Chapter 6 - Accepting engagements Flashcards
What are the 5 stages to accepting an audit engagement?
- Engagement proposal
- Risk analysis
- Acceptance
- Letter of engagement
By what methods may an assurance firm obtain an engagement?
- Being approached by a potential client and being asked to accept the engagement
- Being approached by an existing client and being asked to accept the engagement
- Being approached by a potential or existing client and being asked to tender for the engagement
What is tendering?
In a tender process, several assurance firms are in effect asked to ‘bid’ for the engagement, by setting out the attributes their firm possesses that makes them the best placed to carry out the engagement, and, sometimes very importantly, by indicating the level of fee that they are likely to charge. The tender will then be evaluated by the potential audit client who will then decide which audit team they would like to take on their audit
What key factors do potential audit clients consider when evaluating assurance firm proposals?
- Quality of Service – Evaluates the audit firm’s methodology, risk assessment approach, use of technology, and adherence to auditing standards to ensure a thorough and effective audit.
- Knowledge of the Business – Assesses the firm’s understanding of the client’s operations, financial structure, internal controls, and key risks to provide relevant and insightful audit services.
- Industry Experience – Determines whether the audit firm has experience handling similar businesses, industry-specific regulations, accounting treatments, and common financial challenges.
- Proposed Audit Team – Reviews the qualifications, experience, and expertise of key personnel, including the engagement partner and audit managers, to ensure they have the necessary skills to conduct a high-quality audit.
- References & Reputation – Considers feedback from past or existing clients, regulatory compliance history, and overall market reputation to gauge reliability, professionalism, and effectiveness.
What guidance does the ICAEW Code of Ethics provide on fee disclosure and the basis of computation?
The Code of Ethics suggests that the basis for fee computation should be disclosed to and discussed with the client/potential client as soon as possible, so this would probably be incorporated into a tendering document.
It states that fees should be determined with reference to:
* Seniority and Professional Experience – The level of expertise and qualifications of the personnel involved in the engagement, ensuring that the work is carried out by appropriately skilled individuals.
* Time Expended – The amount of time dedicated by each professional on the engagement, reflecting the complexity and effort required for a thorough audit.
* Risk and Responsibility – The level of risk and professional responsibility associated with the work, particularly in higher-risk engagements where additional diligence and scrutiny are required.
* Client’s Business and Complexity – The nature of the client’s industry, the intricacy of its operations, and the extent of work needed to perform a high-quality audit.
* Priority and Importance to the Client – The urgency and significance of the work for the client, which may impact resource allocation and scheduling.
* Expenses Incurred – Any direct costs, such as travel, technology, or specialist consultations, that are properly incurred in the course of the engagement.
What is lowballing? Is it ethical?
Lowballing refers to the practice of an audit firm charging fees below the ‘market rate’ to secure an audit engagement, often with the expectation of increasing fees in future years or gaining additional non-audit services.
According to the ICAEW Code of Ethics, an audit firm is permitted to quote any fee it deems acceptable, meaning that lowballing is not inherently unethical. However, ethical concerns arise when significantly reduced fees compromise audit quality.
Lowballing increases the self-interest threat, as the audit firm may struggle to allocate sufficient resources to perform the audit effectively while remaining commercially viable. To maintain professional integrity, firms must implement ethical safeguards, such as ensuring adequate staffing, independence, and compliance with auditing standards, to mitigate the risk of performing a substandard audit.
What risks will an assurance firm consider before taking on an assurance engagement and how will it assess these?
- Integrity of Directors/Management: The firm will evaluate whether the company’s directors and management demonstrate honesty and integrity. This can be done by reviewing the company’s accounting policies, assessing the qualifications and background of the finance director, and obtaining references from banks, solicitors, or the previous auditors. Any signs of unethical behavior or conflicts of interest could raise concerns.
- Financial Stability and Record: The firm will consider whether the company has a solid financial record and is financially stable. This is often assessed by reviewing recent and projected financial performance, including profitability, liquidity, and any history of financial difficulties or irregularities. Financial instability or frequent financial issues could be a red flag.
- Internal Controls and Control Environment: A strong internal control environment is critical for the integrity of the financial reporting process. The firm will assess the company’s internal controls, such as the existence of an internal audit department, or will inquire about the control environment directly from management. Weak internal controls or a lack of an internal audit function may lead to greater audit risks.
