Question

Conglomerate public limited company is a listed company that operates in the building and manufacturing industries. During the last Annual General Meeting (AGM), the company passed an ordinary resolution to remove its external auditors for non-performance and impairment of independence and objectivity. At the same AGM, the shareholders of Conglomerate public limited appointed your firm (Raven & Co) as its next auditors after a competitive tendering process.
	Required:
	a.	As the audit engagement partner of Raven & Co, draft a Letter of Engagement to Conglomerate public Limited explaining seven matters that you would include in the Engagement Letter before the commencement of the audit assignment.
	b.	Explain the purpose of an Engagement Letter and when it should be sent out.
You are an audit manager working for Scott & Co, a firm of Chartered Certified Accountants based in Bradford. Your speciality is in the audit of companies in the Brand Design and Consultancy industry. Some issues have recently arisen in relation to a client which require your immediate attention. Track One Ltd is a large, private company which is currently owned by the Wittington family, who hold the majority of the company’s shares. Following the completion of the audit this year, the finance director and a family member, Mark Wittington, contacted you and told you that the family is considering listing the company on the London Stock Exchange (LSE). They would like to recruit one of your audit partners for a fivemonth period to help prepare for the listing. Since the board is concerned that the necessary skills and personnel to support the listing are not currently present within the company, Mark Wittington has also requested that your firm assist them in identifying and recruiting new members to the board. [CONTINUED] Currently, most of the executive director roles are performed by family members, except for the directors of operations and human resources, who are both longserving employees. The board does not have an audit committee and there is only one non-executive director, who works elsewhere as a Branding consultant. Other than the recruitment of new board members, Track One Ltd is not planning to make any changes to its governance structure prior to or subsequent to listing on the LSE. Track One Ltd’s current financial year ends on 31 December 2019, and audit planning is scheduled to take place in October 2020.
	Required:
	c.	Critically evaluate the ethical issues and professional matters in relation to the recruitment requests made by Track One Ltd.
Auditors must obtain sufficient appropriate audit evidence to issue an audit opinion on the financial statements. In order to gain that evidence, auditors may use a combination of tests of controls and substantive procedures.
	Required:
	d.	Discuss a test of control and a substantive procedure. Give at least one example of each that may be used when auditing the completeness of corporate payroll system.

Answer 1

(b) Engagement letter is essentially a legal document which contains the agreement between auditor and auditee and contains the scope of audit, limitations and responsibilities of both auditor and auditee. Professional standards require that before an audit is initiated, an engagement letter containing scope of audit, responsibilities, fees, limitations should be documented and signed.

(a) Following is the engagement letter-

To Mr. X,

Managing Director of the Company,

Address.

Dear sir,

This letter will confirm the terms and limitations of the audit services our firm has agreed to perform for Conglomerate Public Limited for the year ending (Balance Sheet Date).

We will audit the balance sheet of Conglomerate Public Limited as of (Balance Sheet Date), and the related consolidated statements of income, retained earnings (deficit), and cash flows for the year then ended, for the purpose of expressing an opinion on them.

The financial statements are the responsibility of the Company management. Encompassed in that responsibility is the establishment and maintenance of effective internal control over financial reporting, the establishment and maintenance of proper accounting records, the selection of appropriate accounting principles, the safeguarding of assets and compliance with relevant laws and regulations. Management is also responsible for making all financial records and related information available to us.

Our responsibility is to express an opinion on the financial statements based on our audit and is limited to the period covered by our audit. If circumstances preclude us from issuing an unqualified opinion, we will discuss the reasons with you in advance. If, for any reason, we are unable to complete the audit or are unable to form or have not formed an opinion, we may decline to express an opinion or decline to issue a report as a result of the engagement.

We will conduct our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The term “reasonable assurance” implies a risk that material monetary misstatements may remain undetected and precludes our guaranteeing the accuracy and completeness of the financial statements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

Our procedures will include obtaining an understanding of the company’s internal control structure and testing those controls to the extent we believe necessary. Our procedures will include tests of documentary evidence supporting the transactions recorded in the accounts, tests of physical inventories and direct confirmation of receivables and certain other assets and liabilities by correspondence with selected customers, creditors, legal counsel, and banks. At the conclusion of our audit, we will request certain written representations from you about the financial statements and matters related thereto.

Although the audit is designed to provide reasonable assurance of detecting errors and irregularities that are material to the financial statements, it is not designed and cannot be relied upon to disclose all fraud, theft, embezzlements or other illegal or dishonest acts. However, we will inform you of any material errors, and all irregularities or illegal acts, unless they are clearly inconsequential, that come to our attention.

If you intend to publish or otherwise reproduce the financial statements and make reference to our firm, you agree to provide us with printers' proofs or masters for our review and approval before printing. You also agree to provide us with a copy of the final reproduced material for our approval before it is distributed.

The working papers for this engagement are the property of (Firm Name) and constitute confidential information and will be retained by us in accordance with our policies and procedures.

If any dispute arises (between/among) the parties hereto, the parties agree first to try in good faith to settle the dispute through non-binding mediation. The costs of mediation shall be shared equally by the parties.

Our fees will be billed as work progresses and are based on the amount of time required plus outof-pocket expenses. Invoices are payable upon presentation. We will notify you immediately of any circumstances we encounter that could significantly affect our initial estimate of total fees, which will range from $XX,XXX to $XX,XXX.

This Agreement is fully and voluntarily entered into by the Parties. Each Party states that he, she, or it has read this Agreement, has obtained advice of counsel if he, she, or it so desired, understands all of this Agreement, and executes this Agreement voluntarily and of his, her, or its own free will and accord with full knowledge of the legal significance and consequences of this Agreement.

If this letter correctly expresses your understanding, please sign the enclosed copy where indicated and return it to us. We appreciate the opportunity to serve you and trust that our association will be a long and pleasant one.

Sincerely,

______________________________

Signed on behalf of Raven & C0

ACCEPTED AND AGREED TO BY:

Conglomerate Public Limited

Date: ____________________

[Client Signature]

7 matters to be included are-

a. Scope of work

b. Limitations of work

c. Responsibility of each party

d. Nature and method of work by auditor

e. Confidentiality clause

f. Fees

g. Dispute resolution mechanism

C. Auditing professional standards require an auditor to be an indepdent and impartial during conduct of this work. ISA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing contains requirement of indepdence of an auditor.

Auditor independence refers to the independence of the external auditor. It is characterised by integrity and an objective approach to the audit process. Standard provides that an auditor must also be perceived to be an independent in his approach.

With entering into loan staff arrangement, auditor shall end up in a position where auditor will audit his own work which shall impair the auditors independence.

D. Control testing and Substantive testing are two method employed by an auditor as part of his audit execution.

A  test of controls is an audit procedure to test the effectiveness of a control used by a client entity to prevent or detect material misstatements. Depending on the results of this test, auditors may choose to rely upon a client's system of controls as part of their auditing activities. e.g. In sales testing, controls to be tested may include- seggregation of duty, 3 way match between invocie, purchase order and delivery note, invoice date should be after PO. Invoice quantity should not exceed the PO quantity etc.

A substantive procedure is a process, step, or test that creates conclusive evidence regarding the completeness, existence, disclosure, rights, or valuation (the five audit assertions) of assets and/or accounts on the financial statements. example- Cut-off analysis of inventory to test completeness of inventory listing and re-computation of inventory valuation and comparison with recorded value to identify differences, if any.