2.1 Engagement Planning and Client Acceptance
6 min read•august 13, 2024
Engagement planning and client acceptance are crucial steps in the audit process. They involve understanding the client's business, assessing risks, and deciding whether to take on or continue an engagement. These steps set the foundation for a successful audit.
Auditors must carefully evaluate potential clients, considering factors like management integrity, financial condition, and industry risks. This process helps manage and ensures the firm can perform a quality audit while complying with professional standards.
Audit Engagement Planning Process
Understanding the Client and Assessing Risks
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- The audit engagement planning process involves obtaining an understanding of the client's business, industry, and environment to assess risks and determine the nature, timing, and extent of audit procedures
- Auditors should consider the client's business operations, including the nature of its products or services, key customers and suppliers, and the competitive environment in which it operates
- The auditor should evaluate the client's financial condition, including its profitability, liquidity, and solvency, as well as any significant transactions or events that may affect the financial statements
- The auditor should assess the competence and integrity of management and those charged with governance, including their reputation, past experience with the client, and any indications of management bias or fraud
- The auditor should consider the client's internal control environment, including the design and operating effectiveness of key controls over financial reporting
Developing the Audit Strategy and Plan
- Auditors must establish an overall audit strategy that sets the scope, timing, and direction of the audit, and guides the development of the
- The audit plan is more detailed than the overall strategy and includes the nature, timing, and extent of planned risk assessment procedures, further audit procedures at the assertion level, and other planned audit procedures required to be carried out for the engagement to comply with auditing standards
- Auditors must determine levels for the financial statements as a whole and performance materiality levels for particular classes of transactions, account balances, or disclosures
- members should discuss the susceptibility of the entity's financial statements to material misstatement and the application of the applicable financial reporting framework to the entity's facts and circumstances
- The audit plan should be tailored to the specific risks identified during the planning process and should be updated as necessary throughout the engagement based on new information or changes in circumstances
Client Acceptance and Continuance
Evaluating Audit Risk and Firm Resources
- Client acceptance and continuance decisions are critical to managing audit risk and ensuring that the auditor can perform a quality audit in compliance with professional standards
- Accepting or continuing an engagement with a high-risk client may expose the audit firm to legal liability, reputational damage, and regulatory sanctions
- The auditor should consider whether there are any reasons, such as issues or resource constraints, that would prevent the firm from accepting or continuing the engagement
- Auditors should evaluate whether the firm has the necessary competence, capabilities, and resources to perform the engagement in accordance with professional standards and applicable legal and regulatory requirements
- The auditor should assess the firm's ability to complete the engagement within the reporting deadline, considering the availability of personnel with the necessary skills and knowledge, as well as any potential conflicts of interest or other impediments
Documenting Client Acceptance and Continuance Decisions
- Client acceptance and continuance decisions should be documented in accordance with the firm's quality control policies and procedures
- Documentation should include the factors considered in assessing client risk and integrity, as well as the basis for the firm's decision to accept or continue the engagement
- The documentation should be reviewed and approved by appropriate firm personnel, such as the engagement partner or the firm's risk management committee
- The documentation should be retained in accordance with the firm's record retention policies and made available for inspection by regulatory authorities or peer reviewers
- If the firm decides to withdraw from an engagement or decline a potential client, the reasons for the decision should be clearly documented and communicated to the client or prospective client in writing
Assessing Client Risk and Integrity
Evaluating Management and Governance
- The auditor should assess the competence and integrity of management and those charged with governance, including their reputation, past experience with the client, and any indications of management bias or fraud
- Auditors should consider management's philosophy and operating style, as well as their commitment to ethical values and effective corporate governance
- The auditor should evaluate the qualifications, experience, and stability of key management personnel, as well as the effectiveness of the board of directors and audit committee in overseeing financial reporting and internal controls
- Auditors should inquire about any significant changes in management or the board of directors, as well as any known instances of management fraud or illegal acts
