The Stages of an Audit – Appointment - ACCA Audit and Assurance (AA)
Summary
TLDRThis Open Tuition lecture discusses the critical decision-making process auditors face when considering whether to accept an audit engagement. It highlights the importance of evaluating ethical threats, such as familiarity and self-interest, and ensuring professional competence and independence. The lecture also covers acceptance procedures, the necessity of adequate resources, and the risks associated with auditing, including potential legal implications and the impact on the auditor's reputation. Additionally, it touches on the importance of communication with existing auditors, the role of internal audit, and the drafting of an engagement letter that outlines the responsibilities of both the auditor and the client.
Takeaways
- 🤔 Auditors must carefully consider whether to accept an audit engagement, considering ethical principles and potential threats.
- 👥 Familiarity and self-interest threats, such as being related to a client or heavily reliant on their audit fees, can compromise auditor independence.
- 📑 Acceptance procedures include assessing professional qualifications, legal compliance, and evaluating ethical threats.
- 💼 Auditors need to ensure they have adequate resources, including staff, time, and expertise, to handle the audit without compromising quality.
- 💰 The audit fee should cover the work required to gather sufficient appropriate audit evidence, but 'low-balling' can be a risky strategy.
- 🔍 Investigating the directors' backgrounds and financial histories is crucial to understanding the risks associated with an audit.
- 🏦 The nature of the client's business can pose inherent risks, such as cash-based businesses being more susceptible to fraud.
- 📈 Auditors must be aware of and comply with money laundering regulations, which can have severe legal consequences if not adhered to.
- 🗣️ Communication with existing auditors is essential, and their responses (or lack thereof) can provide insight into potential issues.
- 📝 The engagement letter outlines the responsibilities of both the auditor and the client, serving as a contract and a guide for the audit process.
Q & A
What is the first step an auditor should take before accepting an audit engagement?
-The first step an auditor should take is to decide whether or not to accept the audit engagement. This involves considering factors such as ethics, threats to independence, and the potential risks associated with the client.
What are some of the ethical threats that auditors need to consider before accepting an audit?
-Auditors need to consider ethical threats such as familiarity, where they might be too close to or related to the client's finance director, and self-interest threats, such as when a significant portion of the audit firm's income is derived from the client.
Why is it important for auditors to evaluate their professional competence and due care before an audit?
-Auditors must ensure they have the necessary professional competence and due care to perform the audit to a proper standard. This is crucial for maintaining audit quality and avoiding potential issues with the audit outcome.
What does the term 'low-balling' refer to in the context of audit fees?
-Low-balling refers to the practice of quoting an unreasonably low fee to win an audit engagement, possibly with the hope of securing more lucrative work in the future.
How can auditors assess the risk associated with the directors of a company they are considering auditing?
-Auditors can assess the risk associated with directors by investigating their backgrounds, checking databases, court records, and company house registrations for any signs of past misconduct or involvement in fraudulent activities.
What is the significance of the accounting reporting framework in the decision to accept an audit engagement?
-The accounting reporting framework is significant because it determines the standards and rules the company follows for financial reporting. Auditors must ensure that the framework is acceptable and complies with relevant regulations.
Why is it necessary for auditors to communicate with the outgoing auditors before accepting an engagement?
-Communicating with outgoing auditors is necessary to gain insights into any potential issues or concerns from the previous audit, which can inform the decision to accept the engagement and prepare for potential challenges.
What is the purpose of an engagement letter in the audit process?
-An engagement letter serves as a contract between the auditor and the client, outlining the responsibilities of both parties, the scope of the audit, and expectations regarding access to records and information.
How does the audit process handle the issue of confidentiality regarding the audit report?
-The audit process ensures confidentiality by specifying in the engagement letter that the audit report is intended for the company's members and should not be shared with third parties without the auditor's consent.
What role can internal audit play in the external audit process, and why is it significant?
-Internal audit can play a significant role by performing routine parts of the audit, such as testing internal controls and examining transactions. This can help external auditors by reducing the cost and workload, while still ensuring a thorough audit is conducted.
