Do we understand each other?

In October 1997, the American Institute of CPAs auditing standards board issued Statement on Auditing Standards no. 83 and Statement on Standards for Attestation Engagements no. 7, both titled Establishing an Understanding With the Client. These standards provide guidance on the understanding a CPA should have with a client when performing auditing and other attestation services. This article explains why the American Institute of CPAs issued the standards and provides guidance on how to apply them.

WHY ISSUE NEW STANDARDS?

Statement on Quality Control Standards (SQCS) no. 2, System of Quality Control for a CPA Firm's Accounting and Auditing Practice, which became effective on January 1, 1997, requires firms to have policies and procedures for obtaining an understanding about the services to be performed. These policies and procedures are intended to minimize the risk of misunderstandings with the client regarding the nature, scope and limitations of engagements.

While most CPAs have always -- at least implicitly -- realized the need for such an understanding, SQCS no. 2's explicit requirement suggested to the ASB the need to provide related guidance for audit and attestation engagements. The board issued the new standards to provide that guidance and to help firms comply with the SQCS requirement.

WHAT'S REQUIRED?

Both statements require the CPA to establish an understanding with the client for each engagement and provide details on the nature of the understanding. Auditors must document that understanding in the working papers, preferably in writing. CPAs generally can meet these requirements with an engagement letter.

The understanding addresses four areas:

* The objectives of the engagement.

* The responsibilities of management.

* The responsibilities of the practitioner.

* The limitations of the engagement.

Rather than simply identify the areas that need to be addressed, in SAS no. 83 the board provides illustrations of matters that must be included. Exhibit 1, page 55, presents the required elements of an understanding in an audit. Exhibit 2, page 56, is a sample engagement letter, containing the elements and several other items frequently included in an understanding.

USING PROFESSIONAL JUDGMENT IN ATTESTATION ENGAGEMENTS

While SSAE no. 7, like SAS no. 83, requires an understanding in the four areas, it does not provide a list of matters that must be included. The board concluded that the wide variety of attestation services made it impossible to develop such a list. Therefore, a CPA should use judgment on what matters to include. However, for any attestation service, the list included in SAS no. 83 (exhibit 1) may provide a valuable starting point.

ADDITIONAL MATTERS

In addition to the matters listed in exhibit 1, SAS no. 83 presents other items that may be included in the engagement letter:

* Arrangements regarding the conduct of the engagement (for example, timing, client assistance regarding the preparation of schedules and availability of documents).

* Arrangements concerning any involvement of specialists or internal auditors.

* Arrangements involving a predecessor auditor.

* Arrangements regarding fees and billing.

* Any limitation of or other arrangements regarding the liability of the auditor or the client, such as indemnification to the auditor for liability arising from knowing misrepresentations by management to the auditor. (Regulators, including the Securities and Exchange Commission, may restrict or prohibit such liability limitation arrangements.)

* Conditions under which access to the auditor's working papers may be granted to others.

* Additional services relating to regulatory requirements.

* Arrangements regarding other services to be provided in connection with the engagement.

Exhibit 3, pages 58-59, contains sample wording that may be used in an engagement letter. However, the evolving nature of the law and differences in each state's laws make it advisable for CPAs to consult with legal counsel to develop acceptable wording in some areas.

IMPLEMENTATION ISSUES 

The brevity of SAS no. 83 and SSAE no. 7 may lead to questions concerning how they should be implemented. Some guidance follows.

Alternatives to engagement letters. The auditing standards board realizes that in some circumstances these letters will not be used. For some engagements, a formal contract might include all details on the needed understanding. Alternatively, an oral discussion with the client may be summarized in a memo. Board members unanimously believe, however, that following up an oral discussion with an engagement letter is a much better approach than relying entirely on a discussion. The standards state a preference for written communication with the client.

Timing. The standards are silent on when the CPA must obtain the understanding. The first standard of fieldwork reads: "The work is to be adequately planned and assistants, if any, are to be properly supervised." Therefore, we anticipate that CPAs will obtain an understanding during the planning phase. Often CPAs will be able to obtain a signed engagement letter from a client before beginning audit fieldwork. However, occasions may arise in which a CPA obtains the understanding during the audit process. In those situations, the practitioner should consider that the later the understanding is obtained, the more likely the occurrence of misunderstandings.

Who is the client? While the requirement is to establish an understanding with the client, SAS no. 83 and SSAE no. 7 do not indicate the identity of the client for this purpose. Because the Code of Professional Conduct in AICPA Professional Standards defines the client in ET section 92.01, the board did not believe a redefinition was necessary. ET section 92.01 defines a client as "any person or entity, other than the member's employer, that engages a member or a member's firm to perform professional services or a person or entity with respect to which professional services are performed." The board anticipates that practitioners ordinarily will obtain an understanding with management, including the chief executive officer and the chief financial officer, on behalf of the company.

Changes during engagement. A CPA must use judgment when the understanding changes. For example, if the client requests significant additional services, the CPA may wish to use an additional engagement letter to provide assurance that an understanding has been obtained. If a practitioner does not use an engagement letter, at a minimum he or she should discuss the change with the client and document the understanding in the working papers.

Documentation. An understanding in the form of an engagement letter signed by the client ordinarily is adequate. If no engagement letter is used, the practitioner must use judgment on documentation. In certain government audits, a signed contract may serve as proper documentation. In other engagements, the working papers should document the information discussed, including the matters in exhibit 1.

No understanding. Both standards require that a CPA decline an engagement when he or she believes that an understanding with the client has not been obtained. However, the board believes this will be very rare. SAS no. 83 also says that if the auditor is unable to complete the audit or is unable to form or has not formed an opinion -- for any reason -- he or she may decline to express an opinion or decline to issue a report as a result of the engagement.

Codification and dates. SAS no. 83 amends AU sec. 310, "Relationship Between the Auditor's Appointment and Planning," of AICPA Professional Standards and renames that section "Appointment of the Independent Auditor." SSAE no. 7 amends SSAE no. 1, Attestation Standards, AT sec. 100, "Attestation Standards." Both standards are effective for engagements for periods ending on or after June 15, 1998.