Engagement acceptance, preconditions and the engagement letter

• Determine whether the preconditions for an audit in AU-C 210.06 are present.
• List the required contents of an audit engagement letter under AU-C 210.10.
• Evaluate a request to change an audit to a lower level of assurance.

Preconditions come before the letter

AU-C 210.03 sets the objective: accept or continue an audit only when the basis on which it is to be performed has been agreed, by establishing that the preconditions for an audit are present and confirming a common understanding of the terms.

AU-C 210.04 defines the preconditions: management uses an acceptable financial reporting framework, and management agrees to the premise on which an audit is conducted. AU-C 210.06 turns that into two steps:

1. Determine whether the framework is acceptable. GAAP issued by FASB or GASB, or a special purpose framework such as the cash or tax basis, can be acceptable depending on the entity and users.
2. Obtain management's agreement that it acknowledges and understands its responsibility for:
   • preparation and fair presentation of the financial statements under the framework;
   • design, implementation and maintenance of internal control relevant to statements free from material misstatement, whether due to fraud or error; and
   • providing you with access to all relevant information, additional information you request, and unrestricted access to persons within the entity from whom you need evidence.

If the preconditions are not present, AU-C 210.08 requires you to discuss the matter with management and, unless law or regulation requires otherwise, not accept the engagement. AU-C 210.07 adds that if management or those charged with governance of an entity not required to have an audit impose a scope limitation that you expect to result in a disclaimer, you should not accept.

Acceptance also runs through the firm's quality management system: client integrity, competence and capacity to do the work, and independence. The client acceptance guide covers that firm-level layer.

What the engagement letter must say

AU-C 210.09 requires you to agree the terms with management or those charged with governance. AU-C 210.10 requires the terms to be documented in an engagement letter or other suitable written agreement that includes:

• (a) the objective and scope of the audit;
• (b) the responsibilities of the auditor;
• (c) the responsibilities of management;
• (d) a statement that, because of the inherent limitations of an audit and of internal control, an unavoidable risk exists that some material misstatements may not be detected, even though the audit is properly planned and performed under GAAS;
• (e) identification of the applicable financial reporting framework; and
• (f) reference to the expected form and content of reports and a statement that circumstances may arise in which a report differs from its expected form and content.

Firms add fees, billing, timing, access to documentation by regulators or peer reviewers, and nonattest services. Those additions are business terms; the six items above are the GAAS minimum. Our audit engagement letter template maps each clause to AU-C 210.10.

Recurring audits and changes in terms

On recurring audits, AU-C 210.16 requires you to assess whether circumstances require revised terms, such as a change in ownership, a new framework or a change in management. If the terms stand, you still remind management of them and document the reminder. Many firms send a new letter each year instead.

When management asks mid-engagement to downgrade to a review or compilation, AU-C 210.18 requires you to determine whether reasonable justification exists, and AU-C 210.17 bars agreeing to the change without it. A change in circumstances affecting the need for the service, or a misunderstanding about the nature of the service, can be reasonable. A request made to avoid a qualified opinion, or because management will not provide evidence, is not. Under AU-C 210.20, if no justification exists and management will not let you continue the audit, you withdraw where law or regulation permits, communicate the circumstances to those charged with governance, and determine whether you must report them to others, such as owners or regulators.

Common findings

• Engagement letters missing the inherent limitations statement or the framework.
• Letters signed after fieldwork started, so terms were not agreed before work.
• Special purpose frameworks named loosely ("modified cash basis") without describing the modifications.
• Mid-engagement downgrades with no documented justification.

Testing preconditions for a new client