- Complexity or Unusual Transactions: If the company has a complex structure or engages in unusual or non-recurring transactions, it may pose additional risks. The firm can assess this risk by reviewing the company’s published financial statements and publicly available information from sources such as Companies House. A complex structure or unusual transactions might increase the risk of material misstatement or fraud.
What actions will the assurance firm take if certain risks are identified during the analysis?
Depending on the identified risks, the assurance firm may decide whether to accept or decline the engagement. If accepted, the risks will influence the audit approach, including the level of testing, resource allocation, and areas of focus. Additionally, the fee charged may be adjusted to reflect the complexity and risks associated with the engagement.
What are the key pre-conditions of an audit that must be present for an assurance firm to consider acceptance? (2)
Part of accepting (or agreeing to continue) an audit engagement is ensuring that the pre-conditions of an audit are present.
Key to this is:
* Establishing whether the financial reporting framework to be applied is acceptable
* Ensuring that management understands its responsibilities
– To prepare FS
– To maintain a system of internal control
– To provide information and access to auditors
If these conditions are NOT present, the engagement should not be accepted.
What are the key considerations an assurance firm takes into account when deciding whether to accept a new client’s invitation for an audit?
When an assurance firm is deciding whether to accept a new client’s invitation for an audit, the firm must carefully consider several key factors to ensure a successful and compliant engagement. These considerations include:
- Risk Analysis: The firm must evaluate the potential risks associated with the client, such as financial instability, industry-specific challenges, or any inherent risks that could affect the audit process. This helps the auditor determine whether they can manage those risks effectively.
- Ethical Considerations and Independence: The auditor must assess whether they can maintain their independence and objectivity throughout the audit engagement. Any conflicts of interest, prior relationships, or other ethical concerns must be considered. Independence is crucial to ensure the credibility and reliability of the audit opinion.
- Agreement on the Objective and Scope of the Audit: The auditor and the client must mutually agree on the objective of the audit, typically to express an opinion on the financial statements. The scope must also be clearly defined, outlining the areas to be covered, the audit procedures, and any limitations or exclusions. This ensures both parties have clear expectations.
- Integrity of the Client: The auditor must have confidence in the integrity of the client and its management. If the auditor has concerns about the honesty or ethical behavior of the client (e.g., past fraudulent activities or questionable conduct), it may raise doubts about whether proceeding with the engagement is appropriate.
- Compliance with Legal and Regulatory Requirements: The audit must comply with all relevant laws, regulations, and auditing standards (such as International Standards on Auditing or local statutory requirements). The terms of the engagement must align with these legal frameworks, ensuring the audit is conducted within the boundaries of the law.
- Access to Information: The auditor must ensure they will have unrestricted access to all necessary records and information, including financial documentation and communications with management or third parties (e.g., legal counsel). Without full access to relevant data, the auditor cannot perform an effective audit.
- Management’s Responsibility: It should be explicitly stated in the engagement terms that the management is responsible for the preparation and fair presentation of the financial statements, as well as the design and implementation of internal controls. The auditor’s role is to provide an independent opinion, not to prepare the financial statements.
- Terms of Fees and Payment: The terms of the audit engagement must clearly outline the agreed-upon fees, the method of determining the fees (fixed fee, hourly rate, etc.), and the payment schedule. This ensures transparency and avoids any future misunderstandings between the auditor and the client.
- Expectations Regarding Communication: There should be an agreement on the manner, frequency, and timing of communication between the auditor and the client throughout the engagement. This includes how the auditor will report findings, address issues, and deliver the final audit opinion.
How are new auditors of a company appointed? Include reference to legal deadlines
To carry out the audit of a company, the auditor must be formally appointed, and the previous auditor must be removed if necessary. The appointment of an auditor is typically made by an ordinary resolution passed by the company’s shareholders.
Shareholders appoint the auditor at the Annual General Meeting (AGM) or at any other general meeting where the company’s financial statements are being presented for approval. According to legal requirements, the appointment must occur within 28 days following the last date on which the financial accounts must be filed with the relevant authorities. If the company fails to appoint an auditor within this period, the current auditor is automatically reappointed.
If an assurance firm choses to accept an engagement, what steps must be taken to ensure their appointment is valid, with regards to handover from the previous auditors?
1. Obtain Client Authority: When first approached, the prospective auditor must communicate with the existing auditor as part of their professional duty. The client must provide written authority to the existing auditor, allowing them to discuss the client’s affairs with the prospective auditor. Client refuses permission to contact previous auditors, prospective auditor should carefully consider the impact of this on his decision whether to accept the appointment - why are they refusing this request?
