Question

Auditing standards require that audit firmsinvestigate a prospective client (i.e. new client) priorto accepting an engagement. One of the procedures that the successor auditor should carry out to investigate a prospective client is to communicate with the predecessor auditor.

Auditing standards also state that the auditor should establish an understanding with the audit client about the terms of the engagement and should document the understanding through a written communication with the client by means of an engagement letter.

Rodent Limited has been using Fair & Co as its auditor for more than seven years. The company’s management has recently approached your firm to act as the company’s auditor for the year ending 31 December 2020.

Required:

(a) What information should your firm, as the successor auditor, inquire of Fair & Co, the predecessor auditor, before you consider if you could accept the audit engagement?

(b) Why is the understanding mentioned above so important?

(c) What terms should be included in the engagement letter if you have decided to accept the audit engagement?

(d) In establishing the terms of the audit engagement, what topics should be discussed?

Answer 1

Question (a): What information should your firm, as the successor auditor, inquire of Fair & Co, the predecessor auditor, before you consider if you could accept the audit engagement?

Answer (a):

1. Inquiry of the predecessor auditor is a necessary procedure because the predecessor auditor may be able to provide information that will assist the successor auditor in determining whether to accept the engagement.

2. The successor auditor should make specific and reasonable inquiries of the predecessor auditor regarding matters that will assist the successor auditor in determining whether to accept the engagement.

Matters subject to inquiry should include

• Information that might bear on the integrity of management.

• Disagreements with management as to accounting principles, auditing procedures, or other similarly significant matters.

• Communications to audit committees or others with equivalent authority and responsibility regarding fraud, illegal acts by clients, and internal-control-related matters.

• The predecessor auditor's understanding as to the reasons for the change of auditors.

• The predecessor auditor's understanding of the nature of the company's relationships and transactions with related parties and significant unusual transactions.

Question (b) Why is the understanding mentioned above is so important?

Answer (b)

  Inquiry of the predecessor auditor is a important procedure because the predecessor auditor may be able to provide information that will assist the successor auditor in determining whether to accept the engagement.

The successor auditor should bear in mind that, among other things, the predecessor auditor and the client may have disagreed about accounting principles, auditing procedures, or similarly significant matters.

Question (c) What terms should be included in the engagement letter if you have decided to accept the audit engagement?

Answer (c):

1. Identification: You should properly identify who will receive your services. It may be an individual, a group, an entity, or a portion of an entity—it’s important to specify.

2. Scope of Services: Scope of services is probably the most important part of the entire engagement letter. By including your scope of services you help mitigate scope creep and guards against the client developing unreasonable expectations about the services to be performed.

3.Period of Engagement:Specify when the engagement will begin and end. You can also include expected delivery dates if there’s a specific deliverable (ex. an audit).

4. Fee Structure: Detail how much and how often the client will be billed. It’s advisable to also add in what will happen should the client request extra services not covered by the engagement letter

You may include a clause that specifies what happens in the case of late payment. It can be a late fee or suspension of service.

5. Responsibilities: In most engagements, the client is responsible for specific actions and to provide certain information or records. Be specific with what the client’s responsibilities are and state what information you are relying on the client for in order to fulfill the service.

6. Professional standards: The conduct of this engagement in accordance with the standards and ethical requirements.

7. Confirmation of Terms:  The bottom of your engagement letter should include the confirmation of terms which verifies that the client understands the business contract.

Question (d): In establishing the terms of the audit engagement, what topics should be discussed?

In establishing the terms of the engagement, three topics must be covered as mentioned below:

1.The engagement letter;

2.Using the work of the internal auditors; and

3.The role of the audit committee.