The Once and Future Auditors

I n October 1997, the American Institute of CPAs auditing standards board issued Statement on Auditing Standards no. 84, Communications Between Predecessor and Successor Auditors . This new standard supersedes SAS no. 7 of the same name and its interpretations. The ASB believes that the new SAS more accurately reflects todays proposal environment, described below. This article describes the new SAS and provides guidance on its implementation.

Practitioners considering accepting a first-time engagement should apply SAS no. 84 in conjunction with other established client acceptance procedures. Practitioners also should consult Statement on Quality Control Standards no. 2, System of Quality Control for a CPA Firms Accounting and Auditing Practice, (AICPA Professional Standards , QC20, paragraphs 14-16).

Revised Definitions

Revised definitions of predecessor and successor auditors appear in SAS no. 84 and reflect the proposal environment found in practice today. Audit clients often solicit proposals from competing auditors and shop around to compare their current auditors services and costs with other firms. The current auditor is often asked to submit a proposal to be evaluated with the others. In these circumstances, the SAS no. 7 definitions of a predecessor and successor auditor were not appropriate. As a result, the definitions in SAS no. 84 are as follows:

Predecessor auditor. An auditor who (a) has reported on the most recent audited financial statements or was engaged to perform but did not complete an audit of any subsequent financial statements and (b) has resigned, declined to stand for reappointment or been notified that his or her services have been or may be terminated.

Under this definition a current auditor can be considered a predecessor auditor if he or she has been informed by the client that services may be terminated.

Successor auditor. An auditor who is considering accepting an engagement to audit financial statements but has not communicated with the predecessor as required (see below) and an auditor who has accepted such an engagement.

An auditor becomes the successor auditor after the prospective client extends an offer to perform the engagement; at this point the successor auditor can communicate with the predecessor.

The Key Points

Below are the main points of the new SAS and how they affect auditors and the clients they serve.

Required communications. The required communications include specific and reasonable inquiries of the predecessor regarding matters that will help the successor decide whether to accept an engagement. A successor cannot accept an engagement until he or she has communicated with the predecessor and evaluated the responses. Required communications include matters relating to

• Information that might bear on the integrity of management.
• Disagreements with management as to accounting principles, auditing procedures or other significant matters.
• Communications to audit committees or others with equivalent authority and responsibility regarding fraud, illegal acts by clients and internal control related matters.
• The predecessor auditors understanding about the reasons for the change of auditors.

The proposal environment. An auditor should not accept an engagement before evaluating the responses to the above list. However, an auditor may make a proposal on an engagement before initiating communications. In this case, the auditor may wish to advise the prospective client in the proposal letter that he or she cannot formally accept the engagement until the results of the required communications have been evaluated. If a client asks for proposals from several auditors, the predecessor is not expected to respond to inquiries until one auditor conditionally accepts the engagement subject to required communications.

Predecessors response to the successor. A predecessor should respond fully to the successors inquiries. However, a predecessor who limits his or her response should let the successor auditor know this is the case. Litigation, disciplinary proceedings or other such unusual circumstances may result in a limited response. If the successor receives a limited response, he or she should consider its implications and whether to accept the engagement.

Access To Working Papers

SAS no. 84 describes other communications (primarily a review of the predecessors working papers) that may assist the successor in planning the engagement. These communications may occur before or after acceptance of the engagement.

If the successor wants to review the predecessors working papers, he or she should request that the client authorize the predecessor to grant access. To reduce the risk of misunderstanding, the predecessor may wish to obtain written consent from the client. (Appendix A to SAS no. 84 includes a sample client consent and acknowledgment letter.) SAS no. 84 includes a list of the working papers ordinarily made available to the successor, including documentation of planning, internal control, audit results and other matters of continuing accounting and auditing significance.

The predecessor also can limit or deny the successor access to the working papers. The extent of access is always a matter of the predecessors professional judgment. SAS no. 7 referred to valid business reasons as a rationale for limiting or denying access. SAS no. 84 discusses the extent of access as a matter of professional judgment and is silent as to valid business reasons. In practice, access to working papers may be denied for several reasons, such as litigation involving the engagement, an incomplete engagement or unpaid audit fees.

