Update command normally only works after cfglegato has been executed.
If you open .bashrc you will find cfglegato is an alias:
alias cfglegato="pushd . && cd ~/legato_framework/legato && source ./bin/configlegatoenv ; popd"
If you open configlegatoenv you will see that it adds a bunch of directories to your PATH.
If you want to use update from a system command you either need to execute configlegatoenv or add these entries to your PATH manually.
Otherwise you can use a full path to the update command.
Nevermind. I realised you are talking about executing update from on the WP7502.
The concept is the same, your terminal knows where update is, the system command does not.
Either add /mnt/legato/system/bin to your PATH or use the full path /mnt/legato/system/bin/update