Communication with Predecessor Auditors and Management
Explore best practices, common challenges, and crucial procedures for establishing contact with predecessor auditors and management when considering a new audit engagement.
3.2 Communication with Predecessor Auditors and Management
Effective communication with predecessor auditors and current management is essential to gain a well-rounded understanding of a prospective client’s audit environment. This process not only helps to identify matters that might affect audit acceptance but also sheds light on the level of transparency within the organization. As part of due diligence, the successor auditor should obtain approval from the client to reach out to the predecessor auditor before finalizing the acceptance of the engagement. The nature, depth, and outcomes of these discussions can significantly influence the decision to proceed with the engagement.
In this section, we dive into why these communications are so important, examine the process from initial request to final assessment, and offer practical examples and best practices to guide auditors in navigating these crucial discussions.
Importance of Predecessor Auditor Inquiries
Gaining Historical Insights
The predecessor auditor is a valuable resource for understanding the client’s previous financial reporting environment. Through open dialogue, the successor auditor can learn of:
• Any significant disagreements over accounting principles or audit procedures in prior audits.
• Issues related to the integrity or reliability of the client’s management.
• Outstanding fees, disputes, or other unresolved matters that led to the change in auditor.
Identifying Potential Red Flags
When prospective clients refuse to authorize the successor auditor to speak with the predecessor, or if the predecessor fails to respond, these instances may signal:
• Management’s lack of transparency.
• Potential for undisclosed legal or regulatory concerns.
• Difficult issues encountered during prior audits that may resurface.
If any of these red flags appear, it is essential for the successor auditor to determine whether they pose serious risks to the engagement’s integrity.
Communication Flow and Best Practices
The process for contacting the predecessor auditor typically unfolds through several key steps:
flowchart TB
A[Obtain Client's Permission] --> B[Contact Predecessor Auditor]
B --> C[Discuss Key Issues and Reasons for Auditor Change]
C --> D[Request Additional Documentation or Clarification]
D --> E[Evaluate Findings and Decide on Engagement Acceptance]
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Obtain Client’s Permission
The successor auditor requests written or explicit authorization from the prospective client to communicate with the predecessor. Failure to obtain permission is a serious impediment, often advising the successor auditor that the client may be withholding critical information. -
Contact the Predecessor Auditor
Once permission is granted, the successor auditor should send a formal letter or request to the predecessor, outlining the areas of interest. Professional courtesy dictates that the inquiry remains specific and respectful to the predecessor auditor’s engagement knowledge. -
Discuss Key Issues and Reasons for Auditor Change
Engage in open dialogue about possible conflicts, disputes, or difficulties during previous audits. This includes inquiries about: • Management’s integrity or reliability.
• Any disagreements over the application of generally accepted accounting principles (GAAP), audit procedures, or adjusting entries.
• The cause of any significant restatements, if applicable. -
Request Additional Documentation or Clarification
If concerns or inconsistencies surface, the successor auditor may request clarification, documentation, or other evidence supporting the predecessor’s conclusions. This step ensures that the new auditor can corroborate any allegations or identify any anomalies that could affect the current engagement. -
Evaluate Findings and Decide on Engagement Acceptance
Upon gathering information, the successor auditor should decide whether the risk level is manageable or whether it poses a threat to conducting the audit. Red flags, such as inconsistencies between management’s statements and predecessor evidence, may lead to a decision not to accept the engagement.
Topics for Inquiry
Successor auditors often have a predefined list of inquiries for predecessor auditors. Common questions include:
• The nature of any accounting principle disagreements with management.
• Instances of fraud or suspected fraud involving management or employees.
• Reliability of management’s estimates or any unadjusted differences left in prior financial statements.
• Fees remaining unpaid from previous years (which could indicate an ongoing dispute over audit findings or billing).
• Evidence of non-compliance with legal or regulatory requirements encountered during the audit.
These inquiries align closely with AU-C Section 510 (Opening Balances—Initial Audit Engagements), which requires a focus on obtaining sufficient appropriate audit evidence about whether opening balances contain misstatements that materially affect current period financial statements.
