Engagement Risk

Summary

The auditor must evaluate various risk factors when considering a new client, such as the client's financial stability, economic climate, and business model. They also assess the likelihood of financial reporting errors and the potential impact of restatements. The audit firm considers the client's location, internal controls, and the firm's own resources and independence. The audit risk determines the fees charged, which in turn affects the audit quality. Independence is crucial, and if lacking, the engagement cannot proceed.

Takeaways

• 🔍 Auditors must consider various risk factors beyond the auto-risk model when accepting a new client.
• 💼 The client's ability to survive economically is crucial for the auditor as it impacts bill payments and the firm's reputation.
• 🌐 Evaluating the economic climate, technological impact, competition, business development, and geographic location is essential for risk assessment.
• 🏢 The client's business model and the audit firm's business risks are intertwined, affecting the decision to accept the client.
• 💡 Financial reporting risk involves assessing the likelihood of overstatement and the potential impact of a restatement.
• 🔑 Integrity, incentives, and internal controls of the client are critical factors in determining the quality of the company and the audit engagement.
• 💼 The audit firm seeks to associate with high-quality companies to ensure mutual benefits from the audit engagement.
• 💵 Audit fees are determined based on the assessed audit risk, which in turn influences the resources allocated to the audit.
• ⚖️ Independence is a non-negotiable requirement for auditors; lacking it disqualifies the firm from accepting the engagement.
• 🛠️ Competence can be addressed through hiring new personnel or using specialists, but independence issues cannot be resolved.

Q & A

What are the typical risk factors an auditor considers when accepting a new client?

The auditor considers factors beyond the auto-risk model, including the client's business viability, economic survival, and the potential for bankruptcy which could affect the audit firm's reputation.

Why is the client's ability to survive economically important to the audit firm?

The client's economic survival is important because it ensures they can pay the bills, and bankruptcy could lead to reputational damage for the audit firm.

What external factors might an auditor consider when evaluating a client's business?

The auditor might consider the economic climate, technological impact, competition, business model, and geographic location of the client's operations.

How does the geographic location of the client and audit firm affect the audit engagement?

If the client and audit firm are not in the same geographic region, it could introduce additional business risks, potentially making them a poor fit for each other.

What is financial reporting risk and why is it important in the audit process?

Financial reporting risk refers to the likelihood of overstatement in financial reports and the potential impact of restatements. It's important because it helps the auditor assess the quality of the client's financial reporting.

What factors does an auditor consider when determining the complexity of a client's financial reporting?

An auditor considers the client's integrity, incentives, and internal controls to assess the complexity of financial reporting.

Why is it beneficial for an audit firm to associate with high-quality companies?

Associating with high-quality companies that do good work benefits everyone involved, as it enhances the reputation of the audit firm and ensures a more successful audit process.

How does the audit firm determine the audit fees to charge a client?

The audit firm determines the audit fees based on the assessed audit risk, which in turn affects the resources allocated to the audit engagement.

What questions does an audit firm ask regarding the availability of resources for an audit?

The audit firm asks whether the client can provide sufficient resources for the audit, as the lack of resources could make the firm and client a poor fit.

Why is independence necessary for an audit firm to engage in an audit?

Independence is necessary to ensure the objectivity and integrity of the audit process. Without independence, the audit firm cannot accept the engagement.

How can an audit firm address a lack of competence in handling an audit engagement?

An audit firm can address a lack of competence by using specialists or hiring new personnel to gain the necessary expertise.

Is it possible for an audit firm to address a lack of independence?

Lacking independence cannot be addressed, as it is a fundamental requirement for the audit firm to perform an audit.