Outlines
🔍 Deciding to Accept an Audit Engagement
This paragraph discusses the initial considerations an auditor must make before accepting an audit engagement. It highlights the importance of evaluating whether the auditor should accept the work based on ethical principles and potential threats such as familiarity and self-interest. The auditor must also assess their professional competence, resources, and the adequacy of the audit fee. The paragraph emphasizes the need for acceptance procedures, which include considering the company's ethical threats, professional qualifications, and the availability of sufficient staff and time. It also touches on the risk of 'low-balling' with audit fees and the potential risks associated with the audit, such as giving a wrong opinion or failing to detect concealed fraud.
🕵️♂️ Investigating Directors and Assessing Risks
The second paragraph delves into the process of investigating the directors of a company before undertaking an audit. It raises concerns about potential fraud and the need to examine the directors' backgrounds, financial histories, and past behaviors. The paragraph also discusses the risks associated with certain types of businesses, such as cash-intensive operations like casinos, which may pose higher risks due to potential money laundering and illegal activities. It advises auditors to use databases, court records, and other resources to assess the credibility of directors and the nature of the business, weighing the audit fee against the potential risks involved.
📜 Communication with Outgoing Auditors and Engagement Letter
This paragraph outlines the etiquette and procedures for communicating with outgoing auditors when considering a new audit engagement. It explains the importance of obtaining permission from the client to contact the previous auditors and the implications if such permission is denied. The paragraph also discusses the role of engagement letters in defining the responsibilities of both the auditor and the client, setting expectations for the audit process, and establishing the scope of work. It highlights the need for clear communication regarding the audit's objectives, the basis of the audit, and the expectations of access to records and information. Additionally, it touches on the importance of confidentiality and the appropriate use of the audit report.
📝 Engagement Letter Details and Internal Audit Considerations
The final paragraph provides a detailed look at the contents of an engagement letter, which serves as a contract between the auditor and the client. It covers the responsibilities of both parties, the nature and objectives of the audit, and the expectations regarding access to records and information. The paragraph also addresses the issue of confidentiality, emphasizing that the audit report is intended for the company's members and not for external parties such as banks or suppliers. Furthermore, it discusses the planning aspects of the audit, including the reporting framework, the timing of the audit, and the potential role of internal audit in the process. The paragraph concludes by emphasizing the importance of internal audit in performing routine audit tasks and the need for external auditors to review and rely on the work of internal audit.
Mindmap
Keywords
💡Audit
💡Ethical Principles
💡Threats to Objectivity
💡Acceptance Procedures
💡Professional Competence
💡Due Care
💡Resources and Time Management
💡Low-balling
💡Investigating Directors
💡Engagement Letter
💡Internal Audit
Highlights
The lecture discusses the stages of the audit process and the importance of deciding whether to accept an audit engagement.
Auditors must consider ethical issues and threats before accepting an audit, such as familiarity and self-interest.
The lecture explains the concept of acceptance procedures, which include assessing professional qualifications and ethical threats.
Auditors need to ensure they have adequate resources, including staff, time, and expertise, before taking on an audit.
The lecture highlights the risk of 'low-balling', where a low fee is quoted to win an audit with the hope of future lucrative work.
Investigating the directors and the company's history is crucial before accepting an audit to mitigate risks.
The lecture mentions the importance of considering the accounting reporting framework and money laundering regulations.
Auditors must assess the credit rating of the client and foresee potential bad debt problems.
Communication with the present auditors is necessary to understand why they are no longer continuing with the audit.
The process of communication with outgoing auditors involves a careful dance of etiquette and confidentiality.
The engagement letter is a contract that defines the responsibilities of both the auditor and the client.
The lecture emphasizes the importance of setting clear expectations in the engagement letter to avoid misunderstandings later.
The role of internal audit and how external auditors can rely on their work is discussed, including the need for verification.
The lecture concludes with a discussion on the practical aspects of planning the audit, including scheduling and resource allocation.
Ethical considerations are a central theme throughout the lecture, with a focus on maintaining auditor independence and objectivity.
