How Certain Engagement Letter Clauses Affect the Auditor’s Assessment of Perceived Engagement Risk for Non-Issuers

• In Event: Auditing 2

Abstract

AICPA auditing standards (e.g., AU-C210, par. 11) for audits of non-issuers require CPA auditors to use engagement letters or another suitable written understanding to clarify their and their clients’ duties; these letters also minimize CPAs potential legal liabilities to clients. While some CPA firms have extended this tool by adding clauses to minimize potential liabilities to their clients, the SEC, PCAOB and other authoritative bodies prohibit these clauses—fearing their use would impair auditors’ independence.

We examine auditor responses, through measuring the amount of data and fees auditors gather relative to changing engagement letter clauses in normal and unusual risk scenarios. We surveyed 209 CPAs to assess their responses to increasing risk across three engagement letter clauses that can change the level of auditor risk exposure. The engagement clauses include (1) alternative dispute resolution (ADR), (2) holding CPAs harmless from liability, and (3) limiting client's recovery of damages in civil dispute cases. We see that CPAs increase both the quantity of evidence gathered and their engagement fees in response to increasing risk. This finding suggests that auditors’ level of work depends much more on their perceived risks rather than on the three clauses minimizing their legalliabilities.

While PCAOB standards affect only public companies, our results should also be of interest to policy makers that oversee attestation services affecting both public and private companies.

Authors

• Alan Reinstein, Wayne State University

• Brian Patrick Green, University of Michigan–Dearborn

• Philip Beaulieu, University of Calgary