How Certain Engagement Letter Clauses Affect the Auditor’s Assessment of Perceived Engagement Risk for Nonissuers

AICPA auditing standards (e.g., AU-C210, par. 11) for audits of nonissuers 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. But, the SEC, PCAOB and other authoritative bodies prohibit those clauses-fearing their use would impair auditors' independence. We survey 209 CPAs' responses to increasing risk across three engagement letter clauses that can change the level of auditor risk exposure, and measure the amount of data and fees auditors gather relative to changing engagement letter clauses in normal and unusual risk scenarios. We find that CPAs say they increase both the quantity of evidence gathered and their engagement fees in response to increasing risk, which suggests that CPAs' level of work depends much more on their assessment of perceived risks than on the three clauses minimizing their legal liabilities. Auditors further respond to an engagement's aggregate risk in the presence of risk-reducing clauses. We also find that while the clauses can lower the cost of the engagement's risk, auditors do not lower the amount of evidence gathered under the no-unusual-risk scenario, and significantly increase evidence when perceiving an increase in risk. Thus, support exists for authoritative bodies to permit such engagement letter clauses. While PCAOB standards affect only public companies, our results should be of interest to policy makers who oversee attestation services affecting both public and private companies.