Question

Company A is a manufacturer of gaming machines. In a recent investigation by the Corruption Agency that they have been alleged to offer incentives to the members of the parliament to support a proposed bill which would allow increased number of gaming machines in licensed premises. However, there are still no charges to the company. The auditors of Company A were changed during the current year. The executive director of Company A was not happy with the change as the previous auditors had been auditing the company for the past 15 years. The director believes that a lot of time would be wasted in getting the new auditors to understand the systems and processes of the company. Required: Your audit partner has been just approached to accept the audit engagement of Company A. Outline the ethical, legal and other factors to be considered in the decision to accept the audit engagement for the current year and also outline possible steps which are necessary prior to the appointment.

Answer 1

Following are the ethical, legal and other factors to be considered while accepting the Engagement
the AICPA recommended the use of an engagement risk approach in client acceptance/retention decisions. Engagement risk consists of three components:
1 client business risk-the risk associated with the client’s survival and profitability;
2 audit risk-the risk that the auditor may unknowingly fail to appropriately modify his opinion on financial statements that are materially misstated; and
3 auditor business risk-the risk of potential litigation costs from an alleged audit failure and the risk of other costs such as fee realization and reputational effects.
Much of the examination of factors that would affect audit risk are actually occurring in the preengagement process. Client business risk, audit risk, and auditor business risk are included in the written risk assessment policies of the Big 5.
Steps for Accepting the Engagement
Boynton Johnson, and Kell outline a six-step process in deciding whether to accept an engagement:
1 evaluating the integrity of managment --material errors and irregularities (and fraud) are more likely when management is dishonest. How does the auditor get data on management’s honesty?
2 identifying special circumstances and unusual risks --here the auditor focuses on identifying the intended users of financial statements. The auditor’s legal liability exposure may vary based on the intended statement users, especially under common law negligence.
those client firms which face potential significant legal claims and/or financial distress raise the probability of an auditor lawsuit. The auditor should talk to management and creditors, review credit reports, and filings with regulatory agencies. --the auditor should also look for the absence or poor quality of accounting records, weak internal controls, and restrictions imposed by the client on the auditor.
3 assessing competence to perform the audit AU section 150.02--first general standard.
a)which personnel will be assigned to the audit?
The answer to this question determines the amount and type of supervision necessary. The nature of the auditee and its business will affect staffing decisions.
*consultants and specialists should be used by the auditor when needed.
*can the specialist’s work effect the type of audit report issued?

4 evaluate independence
*look at the second general standard of GAAS
*Rule 101 of the Code of Conduct requires and defines independence
5determine the auditor’s ability to use due care
*consider the third general standard of GAAS
*Two factors to consider in assessing the ability to use due care:

   A)The timing of the appointment
*the earlier the appointment for the engagement the better for the auditor. It leaves more time for planning.
*auditor business risk may be increased by acceptance of an engagement near or after the close of the client’s fiscal year.
   B)The scheduling of field work
*interim work done 3 to 4 months before the end of a client’s fiscal year greatly assists the auditor in planning audit procedures
*good audit planning necessitates the use of a time budget. Estimated hours for each staff member should be in the time budget. This also allows preparation of an estimated audit fee. The deployment of client personnel can have a noticeable influence on client audit fees.

6 preparing the engagement letter
GAAS does not require engagement letters. Why bother? An engagement letter is a contract between the auditor and client. The specific terms should be set down on paper:
1)the financial statements to be audited
2)the purpose of the audit
3)the professional standards to be followed by the auditor
4)wording related to the nature and scope of the audit
5)a clear statement that the audit may not detect all irregularities
6)the legal duties of accountants to report illegal client acts should be noted
7)apprising management that it is responsible for the preparation of the financial statements and the maintenance of internal controls
8)the basis on which fees will be computed and any billing arrangements
9)a request for the client to confirm the terms of the engagement by signing and returning a copy of the letter to the auditor