Acceptance

• Week 3
• Threat to independence


  • Threat
  • Safeguard
• Contingent fees


  Fees based on the level of the profits of the company are not allowed
• Compensation/evaluation


  An audit partner can't be evaluated on or compensated based on their success in selling non audit services to the client
• Litigation


  Depends on the significance of the threat - Discuss with the audit committee, obtain an external review, withdraw from the assignment
• Threats to independence


  • Familiarity - The auditor becomes to sympathetic to, or trusting of, a client and no longer applies professional scepticism
  • Long association
  • Personal relationships
  • Movement of staff between a firm and client
• Long Association


  If not a PLC rotate partner, if PLC audit must be put up for tender every 10 yr, audit partner must be rotated every 7 yr, Independent review
• Family relationships


  Remove the individual from the audit team
• Recruitment


  If a PLC can't provide recruitment services for directors and senior management, if in a position to affect the financial statements
• Employment with an audit client

  If a partner joins a client there must be a set of audited FS that the partner was not involved with
• Threats to independence


  • Advocacy - Promoting the position of the client or representing them in some way
  • Self Review - Auditor will be unlikely to admit to errors in their own work, or may not identify errors in their own work
• Accounting and bookkeeping


  If a PLC not allowed, if not a PLC is allowed if separate teams used and no mgmt decisions are made
• Internal controls


  If a PLC not allowed where the service relates to the financial statements
• Tax services


  If a PLC can't prepare tax calcs for a client, if not a PLC work should be reviewed by someone not involved in the audit
• Tax advice


  Is allowed unless it depends on a particular accounting treatment
• IT services


  OK if unrelated to internal controls or FR
• Valuation services


  Not allowed if material to FS
• Temporary staff assignment


  OK if short, no mgmt responsibility, client supervises their work, loaned member is not part of the audit team
• Corporate finance services


  Use professionals who are not part of the audit team
• Situations where auditor confidentiality is permitted to be breached

  • Disclosure is permitted by law and is authorised by the client
  • Disclosure is required by law eg fraud, theft, tax law, money laundering, insider dealing, health and safety law, employment law & environmental offences
  • There is a professional duty or right to disclose eg to comply with a quality review by a professional body, to respond to an inquiry by a regulatory body
• Conflict of interest


  A conflict of interest arises when the same audit firm is used for 2 companies that interact with each other eg Companies operate in the same market, Companies trade with each other
• Safeguards for conflicts of interest

  • Separate engagement teams are used
  • Procedures put into place to prevent information being leaked
  • Engagement teams sign confidentiality agreements
  • An independent partner regularly reviews safeguards
  • If adequate safeguards can't be put into place, decline or resign from one or more of the assignments
• You are the audit manager responsible for the audit of Broome Co, a listed company. You have been informed by one of the audit juniors that the finance director has offered to take the audit team to a World Cup Final at the expense of the client as a thank you for an efficient audit. The finance director has requested that you attend a social event where the company will outline a new rights issue of ordinary shares to shareholders. The finance director believes that the presence of the external auditor will add credibility to the rights issue and increase the chance of raising the required finance.
• Acceptance


  We should only accept a new client if the risk of the assignment is at an appropriate level
• Acceptance considerations


  • Professional competence
  • Fees
  • Reputation of the client
  • Professional clearance
  • Preconditions for an audit
• Professional clearance


  The prospective firm should ask the client for permission to contact the outgoing auditor, the outgoing auditor should also ask the client for permission to speak to the new auditor, if the client refuses permission the outgoing auditor should notify the prospective auditor of this, if no reply is received from the outgoing auditor should try other means to get a reply, ask for all information relevant to deciding whether or not to accept the appointment, make a decision
• Preconditions for an audit

  Check if the financial reporting framework to be applied to accounts preparation is appropriate, ensure management understand and accept their responsibilities to prepare the financial statements using the applicable financial reporting framework and ensure internal controls are in place to produce accounts which are free from material misstatement, provide auditors with access to relevant information and staff to conduct an effective audit
• Engagement letter


  Details the nature of the contract between the audit firm and the client, must be signed before the audit starts, purpose is to minimise the risk of understandings, confirm acceptance of the audit, sets out the terms and conditions of the engagement
• Main contents of engagement letter


  • Objective and scope
  • Responsibilities
  • Financial reporting framework
  • Form and content of reports
  • Basis of fees
  • Reference to professional standards
  • Need for a written representation letter
  • Limitations of an audit
• Changes to the engagement letter


  The engagement letter should be reviewed each year, a new engagement letter should be issued if the scope or context of the assignment has changed eg there is a change of statutory duties due to new legislation, there is a change in professional duties due to new auditing standards, there are changes to other services requested by the client
• Reissuing the engagement letter

  An auditor may wish to remind the client of the terms of the engagement letter if senior management have changed, there is a change in the ownership of the client, the auditors experience shows the client does not fully understand or appreciate the content/terms of the engagement letter
• Risk


  We begin the audit with a risk assessment, set a preliminary level of materiality, we assess risk by understanding the entity, performing analytical review, professional scepticism will be important
• Audit risk model


  Audit risk = Inherent risk x Control risk x Detection risk
• Risk definitions


  • Audit risk - The risk an auditor expresses an inappropriate audit opinion and includes both the risk of material misstatement and detection risk
  • Risk of material misstatement - The risk that the financial statements are materially misstated before the audit starts
  • Inherent risk - The susceptibility of a material misstatement in the financial statements assuming there were no internal controls
  • Control risk - the risk that a material misstatement is not prevented, detected or corrected by the entities internal controls
  • Detection risk - the risk that the audit does not detect a material misstatement and is comprised of sampling risk and non sampling risk
  • Sampling risk - the risk that the conclusion drawn from the results of a sample are not consistent with the conclusion that would have been made had all items been tested (ie a non representative sample Is picked)
  • Non sampling risk - The risk of drawing the wrong conclusions for other reasons
  • Professional scepticism - A questioning mind, being alert to anything that may indicate a material misstatement and making critical assessments of audit evidence
  • Professional judgement - Making informed decisions using knowledge, training and experience
• Materiality


  Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. Materiality is a subjective matter and should be considered in light of the client's circumstances.
• How is materiality measured?


  • Size - ½ - 1% revenue, 5 - 10% profit before tax, 1 - 2% total assets
  • Nature - Compliance with laws and regulations, Compliance with debt covenants, Turning a profit into a loss, Transactions with directors
  • Performance materiality - set at less than the materiality for the financial statements as a whole to ensure smaller individual misstatements are not ignored when in aggregate they would exceed the materiality threshold
• Risk assessment


  Why perform one? Identify risky areas early in the audit, Plan procedures to address these risky areas, To carry out an efficient audit, To reduce the risk of giving an incorrect opinion, Reduce the risk of reputation damage or fines
• Risk assessment procedures


  • Enquiries with management and the internal audit function
  • Analytical procedures
  • Observation of controls
  • Inspection of strategic documents
• Responses to risk assessment

  • Ensuring we exercise professional scepticism
  • Using more experienced staff to look at complex and risky areas
  • Ensuring there is adequate supervision
  • Including an element of unpredictability in our audit procedures
  • Placing less reliance on controls testing
  • Increasing the level of substantive testing
  • Consult experts where needed
  • Increase the frequency of reviews/checks