The Stages of an Audit – Appointment - ACCA Audit and Assurance (AA)

Summary

This 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

00:00

🔍 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.

05:03

🕵️‍♂️ 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.

10:06

📜 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.

15:07

📝 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.

Keywords

💡Audit

An audit refers to the systematic examination and verification of financial records, typically by an independent third party, to ensure accuracy and compliance with relevant accounting standards. In the context of the video, the audit process is central to the discussion, with emphasis on the considerations an auditor must make before accepting an audit assignment, such as evaluating the potential risks and ensuring ethical standards are met.

💡Ethical Principles

Ethical principles are the fundamental guidelines that govern the conduct of professionals, including auditors. They ensure that decisions and actions are made with integrity and in the best interest of all stakeholders. The script discusses how auditors must consider ethical threats, such as familiarity with the client, which could compromise their objectivity and independence.

💡Threats to Objectivity

Threats to objectivity encompass any situation or relationship that could potentially compromise an auditor's impartiality. The video script mentions self-interest threats, such as when a significant portion of an auditor's income is derived from a single client, which could influence their judgment and willingness to critically assess the client's financial statements.

💡Acceptance Procedures

Acceptance procedures are the steps an auditor takes to evaluate whether to accept an audit engagement. This includes assessing professional qualifications, legal requirements, and ethical considerations. The script highlights the importance of these procedures in ensuring that auditors are equipped to perform the audit to a professional standard and without conflicts of interest.

💡Professional Competence

Professional competence refers to the skills, knowledge, and expertise required to perform an audit effectively. The video emphasizes the need for auditors to possess the necessary qualifications and experience, particularly when dealing with complex industries or accounting standards, to ensure a high-quality audit.

💡Due Care

Due care is the obligation of auditors to exercise a reasonable level of care, diligence, and professionalism in performing their duties. It involves thoroughness in the audit process and a commitment to identifying and addressing potential issues. The script suggests that auditors must consider their ability to provide due care when deciding whether to accept an audit engagement.

💡Resources and Time Management

Resources and time management pertain to the availability of adequate staff and the efficient allocation of time to complete an audit. The video script points out that auditors must ensure they have the capacity to undertake an audit without compromising the quality of service to existing clients or risking damage to their reputation.

💡Low-balling

Low-balling is the practice of quoting an unreasonably low fee to win an audit engagement, possibly with the expectation of securing additional business later. The script warns against this tactic, as it could lead to a situation where the auditor is under pressure to cut corners to meet the low fee, potentially compromising the audit quality.

💡Investigating Directors

Investigating directors involves scrutinizing the backgrounds and histories of company directors to assess potential risks associated with engaging in business with them. The video script illustrates this with an example of avoiding associations with directors who have a history of unethical business practices, such as repeated company liquidations.

💡Engagement Letter

An engagement letter is a formal document that outlines the terms of the audit engagement, including the responsibilities of both the auditor and the client. The script explains that this letter serves as a contract, clarifying expectations and reducing the risk of misunderstandings or disputes during the audit process.

💡Internal Audit

Internal audit refers to the evaluation of a company's internal controls and financial processes by its own employees. The video script discusses how external auditors may rely on the work of internal audit to perform certain routine parts of the audit, which can be efficient and cost-effective, provided that the external auditors verify the quality and accuracy of the internal audit work.

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