The lecture provides insights into the practical challenges auditors face, such as managing workload and ensuring audit quality.
Transcripts
this is a lecture from open tuition to
benefit from the lecture you should
download the free lecture notes from
open tuition com in Chapter seven we
begin to go through the stages of the
audit and the diagram here will mainly
go through actually chapter eight is
what we wanted to concentrate on on this
chapter really is whether or not and
what will happen really before you begin
the audit is you have to decide whether
or not you actually want to accept the
audit so if it yourself a company comes
along a finance director of the company
or perhaps a member of the audit
committee comes along approaches your
company and says we would like to put
you forward at the AGM because remember
the members have to vote on we'd like to
put your name forward at the AGM to be
our new auditors and of course it is
immensely fluttering your lies your eyes
will light up with kind of money signs
because there's lots of all fees and so
on coming in here it's it's something
that you would like to take on it says
he devised growth and so on but auditors
have to think carefully whether or not
they should accept work which is offered
to them and you just need to think
perhaps a moment or two why you need to
consider that and it in many ways comes
down to questions and ethics and threats
for example if we're talking about
threats to the fundamental ethical
principles one of the threats was
familiarity that that you are very
friendly with or even related to perhaps
a finance director in the client
so happens if the company which has
approached you the finance director is
your brother or your sister or is a
close friend or ethically you you
couldn't really take that all and on or
what will happen if this is very large
audit and the amount of thieves are
coming from it was going to be maybe
twenty five percent However total fee
income then this would create a
self-interest threat because once you're
in and doing the audit you could not
really bear to lose a client who was
paying you 25% of the audit fees because
it could put you into a kind of severe
financial difficulties
so before we say yes we have to think
carefully about it we have to go through
what's called acceptance procedures I
would have been talking rarely here is
to consider are we professionally
qualified to act are legally are we part
of a an appropriate body what are the
ethics the self-interest threats even
professional competence in due care will
come into that if the auditors in an
insurance company and we have no
experience whatsoever of the particular
problems and risks in insurance
companies then could we carry out that
orbit to the proper standard of
professional competence and to care will
we'll be able to act objectively are we
independent sufficiently of this audit
so you have to go through all the ethics
all the ethical threats to see whether
or not we actually want to take it on we
have to make sure that we have adequate
resources of staff and time management
expertise is emphasizing the
professional competence in jus care
the trouble with many audits is at the
year-end as the 31st of December and so
you're just kind of overworked ready
January March and could we fit in
another audit and if we did would this
be hurting our service to existing
clients and maybe in the long term
hurting our reputation we would be of
course very interested in the theme a
fee which is enough to cover the work
that has to be done to gather a
sufficient appropriate audit evidence
down if you want to but be careful of
low-balling
that would put in a ridiculously low fee
to win the audit perhaps in the hope of
getting other lucrative work later on
here's one that may surprise you
investigate directors when you take on
and you audit you will be getting fees
but you are exposing yourself to risk
the risk that you give the wrong ordered
opinion the risk may be that there is
fraud occurring within that company
which has been well concealed from you
in which you don't see and it is normal
for potential auditors to investigate
the directors and if it's of a listed
company there's a private company the
main owners of that company where did
they get their money from have a history
of setting up companies putting them
into liquidation kind of setting up
again putting them into liquidation and
so on do you do you really want to be
associated with that I can remember
maybe six years ago teaching auditing in
a particular country abroad and again I
wouldn't mention which one it is and it
was to teaching auditing to one of the
big four firms of accountants and one of
the people I said yes our company will
never take on any order work to do with
casinos because at that time in that
country the chances were that the casino
business
I was effectively dominated by the local
mafia and it was being used for money
laundering and all sorts of potentially
illegal activities and of course these
are exactly the sorts of managers and
shareholders who might be willing to
bring to bear a bit of physical
intimidation and they thought it was
just safer better for all concerned to
stay well away from that sector of the
market but you can look at a databases
you can look at court records you can
look at usually the kind of companies
house where companies are registered you
can look for directors who've been
banned for a period maybe because of bad
behavior in the past you can look at
