standard also requires the auditor to consider the opening balances for significant classes of transactions, account balances and disclosures that are carried forward in the risk assessment, and to determine whether the opening balances contain misstatements that could materially affect the current period.

Current-period work that doubles as opening evidence

For many balances, current-year procedures give most of the answer. Cash collected on opening receivables, payments of opening payables, and the roll-forward of fixed assets all speak to opening balances. The auditor evaluates whether that evidence is enough, and documents the link.

Relying on the predecessor's workpapers

The firm cannot assume access. The predecessor decides whether to allow it, usually after the client gives consent. Common practice is to ask the client to authorize the predecessor to respond and to make the workpapers available, and to treat refusal as a matter that bears on acceptance and on the evidence available.

When the firm does review workpapers, the review should be targeted at the balances and accounting policies that matter. Reading them tells the firm what the predecessor did. It does not replace the new auditor's own judgment about whether the evidence is sufficient. The standard also notes that the extent of reliance depends on the predecessor's professional competence and independence, and the auditor considers that.

Which balances are hardest?

Practice observations, not requirements:

• Inventory. If the firm was not engaged until after the prior year-end, it could not observe the opening count. Common responses include reviewing the predecessor's inventory procedures, testing current-year purchases and sales around the opening date, and testing gross profit margins. If the firm cannot obtain enough evidence, a scope limitation on cost of sales and net income may follow.
• Long-lived balances. Fixed assets, goodwill, intangible assets, and long-term debt can usually be supported by examining records and current-year activity.
• Equity and retained earnings. These roll from the prior period. Tie them to the predecessor-audited financial statements and examine any prior-period adjustments.
• Entities with unaudited prior periods. The opening balances have had no audit, so the firm may need specific procedures on every significant balance. This is the heavier end of a reaudit.

How do opening balances affect the audit plan?

The assessed risk and the procedures change in an initial audit. Opening balances that cannot be corroborated increase risk for the related accounts, and the auditor considers whether the audit strategy and plan need to change. Budget more time for the first year and tell the client early what the team needs. See AU-C 315 risk assessment.

If the auditor finds misstatements in opening balances, they are evaluated like others. A misstatement that affects the current period is accumulated and evaluated under AU-C 450. If it has a material effect on the current-period financial statements, the auditor communicates it to the appropriate level of management and, unless all of those charged with governance are involved in management, those charged with governance. If the auditor concludes that a material misstatement affects prior-period statements on which a predecessor reported without modification, AU-C 510 has communication requirements for that case, which include asking management to inform the predecessor. This page does not set out the steps, or what follows if management does not inform the predecessor. Read the communication paragraphs of AU-C 510 before acting on that situation.

What are the reporting consequences?

When the current statements include comparatives audited by a predecessor and the predecessor's report is not reissued, the other-matter paragraph is required. It states that the prior period was audited by a predecessor auditor, the type of opinion expressed and, if modified, the reasons, the nature of any emphasis-of-matter or other-matter paragraph in that report, and the date of that report. If the predecessor reissues its report, this paragraph is not needed. A single-period audit has no comparatives, so this paragraph does not arise. The AICPA reporting standards on comparative financial statements set these requirements. See AU-C 706, AU-C 705 and AU-C 700.

What must be documented?

• The evidence obtained on opening balances and the procedures used, including any review of the predecessor's working papers and the extent of that review
• Communications with the predecessor, and permission obtained to access workpapers
• Conclusions on whether opening balances are free from material misstatement
• Any effect on the audit plan, the risk assessment and the opinion

See AU-C 230 audit documentation.

Common weaknesses in first-year audits

Practice checks, not requirements of the standard. Gaps to avoid:

• Opening balances documented only by a statement that "prior year was audited", with no procedures
• No evidence the firm requested or reviewed predecessor workpapers when relying on them
• Inventory opening balance not addressed in a first-year audit of an inventory-heavy client
• Accounting policy changes between years not evaluated
• No increased risk assessment for initial engagements

Related

• AU-C 700 forming an opinion and reporting
• AU-C 705 modifications to the opinion
• AU-C 706 emphasis-of-matter and other-matter paragraphs
• AU-C 315 risk assessment and SAS 145
• Audit engagement letter template
• Inventory observation audit procedures

Sources

• AICPA, AU-C Section 510, Opening Balances — Initial Audit Engagements, Including Reaudit Engagements
• AICPA, AU-C Section 210, Terms of Engagement (predecessor communications; SAS No. 147)
• AICPA, AU-C Sections 700, 705 and 706 (reporting effects)
• AICPA, AU-C Sections 450 and 230

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