- The auditor should consider the client's relationships and transactions with related parties, as well as any significant unusual transactions or complex accounting issues that may increase audit risk
Assessing the Client's Business and Financial Condition
- The auditor should consider the client's business operations, including the nature of its products or services, key customers and suppliers, and the competitive environment in which it operates (e.g., market share, pricing strategies, regulatory environment)
- Auditors should evaluate the client's financial condition, including its profitability, liquidity, and solvency, as well as any significant transactions or events that may affect the financial statements (e.g., mergers, acquisitions, restructurings)
- The auditor should assess the client's vulnerability to economic, industry, or regulatory risks, as well as its ability to continue as a going concern
- Auditors should consider the client's growth strategies, financing arrangements, and capital structure, as well as any off-balance sheet transactions or contingent liabilities that may impact financial reporting
- The auditor should evaluate the client's information systems and technology, including the reliability and security of data processing and storage, as well as the effectiveness of IT general controls and application controls
Engagement Letter Elements and Purpose
Key Components of an Engagement Letter
- An is a written agreement between the auditor and the client that documents the terms of the audit engagement, including the objectives, scope, and responsibilities of both parties
- The engagement letter should identify the applicable financial reporting framework for the preparation of the financial statements (e.g., IFRS, U.S. GAAP) and the expected form and content of any reports to be issued by the auditor (e.g., audit report, management letter)
- The letter should describe the responsibilities of management for preparing the financial statements, maintaining effective internal controls, providing the auditor with access to all relevant information, and responding to the auditor's inquiries
- The engagement letter should specify the auditor's responsibilities for conducting the audit in accordance with professional standards, communicating significant matters arising from the audit, and providing reasonable assurance about whether the financial statements are free from material misstatement
- The letter may also include other matters, such as the involvement of other auditors or experts (e.g., IT specialists, tax professionals), the use of a specialist, or the application of specific audit procedures to address identified risks (e.g., forensic procedures, confirmations)
Importance of the Engagement Letter
- The purpose of the engagement letter is to ensure that there is a clear understanding between the auditor and the client regarding the terms of the engagement, to minimize misunderstandings, and to provide a basis for communication throughout the audit process
- The engagement letter helps to establish the expectations and responsibilities of both parties, reducing the risk of disputes or disagreements later in the engagement
- The letter serves as a contract between the auditor and the client, providing legal protection to both parties in the event of a dispute or legal action
- The engagement letter helps to ensure compliance with professional standards, such as independence requirements and quality control procedures, by documenting the terms of the engagement and the auditor's responsibilities
- The letter can be used as a reference point throughout the audit, helping the engagement team to stay focused on the agreed-upon scope and objectives of the audit and to communicate effectively with management and those charged with governance
Key Terms to Review (18)
Appropriate Evidence: Appropriate evidence refers to the information collected during an audit that is both relevant and reliable, which supports the auditor's conclusions and opinions. The quality of this evidence is critical, as it influences the effectiveness and credibility of the audit process. Auditors must gather appropriate evidence to assess risks, test controls, and verify financial statement assertions, ensuring that their findings are substantiated by sound data.
Audit Partner: An audit partner is a senior-level accountant responsible for overseeing the audit process of a client’s financial statements, ensuring compliance with regulations and standards. This role is pivotal in engagement planning and client acceptance as the audit partner is accountable for the overall quality and integrity of the audit, leading the team, making key decisions, and maintaining the relationship with the client throughout the audit cycle.
Audit plan: An audit plan is a detailed strategy that outlines the objectives, scope, and procedures of an audit engagement, ensuring that the audit is conducted efficiently and effectively. It serves as a roadmap for the audit process, guiding auditors on how to allocate resources, manage risks, and address significant areas of concern throughout the engagement. A well-structured audit plan helps to align the auditors' efforts with the client's specific needs and regulatory requirements.
Audit risk: Audit risk is the risk that an auditor may issue an inappropriate opinion on financial statements that are materially misstated. This concept highlights the uncertainty inherent in the auditing process, as it acknowledges that errors or fraud might go undetected due to various factors such as judgment, estimation, and the effectiveness of internal controls.