county court judgments to see whether or
not maybe the director has been sued for
you know not paying debts or something
of that effect and you're going to be
looking at or at risk or at risk both
because maybe the directors and managers
but also the sort of businesses here
again I would go back maybe to the
casino business even if you didn't
suspect the owners of being less than
trustworthy the casino business is a
cash business and it can be quite tricky
to establish proper controls on a cash
business a lot of state unless the
business itself is very
security-conscious you know with
closed-circuit televisions in the
ceiling looking at the money passing
through it and just the risk might be
too high the risk that you're going to
get the order wrong and you know we are
weighing up fee versus risk you know
we're not auditors for charitable
purposes we are auditors to make a
profit and and part of making a profit
is not experiencing too much risk for
the fee you're going to be getting is
the accounting reporting framework
acceptable so so basically if the
company is accounting according to the
higher forces and high ASA's and so on
it probably will be acceptable but you
might be worried of
what they're doing is reporting only on
a cash basis rather than the crawlspaces
you have to be aware of money laundering
regulations money laundering regulations
can get auditors into trouble certainly
in the UK auditors are required to
report suspicions of money laundering to
the authorities they don't even have to
have proof just a suspicion of money
laundering and if they don't report that
it's up to five years in prison
furthermore when they reported they
mustn't tell the client they have
reported that there mustn't be any
what's called tipping off other was of
course they the client will begin to the
gonna conceal matters they would have
been warned expertise and competence I
think I've touched on and the examples
insurance company what about the credit
rating of the client it's all very well
arranging a fee but if the client looks
as though it's you know very high
current liabilities very low current
assets how's it going to pay the theme
we don't want that Dan so wouldn't we be
just a bit stupid if has auditors we
didn't foresee a bad debt problem in a
client when we would have lots of
information potentially available to us
now we also have to communicate with the
present auditors why are they not going
to be the current auditors anymore and
there's two reasons which we have
mentioned it in in the past one is the
present auditors have resigned secondly
the president others are being sacked
both situations might be innocent you
might resign because the client has
grown you you might be essentially
sacked because the company wants or has
a deliberate policy of changing its
auditors every 10 years perhaps because
I think that cuts down the familiarity
risk and is allowing fresh pairs of eyes
to come in and to do the audit but
always in a back in mind you're worried
the present auditors are resigning
because they
have lost trust in the directors they
think is a fraud going on that the
directors are concealing or perhaps they
have been sacked by the company because
he auditors are too good they keep
picking away they keep wanting to see a
contract and so on they keep insisting
that Accounting Standards are adhered to
when really the client would rather
manipulate profits in a in a much easier
way
here is the way in which you were
supposed to communicate with the
existing auditors or the outgoing
auditors it's a bit of a kind of dance
of kind of good manners and etiquette
here so if you're approached by a client
and this is the first audit then you
obviously can't communicate with
previous auditors you have to make your
own mind up about the integrity of the
directors if it's not the first order to
orde it then it will be previous
auditors and first of all you have to
ask permission from the client to
contact the outgoing order term and if
the client refuses essentially that's
the end of the matter you're not going
to go any further because the
presumption is that the client is
refusing because they're covering up
some some some difficulty you are given
her permission to write to the outgoing
auditor but then of course
confidentiality rules mean that the abbé
going auditor countries right back to
you and say yes the fine or lower things
there's been a problem in the past
they're bound by confidentiality and
they have to get permission from there
in a way hold client to write back to
you and again if the potential client
doesn't give permission to the old
auditors to write that's an end of it
the potential client is trying to you
know put a clamp on the communication to
stop the communication working and you
presume the worst
what you hope for is that the relevant
information will be provided you hope
that the old order tool will write back
to say there is no particular reason why
we're resigning
we have no particular suspicions with no
particular difficulty maybe with the
client and that's pretty much a green
light for you to go if they don't write
back or perhaps you think they're
writing back using slightly cagey a
words and so on then you might get a
little bit worried and you have to work
a bit harder to try to find out missing
information in other ways so we've gone
through the process now we've looked at
whether or not we take what they take on
the client we've got kind of the no
worrying signs from the external for me
outgoing orator
