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AUDITING THEORY (ACCTG 9) Compiled by: Ray Patrick S.

Guangco, CPA
At the beginning of the current audit engagement, the auditor Integrity of Management
should perform following activities: PSA 220 requires the firm to conduct a background investigation of
a. Perform procedures required by PSA 220, “Quality Control the prospective client in order to minimize the likelihood of
of an Audit of Financial Statements” regarding the association with the clients whose management lacks integrity. The
continuance of the client relationship and the specific task would involve:
audit engagement.  Making inquiries of appropriate parties in the business
b. Evaluate compliance with ethical requirements, including community such as prospective client’s banker, legal
independence as required by PSA 220. counsel, or underwriter to obtain information about the
c. Establish an understanding of terms of engagement as reputation of the client.
required by PSA 210, “Agreeing the Terms of Audit  Communicating with the predecessor auditor
Engagements.” Before the incoming auditor contacts with the predecessor
auditor, the incoming auditor should obtain client’s
Performing these preliminary engagement activities enables the permission to communicate with the predecessor auditor.
auditor to plan an audit engagement for which, for example: This is a necessary procedure because the code of ethics
 The auditor maintains the necessary independence and prevents an auditor from disclosing any information
ability to perform the engagement. obtained about the client without the client’s explicit
 There are no issues with management integrity that may permission. Refusal of the prospective client’s
affect the auditor’s willingness to continue the management to permit this will raise serious questions as
engagement. to whether the engagement will be accepted.
 There is no misunderstanding with the client as to the
terms of the engagement. Once permission of the client is obtained, the incoming
auditor should inquire into matters that may affect the
PSA 220, Quality Control for Audits of Historical Financial decision to accept the engagement. This includes
Statements, provides that there should be an evaluation of questions regarding:
prospective clients and a review, on a ongoing basis, of existing  The predecessor auditor’s understanding as to
clients is to be conducted. An auditor is not obligated to accept the reasons for the changes of auditors.
undesirable clients, nor are they obligated to continue to serve  Any disagreement between the predecessor
clients when relationships deteriorate or when the management auditor and the client.
comes under a cloud of suspicion. The auditor must maintain  Any facts that might have a bearing on the
credibility with creditors, shareholders and the investing public by integrity of the prospective client’s management.
demonstrating independence, integrity, objectivity and appropriate The Code of Ethics requires the predecessor auditor to
level of professional scepticism. Thus the decision to accept a new respond fully to the incoming auditor’s inquiry and advise
audit client or continue a relationship with an existing client should the incoming auditor if there are any professional reasons
not be taken lightly. Acceptance and continuance of client why the engagement should not be accepted.
relationships and specific audit engagements including considering:
 The integrity of the principal owners, key management The CPA firm shall establish whether the preconditions for an audit
and those charged with governance of the entity are present such as:
 Whether the engagement team is competent to perform  Whether the financial reporting framework to be applied
the audit engagement and has the necessary time and in the financial statements are acceptable
resources  Agreement of management that it acknowledges and
 Whether the firm and the engagement team can comply understands its responsibility
with ethical requirements 1. The preparation of financial statements in accordance
In other words, in deciding whether to accept or reject an audit with applicable financial reporting framework
engagement, the firm should consider: including where relevant to their fair presentation.
 Competence 2. Such internal control as management determines is
 Independence necessary to enable the preparation of financial
 Ability to serve the client properly statements that are from material misstatement
 The integrity of the prospective client whether due to fraud or error, and
3. To provide the auditor with:
Competence a. Access to all information of which
Before accepting an audit engagement, the auditor should obtain a management is aware that is relevant to the
preliminary knowledge of the client’s business and industry to preparation of financial statements such as
determine whether the auditor has the degree of competence records, documentation and other matters.
required by the engagement or whether such competence can be b. Additional information that the auditor may
obtained before the completion of the audit. request from management for the purpose
of the audit.
Independence c. Unrestricted access to persons within the
Before accepting an audit engagement, the auditor should consider entity from whom the auditor determines it
whether there are any threats to the audit team’s independence and necessary to obtain audit evidence.
objectivity and, if so, whether adequate safeguards can be Procedures in Evaluating New Client
established. 1. Obtain and read financial information relating to the client
and its operations.