Successor acknowledgment letter. Before granting access to the prior-year working papers, a predecessor may request that the successor agree in writing to certain assurances. In order to obtain access, the successor might consider agreeing to certain limitations. Such agreements, although common in larger firms, may be less familiar to smaller ones, so SAS no. 84 includes an example in appendix B. The use of these written agreements in practice has provided the successor with greater access to the working papers. Obtaining greater access can assist the successor in identifying and evaluation issues when planning a first-time engagement. SAS no. 84 also includes examples of limitations the successor may agree to in order to gain access:

• The successor will not comment, orally or in writing, to anyone as a result of the review as to whether the predecessors engagement was performed in accordance with generally accepted auditing standards.
• The successor will not provide expert testimony or litigation services or otherwise accept an engagement to comment on issues relating to the quality of the predecessors audit.
• The successor will not use the audit procedures or results thereof documented in the predecessors working papers as evidential matter in rendering an opinion on the financial statements of the client, except as contemplated in SAS no. 84.

Although a sample letter is included in SAS no. 84, the use of this letter is not required by professional standards.

Evidential Matter

What constitutes sufficient competent evidential matter with respect to evaluating opening balances? SAS no. 84 says, The audit evidence used in analyzing the impact of the opening balances on the current-year financial statements and consistency of accounting principles is a matter of professional judgment. It continues with examples that may be used as audit evidence:

• The most recent audited financial statements and the predecessors audit report on those statements.
• The results of inquiry of the predecessor.
• The results of the successors review of the predecessors working papers.
• Audit procedures performed on the current periods transactions that may provide evidence about the opening balances or consistency.

The successor should not rely on the predecessors working papers. Instead, the successor should determine how the results of his or her review of those working papers affect the nature, timing and extent of the procedures to be performed on the opening balances and the consistency of accounting principles. The results of the successors review are the conclusions the successor reaches regarding the procedures performed and the evaluations made by the predecessor in the prior years engagement.

Ultimately, the successor must use his or her judgment in determining the extent of procedures to be performed and the audit evidence to be obtained with respect to the opening balances.

Reaudits and Discovery Of Misstatements

Interpretations to SAS no. 7 contained guidance on reaudits and the discovery of possible misstatements in financial statements reported on by a predecessor. The new statement incorporates this guidance.

Reaudits. A reaudit is an engagement in which an auditor is asked to audit and report on financial statements that have been previously audited and reported on. An auditor who is considering accepting a reaudit engagement is considered to be a successor auditor and the previous auditor is a predecessor auditor under SAS no. 84. Therefore, the required communications also are applicable in this situation. In a reaudit, the successor may consider the information obtained from inquiries of the predecessor and the review of the predecessors audit report and the prior working papers. However, this information alone is not sufficient for the successor to render an opinion; additional audit work is necessary. The results of the current period audit may be used in planning and performing the reaudit of the prior period and may even provide evidential matter useful in the reaudit. As in all audits, if the successor is unable to obtain competent evidential matter in order to express an opinion, he or she should qualify or disclaim an opinion.

Discovery of misstatements. During an audit or reaudit, the successor may become aware of information that leads him or her to believe that the financial statements the predecessor reported on are misstated and require revision. If this situation exists, the successor should ask the client to contact the predecessor so all parties can discuss and resolve the matter. If the client refuses to allow the successor to discuss the issue with the predecessor, or if the successor is not satisfied with the resolution of the matter, the successor should evaluate the implications and determine if it is necessary to resign from the engagement. The successor also should consider consulting an attorney to determine the appropriate course of action.

Predecessor is gone. Section 9900.11-.18 of the AICPA Technical Practice Aids (TPAs) provides guidance for situations in which a predecessor auditor has ceased operations. (a TPA offers nonauthoritative guidance based on selected practice problems.) Although not included in SAS no. 84, practitioners should be aware of the existence of this guidance and have it readily available if needed.

Effective date. SAS no. 84 is effective with respect to acceptance of an engagement after March 31, 1998.

Frequently Asked Questions

Below are some common questions about the new SAS.

