The auditor change process.

Some standards are being applied inconsistently.

When a company changes auditors, professional standards specify the successor and predecessor auditors follow certain procedures. Additional procedures have developed through custom. Statement on Auditing Standards no. 7, Communications Between Predecessor and Successor Auditors, provides guidance on communications (some required, others optional) between old and new auditors. The required communications are intended to help the successors decide whether to accept an audit engagement. The optional ones facilitate performance of the audit, particularly in areas concerning balances at the beginning of the period under audit.

SAS no. 7 was written from the perspective of an auditor accepting or rejecting a client's request for service; today, the more common practice is for a client to accept or reject an auditor's proposal. This change in the decision-making process could affect the auditor's actions. This article describes the results of a survey conducted to determine how certain aspects of SAS no. 7 are applied in practice and to better understand other facets of the auditor change process, including optional provisions related to reviewing a predecessor auditor's working papers.

THE TAkE OF SAS 7 AND THE PREDECESSOR AUDITOR

In SAS no. 7, "predecessor auditor" is one who has resigned or been notified his or her services have been terminated. In practice, however, the predecessor may be retained during the proposal process. "Successor auditor" is one who has accepted an engagement or has been invited to make a proposal. The communication responsibility rests with the successor--whether or not the successor accepts the engagement.

Required communication. A potential successor auditor should (with client permission) make specific inquiries of the predecessor on matters that will help determine whether to accept the engagement. The standard says the inquiries should include specific questions about, among other things, facts that bear on management's integrity; disagreements with management as to accounting principles, auditing procedures or similar significant matters; and the predecessor's understanding of the reasons for the change of auditors. The predecessor auditor should respond fully to the inquiries, except in unusual circumstances when the predecessor should indicate the response is limited.

Optional procedures. The successor auditor also may perform some additional procedures, including making inquiries of the predecessor that will help in expressing an audit opinion. SAS no. 7 says the successor auditor's work may be facilitated by

* Making specific inquiries of the predecessor about matters the successor believes may affect the conduct of the audit.

* Reviewing the predecessor auditor's working papers.

Other issues concern which working papers are to be made available and which can be copied.

WHAT AUDITORS DID

We mailed a questionnaire to 400 CPAs randomly chosen from American Institute of CPAs members who said auditing was their specialty. There were 151 replies, a 38% response rate. The survey included questions about the extent, timing and form of communication between predecessor and successor auditors and the successor's use of the predecessor auditor's working papers.

The first question presented a scenario in which three CPA firms had been asked to submit a proposal to audit Zeta Co., a company previously audited by another CPA firm. Survey respondents were asked to assume they had visited Zeta and reviewed its financial records and procedures to the extent needed to prepare a proposal.

Respondents were asked if they would communicate with the predecessor auditor

1. Before visiting Zeta and reviewing its financial records and procedures.

2. After the visit and review but before sending the proposal.

3. Only if the proposal was accepted.

4. Under no circumstances.

Because SAS no. 7 requires communication before accepting a new client and Zeta Co. becomes a client on acceptance of the proposal, only answers 1 and 2 technically comply with the standard. The results are presented in exhibit 1, above.

While all would communicate at some point, 77% would do so only if the proposal was accepted. The responses showed auditors understood the requirement to communicate but were not consistent in adhering to the required timing. As noted earlier, the fact the client rather than the auditor often makes the acceptance decision may confound the timing issue because SAS no. 7 assumes the successor makes the decision. In fact, if the client accepts the successor's proposal there is really no opportunity to make the necessary inquiries. The client's acceptance of the proposal means the auditor has in fact accepted the engagement.

We also investigated the types of inquiries made by a successor auditor. Auditors were given six potential inquiries (including the three required in SAS no. 7) and asked to select those they thought appropriate. These inquiries and the frequency of selection are shown in exhibit 2, below.