2. Contact the Existing Auditor:
The prospective auditor must write to the existing auditor, requesting information that could influence the decision to accept the appointment. If the existing auditor does not respond, the prospective auditor should send a formal letter via recorded delivery, stating their intention to accept the appointment in the absence of a reply.
3. Written Authority for the Existing Auditor: The existing auditor should obtain written consent from the client before sharing any information with the prospective auditor. The existing auditor should respond promptly to the prospective auditor’s request.
4. Review the Existing Auditor’s Response: If there are no significant concerns, the existing auditor should confirm this in writing. If there are issues, the existing auditor should inform the prospective auditor about:
* Unlawful acts by the client.
* Unpaid fees (if significantly overdue).
* Disagreements between the client and the previous auditor.
5. Make a Decision: If the client refuses permission for the prospective auditor to contact the previous auditor, they should carefully assess how this affects their decision to accept the appointment. If satisfied with the responses and no major concerns arise, the prospective auditor can accept the appointment, ensuring compliance with professional and ethical standards.
What are the two scenarios in which a previous auditor will be removed from an audit?
The previous auditor can be removed if they resign or if the company decides to remove them before the end of their term. This may happen for various reasons, such as a breakdown in the working relationship or a change in the company’s needs.
What legal rights and responsibilities are awarded to auditors when they are being removed by a client?
Responsibilities:
* The auditor must provide a written statement explaining the circumstances surrounding their removal. This statement should be deposited at the company’s registered office.
* For auditors of non-listed entities, if there are no specific circumstances to explain, the auditor must submit a “statement of no circumstances” (option is not available for auditors of listed companies).
Rights:
* The auditor has the right to receive notice of, attend, and speak at the meeting where the new auditor is appointed (typically the Annual General Meeting, or AGM).
* The auditor has the right to request that written representations be circulated to all shareholders. These representations may explain why the auditor believes they should not be removed. This right ensures that auditors have an opportunity to present their side and prevents situations where directors might attempt to remove an auditor inappropriately due to personal disagreements or conflicts.
What legal rights and responsibilities are awarded to auditors when they are resigning?
Responsibilities:
* The auditor must submit a written notice of resignation to the company’s registered office.
* The auditor must provide a statement of circumstances explaining the reasons for their resignation.
* For auditors of non-listed entities, if there are no specific circumstances to explain, the auditor must submit a “statement of no circumstances” (option is not available for auditors of listed companies).
Rights:
* The auditor has the right to request that the company’s directors convene a general meeting, allowing the auditor to explain the circumstances behind their resignation.
* The auditor also has the right to require that the directors circulate the statement of circumstances to all shareholders before the meeting.
What is a letter of engagement with regards to assurance?
A Letter of Engagement in the context of assurance services is a formal agreement between an auditor (or an assurance provider) and the client, outlining the scope, terms, and responsibilities of the engagement. It serves as a contract that clarifies expectations for both parties before the assurance work begins.
What matters should be included in a letter of engagement? Consider ‘why’ each component is included
The form and content of an engagement letter will vary, but should cover the following matters:
* Objective and Scope: The objective and scope of the audit of financial statements, including reference to applicable legislation, regulations, financial reporting framework, and auditing standards, to define the extent of work and ensure compliance.
* Management’s Responsibilities: Management’s responsibilities, including responsibility for the financial statements and the company’s system of internal control, to clarify that management, not the auditor, is responsible for financial accuracy.
* Auditor’s Responsibilities: The auditor’s responsibilities, to outline the auditor’s role in obtaining reasonable assurance that the financial statements are free from material misstatement.
* Reports and Communication: The form and content of reports and communications that will arise from the audit, to inform management about expected deliverables such as audit reports and management letters.
* Limitations of an Audit: The inherent limitations of an audit, emphasizing that due to sampling and other constraints, some material misstatements may remain undetected, managing expectations.
* Access to Records: The auditor’s right to unrestricted access to records, documents, and other information requested in connection with the audit, ensuring they can gather sufficient appropriate audit evidence.
* Written Representations: The expectation that management will provide written representations, confirming their responsibilities and ensuring necessary audit confirmations are documented.
* Practical Arrangements: Practical matters, such as planning arrangements, the use of experts, liaison with the internal audit department, fee structure, and restriction of auditor liability, to establish logistical details and minimize conflicts during the audit.
