Audits of Special Purpose Frameworks: Obtaining Substantive Evidence from Engagement Letters

Read more from Larry Perry here and in the Today’s World of Audits archive.

For some auditors, obtaining engagement letters has become a routine procedure. Copying the letter format from purchased practice aids, making slight modifications to the content and mailing the letter for signature by an entity’s president or board chairman has been the customary practice. But smart auditors can find significant advantages to going beyond the boilerplate.

For decades, not all auditors have not been taking full advantage of the opportunities to maximize substantive evidence from engagement letters. In this multi-part discussion, the focus will be first on the requirements of the Clarified Auditing Standard requirements and, second, on the practical engagement administrative and evidence contributions that can flow from preparing and delivering engagement letters.

The basic objective of the auditor is to determine first that the preconditions for an audit are present.

Precondition #1: Determining that the financial reporting framework used by the entity in the preparation of the financial statements is acceptable.

Precondition #2: Obtaining the agreement of management persons and those charged with governance that they acknowledge and understand their responsibility for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework. They are also responsible for the design, implementation, and maintenance of internal controls relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Management must provide the auditor with access to all information of which management is aware that is relevant to the preparation and fair presentation of the financial statements, such as records, documentation, and other matters. They also have to give the auditor any additional information that the auditor may request from management for the purpose of the audit.

Management must give unrestricted access to persons within the entity from whom the auditor determines it is necessary to obtain audit evidence.

Precondition #3: Being aware of other factors affecting engagement acceptance. When the preconditions are not present, the auditor should discuss the matter with management and decline the engagement.

Specifically, if the auditor has determined the applicable financial reporting framework is unacceptable, or if management’s agreement to the terms of the engagement cannot be obtained, the auditor should not accept the engagement.

Precondition #4: Obtaining agreement on terms of an engagement. The auditor should agree upon the terms of the audit engagement with management or those charged with governance, as appropriate. The terms of each audit engagement should be documented in an audit engagement letter or other suitable form of written agreement and should include the following:

  • The objective and scope of the audit of the financial statements.

  • The responsibilities of the auditor.

  • The responsibilities of management.

  • A statement that because of the inherent limitations of an audit, together with the inherent limitations of internal control, an unavoidable risk exists that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with GAAS.

  • Identification of the applicable financial reporting framework for the preparation of the financial statements.

  • Reference to the expected form and content of any reports to be issued by the auditor and a statement that circumstances may arise in which a report may differ from its expected form and content.

In the next blog, I’ll begin to discuss practical issues related to the requirements of this auditing standard and to obtaining effective and efficient engagement letters. Later in 2014, I will also present a one-hour, free webcast on entitled Obtaining Key Audit Correspondence that will include a discussion of ways to maximize substantive evidence from obtaining engagement letters.


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