Ability to serve the client properly 2. Make inquiries of third parties who have previous business
An engagement should not be accepted if there are no enough associations with the client including the client’s attorneys,
qualified personnel to perform the audit. PSA 220 suggests that underwriters, bankers and predecessor auditor, if
audit work should be assigned to personnel who have the applicable.
appropriate capabilities, competence and time to perform the audit 3. Evaluate the firm’s independence with respect to the
engagement in accordance with professional standards. In addition, entity.
there should be sufficient direction, supervision and review of work 4. Evaluate the firm’s ability to adequately staff the
at all levels in order to provide reasonable assurance that the firm’s engagement.
standard of quality is maintained in the performance of the 5. Evaluate whether the appointment will take effect early
engagement. enough to allow all necessary audit procedures to be
6. Determine whether the engagement would require
specialized industry knowledge or other types of expertise
and whether this knowledge can be obtained prior to
completing the engagement.
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AUDITING THEORY (ACCTG 9) Compiled by: Ray Patrick S. Guangco, CPA
Retention of Existing Clients Changes in the Terms of Engagement
The auditor’s evaluation of clients is not a one-time consideration. An auditor who, before the completion of the engagement, is
Clients should be evaluated at least once a year or upon occurrence requested to change the engagement to one which provides a lower
of major events such as changes in management, directors, level of assurance, should consider the appropriateness of doing so.
ownership, nature of client’s business, or other changes that may A request from the client for the auditor to change the engagement
affect the scope of the examination. In general, conditions which may result from:
would have caused an accounting firm to reject a prospective client 1. A change in circumstances affecting the need for the service,
may also result or lead to a decision of terminating an audit 2. A misunderstanding as to the nature of an audit or related
engagement. service originally requested or
3. A restriction on the scope of the engagement, whether
imposed by management or caused by circumstances.
It documents and confirms the auditor’s acceptance of the
The auditor shall consider the justification given for the request,
appointment, the objective and scope of the audit, the extent of the
particularly the implications of a restriction on the scope of the audit
auditor’s responsibilities to the client and the form of any report.
engagement. Before agreeing to change an audit engagement to a
When other services such as tax, accounting, or management
related service, an auditor who was engaged to perform an audit in
advisory services are to be provided, separate letter may be
accordance with PSAs would consider, in addition to the above
matters, any legal or contractual implications of the change.
After accepting the audit engagement, an engagement letter should
be prepared. This serves as the written contract between the auditor Acceptance of a Change Engagement
and the client. This letter sets forth: If the terms of audit engagement are changed, auditor and
 The objective and scope of the audit of the financial management shall agree on and record the new terms of the
statements engagement letter or other suitable form of written arrangement.
 The responsibilities of the auditor
 The responsibility of the management Rejecting a Change in Engagement
 Identification of the applicable financial reporting If the auditor is unable to agree to a change in the terms of the audit
framework for the preparation of the financial statements engagement and is not permitted by management to continue the
 Reference to the expected form and content of any original audit engagement, the auditor shall:
reports to be issued by the auditor and a statement that a. Withdraw from the audit engagement where withdrawal is
there may be circumstances in which a report may differ possible under applicable law or regulation
from its expected form and content. b. Determine whether there is any obligation, either
In addition, the auditor may also include the following items in the contractual or otherwise, to report the circumstances to
engagement letter. other parties, such as those charged with governance,
 Billing arrangements owners or regulators.
 Expectations of receiving management representation
Auditing Theory by Cabrera, 2017 edition
 Arrangement concerning the involvement of others
Auditing Theory : A guide in understanding PSA by Salosagcol, Tiu &
(experts, other auditors, internal auditors and other client
Hermosilla, 2014 edition
Auditing and Assurance Principles by Ireneo, Ireneo, & James, 2012
 Request for the client to confirm the terms of the
Importance of the Engagement Letter
It is in the interest of both the auditor and the client that the auditor
sends engagement letter in order to:
 Avoid misunderstandings with respect to the engagement.
 Document and confirm the auditor’s acceptance of the
Recurring Audits
The auditor does not normally send new engagement letter every
year. However, the following factors may cause the auditor to send a
new engagement letter:
 Any indication that the client misunderstands the objective
and scope of the audit.
 Any revised or special terms of the engagement.
 A recent change of senior management, board of directors
or ownership
 A significant change in the nature or size of the client’s
 Legal requirements and other government agencies
When the auditor decides not to send a new engagement letter, it
may be appropriate for the auditor to remind the client of the
original arrangements.
Audits of Components
When the auditor of a parent entity is also the auditor of its
subsidiary, branch or division (component), the auditor should
consider the following factor in making a decision of whether to
send a separate letter to the component:
 Who appoints the auditor of the component.
 Whether a separate audit report is to be issued on the
 Legal requirements
 The extent of any work performed by other auditor
 Degree of ownership by parent.
 Degree of independence of the component’s
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