the next thing we do is to send out an
engagement letter and the way to think
about an engagement letter is it
essentially is a contract between the
auditor and the client what the auditor
will do around what they order to
expects the client to do to do and if
this isn't set out in a kind of contract
at the start then the chances are that
further down the road when you're in the
middle of the audit the client says oh I
didn't know I had to do that or I didn't
know I had to show you the board minutes
so and if you haven't agreed all of this
in the engagement letter then you are in
a relatively weak position so what the
engagement that it will do we will
define the auditors and management's
responsibilities it will say that
management is responsible for preparing
the financial statements management is
responsible for implementing a good
system of internal control management is
responsible for preventing and detecting
fraud our responsibility of as auditors
is to audit the financial statements
the letter provides written evidence so
far acceptance so people know now they
have an auditor and will be sent to the
the Board of Directors or the Audit
Committee and all the audit committee
prior to the first audit so before we
kind of go in through the door the
contract is in place the may in some
cases be additional reports required an
additional to the audit report and if so
some some some businesses require may be
in a travel business they require some
sort of report about the liquidity of
the business so in holidaymakers aren't
going to be stranded somewhere when the
holiday company fails but that will be
agreed in advance with an engagement
letter other matters we would say we
would explain to management the nature
or the objectives of the audit is to
give a true and fair view who did
explain to auto to see whether we can
give it the financial statements give it
true and fair view we would explain to
two managers that the order will be
carried out under test basis we're not
going to look at everything we're not
going to give absolute assurance when
you're going to give reasonable
assurance we're not going to detect
every potential fraud which is there we
will be looking suffering on a sample
basis and quite often that sample basis
is a relatively small proportion of the
transactions it will say to directors we
expect unrestricted access to all
records we also expect complete answers
to all our questions at all explanations
must be given when we ask them
confidentiality of reports are quite
interesting again we've kind of hinted
to that because the order report at the
top said to the members and I emphasized
that this audit report was not for the
bank and off from supplies it was tula
members what we're doing in the letter
of engagement engagement letter is to
say to the directors this order report
is for the members you are not to be
kind of show
to potential investors or showing it to
the bank or suppliers and so on if you
want us to prepare something for the
bank we will do that but it's not the
function of the order to do that and you
don't have our permission to send this
with a loan application to support that
application it's as I said it I mean
it's slightly slightly peculiar because
the financial statements in the order
report are public documents and of
course the bank will ask for a set of
financial statements and they will see
the ordered report in there but as I
said before the order report is we try
to keep it a private matter between the
auditors and the members other people
you can't stop them looking at it but
it's kind of at their own risk
either saying about the applicable
reporting framework is is IFRS a--'s and
so on it says something about the
planning this would be negotiated with
the client when we'll come on our
various visits we need to know when the
client needs the order to be finished by
sometimes if the client is a subsidiary
of another company then you have to make
sure all the timetables work so that the
group accounts can be prepared on time
it will be thinking perhaps how many
people we need for the various visits to
the client we will be thinking how many
factories is Atlanta how many offices
has a client how many of these do need
to visit and tender like fees I think
I've mentioned and the final thing that
we set out in many engagement letters is
the role to be played by internal audit
internal audit are employees of the
company and one of the main tasks is to
look at a system of internal control
assess whether it's working
to test documents to make sure the
internal control regulations are being
followed and relying an internal audit
can be a great help to external auditors
it's quite common if you had let's say a
chain of shops with ten branches maybe
for the external auditors to visit
all of those and look at the stock takes
at four of them examinee the banking's
from the till in four of them and for
the other six to examine by internal
audit and then next year you move around
you you you visit a different four and
so on
it keeps down the cost to the client
really that we will be talking later
about the sort of things we need to
consider when relying on internal audit
but they are can be very useful at
performing routine parts of the audit we
will investigate and review what they've
done to make sure the work has been done
properly but these people are in a way
experts in the company and they can
carry out some of these tests very
efficiently indeed
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