• Is there a situation in which a prior auditor would not be considered to be a predecessor auditor? Yes. SAS no. 84 is not applicable if the most recent audited financial statements are more than two years prior to the beginning of the earliest period to be audited by the successor auditor.
• If the most recent financial statements were compiled or reviewed, is SAS no. 84 applicable? No. SAS no. 84 says that in this case, the accountant who reported on those financial statements is not a predecessor auditor. However, a successor auditor may find it useful to make certain inquiries of the prior accountant in determining whether to accept the engagement.
• What are the documentation requirements of SAS no. 84? The new SAS does not have any specific documentation requirements. Firm policy will dictate whether or not documentation will be required. However, the standard says communications may be either written or oral and includes examples of a client consent and acknowledgment letter and a successor auditor acknowledgment letter.
• Does SAS no. 84 provide guidance when a successor is replaced before completing an audit engagement and issuing a report? Yes. In this circumstance, there are two predecessors: The earlier one is the auditor who reported on the most recent audited financial statements and the second is the auditor who has been engaged to perform but did not complete an audit of any subsequent financial statements.
• What should a successor do if the prospective client does not permit the predecessor to respond to the successors inquiries? If the prospective client prohibits the predecessor from responding to the successor, the successor should ask the prospective client why and then should consider the implications of that refusal in deciding whether to accept the engagement.
• Is a predecessor required to respond to the successors inquiries? Yes. SAS no. 84 says, The predecessor auditor should respond promptly and fully, on the basis of known facts, to the successor auditors reasonable inquiries. a predecessor who limits his or her response to the inquiries should tell the successor auditor that this is the case.
• Is a successor required to review the predecessors working papers? No. It is, however, customary and beneficial for the successor to review them. This review can affect the nature, timing and extent of the successors procedures. a successor who does not review the prior-year working papers must use his or her judgment to determine whether sufficient audit evidence was obtained in analyzing the impact of the opening balances and consistency of accounting principles for the current years engagement.
• SAS no. 84 says the results of the successors review of the predecessors working papers can be considered audit evidence. What is meant by the results of the successor auditors review? The results of the successors review of the predecessors working papers are the conclusions reached by the successor auditor regarding the audit work performed on various account balances. The successor should use his or her judgment in determining whether the results of the review of these working papers provide enough audit evidence to be used in analyzing the impact of the opening balances and the consistency of accounting principles. For example, the successor might review the working papers related to accounts receivable or inventory and reach a conclusion as to whether the auditing procedures performed on the aging of receivables or the cutoff tests performed on inventory provide the successor with sufficient audit evidence.
• Can the predecessors working papers alone be considered sufficient evidential matter with respect to evaluating the opening balances? No. SAS no. 84 says the successor must obtain sufficient competent evidential matter to allow him or her to afford a reasonable basis for expressing an opinion of the financial statements under audit. The predecessors working papers alone are not sufficient evidential matter. The successor must use his or her judgment and evaluate the results of those working papers as they pertain to the opening balances. The successor also should consider other audit evidence available, such as the predecessors audit report, the results of inquiries with the predecessor auditor and audit procedures performed in the current years engagement that may provide evidence about opening balances or consistency. Also, the successor may apply procedures to the account balances at the beginning of the period, such as vouching for fixed assets from prior years.
• Can a successor obtain competent evidential matter if a predecessor denies access to the prior years engagement working papers? Yes. Although it is customary to provide access to working papers, if a predecessor denies access, the successor still can obtain audit evidence with respect to the opening balances. Audit evidence may include the predecessors audit report and the related financial statements, the results of the predecessors inquiry, the audit procedures performed on the current periods transactions and the audit procedures performed on account balances at the beginning of the period under audit and on transactions in prior periods. Again, the successor must use judgment in determining the nature, timing and extent of procedures to be performed with respect to the opening balances.
• If the successor signs a successor acknowledgment letter as illustrated in SAS no. 84, which includes a statement that the successor auditor will not comment, orally or in writing, to anyone as a result of the review of the working papers as to whether the predecessor auditors engagement was performed in accordance with GAAS, does this also preclude the successor auditor from informing the client of the nonperformance? Yes. The successor should comply with the agreement not to comment orally or in writing to anyone, including the client, in this area. However, if during the current audit the successor becomes aware of information that leads him or her to believe that the financial statements reported on by the predecessor may require revision, the successor should discuss the situation with the client. The three parties involved should then discuss the information and attempt to resolve the matter. The discovery of the possible misstatement would be a result of the current years audit engagement and not a result of the review of the predecessor auditors working papers.