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New Changes to Engagement Letters Preclude Company Intervention in Portions of Audits Performed by Company Personnel

A recent auditing standard issued by the AICPA’s Auditing Standards Board may result in the inclusion of a new provision in auditors’ engagement letters related to external auditors’ use of the work of internal auditors and other company personnel. The new provision may specify that a company will not intervene in work done by internal auditors and other company personnel when that work is used by external auditors. It also provides that the external auditors will direct, supervise, and review the work performed by company personnel on the audit engagement. Although no similar provision is required by any PCAOB auditing standard applicable to public companies, PCAOB Staff Audit Practice Alert No. 11 does state that, “When using the work of others that provide direct assistance, the auditor should supervise that work, including reviewing the work, as well as testing and evaluating it.”

An example of the new engagement letter provision follows:

Management will allow those providing direct assistance to Auditor in the course of the audit, including members of the internal audit staff and others performing internal audit control related procedures, to follow Auditor’s instructions, and the company will not intervene in the work such individuals perform for the Auditor.

The AICPA’s Auditing Standards Board’s Statement on Auditing Standards No. 128 (SAS 128), was issued in February 2014 and is applicable to audits of nonpublic company financial statements for periods ending on or after December 15, 2014. It was developed based on International Standards on Auditing 610 (revised 2013), “Using the Work of Internal Auditors.” Paragraph 30 of SAS 128 provides that:

Prior to using internal auditors to provide direct assistance, the external auditor should obtain written acknowledgment from management or those charged with governance, as appropriate, that internal auditors providing direct assistance to the external auditor will be allowed to follow the external auditor’s instructions, and that the entity will not intervene in the work the internal auditor performs for the external auditor.

While prohibiting a company from intervening in the audit work performed by the internal auditor or other company personnel may seem intrusive, including the new provision in a public company’s audit engagement letter—while not required by PCAOB auditing standards—may be necessary in order for the external auditors to be comfortable relying on such company personnel’s work. The overall cost of an audit may be lower to the extent that external auditors are able to obtain direct assistance from internal auditors and others in conducting an audit. Nevertheless, public companies may want to consider whether the obligation to not “intervene” with the work could unnecessarily interfere with ordinary course employment decisions by the company.

Copyright © 2020 by Morgan, Lewis & Bockius LLP. All Rights Reserved.National Law Review, Volume IV, Number 129

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About this Author

Linda Griggs, Securities attorney, Morgan Lewis
Senior Counsel

Linda L. Griggs’s practice focuses on securities regulation and corporate law matters. She draws on her experience as a former chief counsel to the chief accountant of the US Securities and Exchange Commission (SEC) to advise clients on issues related to financial reporting, accounting, and other disclosure requirements under securities laws and public and private securities offerings. Linda also advises clients on the fiduciary duties of directors and officers, as well as corporate governance matters.​​

202.739.5245
Sean Donahue, Capital markets lawyer, Morgan Lewis
Partner

Sean M. Donahue counsels public companies across the United States on activist defense matters. As a member of the firm’s market-leading shareholder activism defense practice, he advises public companies in high-profile proxy contests, activist shareholder campaigns, contests for corporate control and negotiated and contested mergers and acquisitions (M&A). Sean also advises public companies and their boards of directors on the latest techniques for lessening a company’s vulnerability to activist shareholders, board advisory matters, and the implementation of takeover defenses.​​

202-739-5658
Howard A. Kenny, Securities Lawyer, Morgan Lewis
Partner

Howard A. Kenny focuses on public and private securities offerings, securities regulation, corporate governance, and various business transactions. He counsels clients in a wide variety of industries, including media, retail, life sciences, financial services, and food. He assists clients in capital raisings, IPOs, follow-on and secondary offerings, tender and exchange offers, and acquisitions and sales of businesses.

212.309.6843