Of the required inquiries, disagreement with management about accounting principles and auditing procedures (94%) and management's integrity (84%) were selected frequently; however, the reason for the change in auditors was selected only 62% of the time. Some auditors believed they could ascertain the reason for the change in auditors from responses to other inquiries; however, a specific inquiry could produce information that might not otherwise be forthcoming. Inquiries not required by SAS no. 7 were selected somewhat less frequently than required ones, with difficulties encountered in performing the prior audit selected most frequently (82%) and fee disputes chosen least frequently (68%). Although not required, auditors appeared to recognize the importance of these inquiries in planning an audit.

Other questions were related to the review of predecessor auditor working papers and the timing, restrictions and procedures involved. The results are presented in exhibit 3, below.

Predecessor auditor working papers are likely to be useful for evaluating beginning balances and the consistent application of accounting principles, as well as identifying potential problem areas for planning purposes. Successor auditors appeared to routinely request permission to review the predecessor's audit working papers either before accepting a new engagement or after. Only one auditor never asked to review the working papers of the predecessor auditor.

SAS no. 7 says it is customary for the predecessor auditor to; make the working papers available to the successor but acknowledges the predecessor might not allow a review because of valid business reasons, such as pending or threatened litigation between the client and the predecessor. In addition, respondents said that unpaid fees could be a reason for denial. The survey showed that it was rare in practice (question 2 of exhibit 3) for a predecessor to deny a successor's request to review the audit working papers.

The predecessor and successor auditors should "agree on the working papers that are to be made available for review," which suggests the successor auditor may not request or be granted unrestricted access to all audit working papers. For example, working papers not related to matters of continuing accounting significance, such as staff time budgets, preliminary report drafts and proprietary information, may not be requested or made available. The survey found some restrictions did occur. Respondents commented that administrative working papers and occasionally audit programs might be withheld.

If predecessor auditors believe their audit working papers contain proprietary information, such as unique audit approaches, or if they prefer the audit documentation not be reproduced, the predecessor may not allow the working papers to be copied. Placement of such restrictions apparently isn't widespread.

SAS no. 7 does not address whether the predecessor auditor should remain with the successor during the review of the working papers. Some auditors believe they should control their audit working papers; thus, they remain in the room with and observe the successor auditors during the reviews and bill this time to their former clients. Other predecessor auditors do not believe observation is necessary. The survey showed predecessor auditor observation was common and most likely among respondents from national firms.

UNDERSTANDING THE RESPONSIBILITY

While CPAs seem to understand their responsibility to try to communicate with predecessor auditors, they are inconsistent in applying SAS no. 7's timing requirement. Part of the reason for this may be the statement's wording--it is written in the context of an auditor accepting or rejecting a request for service from a client. In today's competitive environment, it is more common for a client to accept or reject proposals from one or more auditors, leaving no opportunity for the successor to make the necessary inquiries. Successor auditors seem to be making the specific inquiries required by SAS no. 7, except for asking why a change in auditors is occurring.

EXECUTIVE SUMMARY

* PROFESSIONAL STANDARDS SPECIFY THAT when a company changes auditors, the successor and predecessor auditors must follow certain procedures. Statement on Auditing Standards no. 7, Communications Between Predecessor and Successor Auditors, offers CPAs guidance on required and optional communications.

* SAS NO. 7 IS WRITTEN FROM THE perspective of an auditor accepting or rejecting a client's request for service. Today, it's more common for a client to accept or reject an auditor's proposal. This new decision-making process may affect the auditor's actions.

* A SURVEY INVESTIGATED THE EXTENT, timing and form of communication between predecessor and successor auditors and the successor's use of the predecessor's working papers. Given four scenarios (only two of which technically are covered by SAS no. 7), 77% of auditors said they would communicate with the predecessor only if the proposal were accepted; all would communicate at some point in the process.

* SUCCESSOR AUDITORS APPEARED TO routinely request permission to review the predecessors' audit working papers either before accepting a new audit engagement or after. The survey showed it was rare in practice for a predecessor to deny a successor access to the papers except in the case of valid business reasons, such as potential litigation.

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G. WILLIAM GLEZEN, CPA, is Walter B. Cole Professor of Accountancy at University of Arkansas, Fayetteville. MARK B. ELSER, CPA, is a senior associate with Coopers & Lybrand in Tulsa, Oklahoma.