Management’s Role in the Communication Process
Authorization and Transparency
Before any conversation takes place, the client must provide permission—preferably in writing—to the successor auditor, empowering the auditor to talk with the predecessor. An unwillingness to do so can highlight potential management integrity issues.
Scope Clarification
After the successor auditor connects with the predecessor, they also continue discussions with management to confirm:
• The engagement’s objectives and scope.
• Important financial reporting deadlines.
• The client’s expectations regarding deliverables or special reporting requirements.
Understanding these elements early in the process allows the successor auditor to align the engagement team, timeline, and budget accordingly.
Unresolved Differences, Adjusting Entries, and Estimates
Management and the successor auditor may address outstanding unadjusted differences or historically problematic estimates. If previous disputes about revaluation of assets or unrecorded liabilities remain, the new engagement team should evaluate them for the current audit plan.
Potential Challenges and Pitfalls
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Client Refusal to Authorize Communication
Refusal to grant permission for contacting the predecessor auditor is a major red flag. The auditor should reexamine the riskiness of the engagement and potentially decline if the client’s refusal indicates a lack of transparency. -
Predecessor Auditor Silence
In some situations, the predecessor auditor may be slow to respond or entirely unresponsive. While there could be legitimate reasons—for example, busy season or pending legal issues—non-responsiveness could also indicate deeper problems. After reasonable attempts, the successor auditor must evaluate whether sufficient evidence about opening balances can still be collected. -
Incomplete or Inconsistent Information
The successor auditor might receive contradictory accounts of events from management versus the predecessor auditor. This conflict requires further investigation or additional documentary evidence to resolve discrepancies effectively. -
Legal and Confidentiality Considerations
Predecessor auditors are bound by professional ethics regarding confidentiality. They may only disclose necessary information once the prospective client grants explicit permission. Failure to adhere to these guidelines can result in professional and legal consequences.
Practical Example: A Hypothetical Audit Switch
Consider a midsize manufacturing company, “FlexiSteel Inc.,” that recently replaced its auditor of five years. The predecessor auditor states there were frequent disputes over inventory costing methods, ultimately impacting the company’s cost of goods sold (COGS). Management had refused to adjust this critical estimate in prior years, leaving potential unadjusted differences on the books. The predecessor auditor also discloses that certain prior-year fees remain unpaid.
Upon contacting management, the successor auditor learns that these disputes primarily involved interpretation of international financial reporting requirements, and the unpaid fees were tied to management’s disagreement with the required revaluation entries. Management insists that the prior auditors were overly conservative. Importantly, management grants full permission to the successor auditor to speak with the previous firm, showing a willingness to resolve outstanding matters.
In analyzing both insights, the successor auditor plans additional substantive testing on inventory and cost allocations in the upcoming audit. They also note the risk of continuing disputes if management’s chosen methods continue to deviate from auditing standards. However, the open dialogue with both parties helps the successor auditor prepare more robust audit procedures, mitigating potential unethical practices or hidden liabilities.
Regulatory Guidance and Professional Standards
• AU-C Section 510: Provides guidance on opening balances for new audit engagements and underscores the importance of learning about predecessor Auditor’s work.
• AICPA Code of Professional Conduct: Outlines the ethical considerations auditors must follow concerning confidentiality and integrity.
Additional Resources
• “Successor Auditor Communications: Minimizing Surprises” (CPA Practice Advisor).
• Wiley CPA Study Guide for Audit: Features comprehensive checklists and illustrative examples for contacting the predecessor auditor and evaluating initial engagement risk.
Glossary
• Predecessor Auditor: The public accounting firm that audited the client’s financial statements in the prior period(s).
• Successor Auditor: The new auditor proposing to accept or having accepted the audit engagement.
• Scope: The breadth or boundaries within which the audit is conducted, including time frame and financial aspects.
• Unadjusted Differences: Proposed adjusting entries identified during the audit that management declines to record in the financial statements.
Quiz: Effective Communication with Predecessor Auditors
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