Accepting an audit
Appointment
Lecture 3
Quick Recap
What is auditing ?
Auditing vs. Accounting
External vs. Internal Audit
International Standards on Auditing
Audit Report
◦ Unqualified
◦ Qualified
Non compliance with one of GAAP’s
Limitation of scope
Types of Audit
◦ Financial
◦ Operational
◦ Management
Objectives of Auditing
◦ Primary Objective
Expression of Independent opinion
◦ Secondary Objective
Detection of Fraud
Prevention of Fraud
◦ Implied Objective (advantages of Audit)
Moral Check
Implementation of accounting procedures
Credibility of Financial statements
Compliance of statutory requirements
Share holders satisfaction
Prevention of disputes among partners
Advice from auditor
Attraction for investors
Economic development
Type of Financial Audit
Continuous Audit
Interim Audit
Final Audit
Audit Process Model
Phase I - Client Acceptance
Phase II - Planning
Phase III - Testing and Evidence
Phase IV - Evaluation and Judgment
Phase I Client Acceptance
The client acceptance phase of the audit plan,
Phase I, involves deciding whether to accept a
new client or continue with an existing one.
Procedures: (1) Evaluate the client's background
and reasons for the audit. (2) Determine
whether the auditor is able to meet the ethical
requirements regarding the client. (3)
Determine need for other professionals. (4)
Communicate with predecessor auditor; (5)
Prepare client proposal. (6) Select staff to
perform the audit, and (7) Obtain an
engagement letter.
Steps in Accepting an Audit Engagement
Client Screening
ISA315 Identifying and Assessing risks of
Material misstatements through
understanding the entity and its environment
requires auditors to obtain a knowledge of
the client’s business, sufficient to enable
them to identify and understand those issues
that may have significant impact on financial
statements.
Client Screening
Knowledge on the following areas will usually
be required:
General economic factors
Industry conditions
Entity itself
Entity’s products, market, suppliers etc.,
Its financial performance and condition
Reporting requirement
Management Integrity
Communication with the Predecessor Auditor
Make inquiries of other third parties
Review previous experience with existing
clients
◦ Knowledge of critical success factors & competition
Client background checks
◦ Previous bankruptcy
◦ Previous convictions
◦ Suspected ties to organized crime
Industry experience
Identify Special Circumstances and
Unusual Risks
Focus on the auditor’s business risks
Identify intended users of audited statements
◦ Purchase and sale of business
Assess prospective client’s legal and financial
stability
◦ Client’s need for capital
Identify scope limitations
Evaluate the entity’s financial reporting
systems and auditability
◦ Inadequate internal controls
Assess Competence to
Perform the Audit
Services desired
Identify the audit team
Need for consultation and use of specialists
Trend in industry specialization
Overview of Business Cycle
Figure 7-4
Understanding the
Business and Industry
The clients business risks are strongly
correlated with the auditor audit risk.
Do audit tests ensure that the entity’s
outcomes associated with business risks are
fairly presented in the financial statements?
Understanding the Client’s Business
Figure 7-5
Key Issues What to Understand
Senior Management Does management depend on one or a few key individuals?
How experienced is the entity’s management?
What is management’s attitude toward accepting risks?
How does management delegate authority and responsibility?
What is management’s reputation for integrity and business
ethics?
Management Goals What are management’s primary goals?
and Objectives Obtaining additional market share?
Growth in sales?
Growth in profits?
Growth in operating cash flows?
Growth in market valuation?
Understanding the Client’s Business
Figure 7-5
Key Issues What to Understand
Organizational
Resources
Financial Resources What is the entity’s financial position in terms of cash,
investments, and receivables?
What is the entity’s ability to generate cash flow from
operations and free cash flow?
What is the entity’s ability to gain access to capital markets?
Asset-based Is the entity in a capital-intensive industry?
Resources What tangible assets are needed to generate sales and
profits?
Human Resources How important is the entity’s workforce to its core processes?
Information Do information systems provide reliable and timely
Resources information to support its decision-making needs?
Intangible Resources To what extent does the entity’s performance depend on
research and development, patents, or trademarks?
To what extent does the entity’s performance depend on
customer loyalty?
Understanding the Client’s Business
Figure 7-5
Key Issues What to Understand
Products and
Services, Markets,
Customers, and
Competition
Products and Services What is the entity’s product or service?
Does the entity have a diversified product line or does the
entity rely on the success of a single product or service?
Does the entity plan changes in the product/service mix?
Are products/services in emerging, mature, or in declining
stages of a product life cycle?
Market for Products What is the entity’s product or service?
and Market Share How diversified is the product mix?
What are the entity’s plans for new products or customers?
Is the entity’s product life cycle at emerging, mature, or
declining stages?
What is the entity’s market share?
Who is the Entity’s What advantage does the client have versus the competition?
Competition? Does the entity face competition from new or substitute
products?
Influence of Does the entity face significant regulation of products or
Regulation and services?
Industry Forces What other factors influence industry performance?
Understanding the Client’s Business
Figure 7-5
Key Issues What to Understand
The Entity’s Core
Processes and
Operating Cycle
Core Processes What are the entity’s critical success factors with respect to
innovation and new product/service development?
What are the essential steps in the manufacture of the
entity’s product (or delivery of service)? How does the entity
assess effectiveness and efficiency?
What critical steps must be performed after the sale?
Costs Structure What is the entity’s mix of fixed and variable costs?
How profitable is the entity relative to its competitors?
Operating Cycle What is the entity’s operating cycle? Inventory turnover?
Accounts receivable turnover? Accounts payable turnover?
How much cash is needed to fund the entity’s planned
growth?
Is the entity generating positive cash flow from operations?
The Entity’s
Investing and
Financing Decisions
How Capital is What investments are needed to grow the entity?
Invested
Source of Capital Describe the enity’s sources of financing.
Is the entity generating free cash flow?
Evaluating Independence
Evaluate whether there are any circumstance
that would impair independence
Decision to Accept
Steps in Accepting an Audit Engagement
Engagement Letter
ISA 210 terms of Audit enagagement
Documents the contractual duties agreed
to by the auditor and the client
◦ Description of scope of services to
be provided
◦ Obligation of client’s staff in
assisting auditor
◦ Fee or method of determining fee
◦ Other services to be provided
Items Usually Included in Audit
Engagement Letters
Name of the entity
Statements to be examined
Scope of services, including any
limitations
Type of opinion expected to be issued if
other than unqualified
Disclaimer of responsibility for detecting
fraud
Obligations of the client’s staff to prepare
schedules and statements
Items Usually Included in Audit
Engagement Letters
Requirement that auditors read all
printed material in which the report
appears
Responsibility for preparation or review
of tax returns
Fee or method of determining fee
Provision for client’s acceptance
signature and date
Professional Procedures
Clearance Procedures
◦ Communication with the previous/present auditor
◦ Letter of etiquette
Ethical statement on fees
Conflict of interest between clients
Ownership of books and records