Conflict of Interest: A conflict of interest arises when an individual or organization has competing interests or loyalties that could potentially influence their decision-making or actions. This situation can lead to biased judgments, eroding trust and integrity, especially in professional settings where impartiality is crucial.
Control Risk: Control risk is the risk that a client’s internal controls will not prevent or detect material misstatements in the financial statements. Understanding control risk is essential for auditors as it helps them determine the extent and nature of audit procedures needed to assess the reliability of financial reporting and the effectiveness of internal controls.
Due Diligence: Due diligence refers to the comprehensive investigation and evaluation process that auditors undertake to ensure they are fully informed about a client's financial situation, operations, and risks before accepting an engagement or performing an audit. This careful assessment helps auditors identify any potential issues, understand the client's business environment, and develop an appropriate audit strategy.
Engagement Letter: An engagement letter is a formal agreement between an auditor and a client that outlines the scope, objectives, and terms of the audit services to be provided. It serves as a crucial document that sets clear expectations for both parties, detailing the responsibilities of the auditor and the client while also addressing any limitations and legal considerations involved in the audit process.
Engagement Team: An engagement team refers to a group of professionals assigned to carry out an audit, review, or other assurance service for a client. This team usually consists of auditors with varying levels of experience and expertise, working collaboratively to ensure that the client's financial statements are accurately represented. The composition and size of the engagement team can vary based on the complexity of the client's operations and the scope of the engagement.
Financial Statement Audit: A financial statement audit is an independent examination of an organization’s financial statements and accompanying disclosures, conducted to ensure their accuracy and adherence to generally accepted accounting principles (GAAP). This type of audit helps stakeholders, including investors and regulators, gain confidence in the integrity of the financial information presented by the organization. It plays a critical role in enhancing transparency and accountability in financial reporting.
Generally Accepted Auditing Standards (GAAS): Generally Accepted Auditing Standards (GAAS) are a set of guidelines established to ensure the quality and consistency of audit engagements. These standards provide a framework for auditors to follow during the planning, execution, and reporting phases of an audit, helping to safeguard the integrity of financial statements and increase stakeholder trust.
Independence: Independence in auditing refers to the auditor's ability to remain impartial and objective when conducting an audit, free from any influences that could compromise their judgment. This concept is critical because it ensures that the auditor's findings and opinions are credible and trustworthy, thereby enhancing the reliability of financial statements. Independence relates to various aspects of auditing, including ethical responsibilities, engagement planning, forming audit opinions, and the detection of fraud.
Inherent Risk: Inherent risk refers to the susceptibility of an account balance or class of transactions to misstatement due to error or fraud, assuming there are no related internal controls. It highlights the natural level of risk that exists in the absence of any mitigating factors, such as the effectiveness of a company's internal controls, and is crucial in understanding audit processes and planning.
Internal audit: An internal audit is an independent, objective evaluation of an organization’s operations, risk management, control processes, and governance. It aims to improve the effectiveness of risk management, control, and governance processes while ensuring compliance with laws and regulations. Internal audits play a critical role in enhancing transparency and accountability within organizations, supporting continuous improvement, and providing assurance to management and stakeholders.
International Standards on Auditing (ISA): International Standards on Auditing (ISA) are guidelines established by the International Auditing and Assurance Standards Board (IAASB) that provide a framework for auditing financial statements. These standards aim to enhance the consistency and quality of audits across different jurisdictions, ensuring that auditors conduct their work with a high level of professionalism and integrity.
Materiality: Materiality refers to the significance of financial information and its impact on the decisions made by users of financial statements. It helps auditors determine which misstatements or omissions are likely to influence the economic decisions of users, guiding the scope and focus of an audit.
Sufficient evidence: Sufficient evidence refers to the adequate quantity and quality of information gathered during an audit that supports the auditor's conclusions and opinions. This concept is essential because it ensures that the auditor can provide a reasonable basis for their judgments, whether they are assessing internal controls, compliance with laws, or financial statement assertions. The emphasis on sufficiency highlights the need for auditors to balance the depth of their testing with the overall audit objectives to ensure effective decision-making.
Working papers: Working papers are the documents prepared and used by auditors to support their conclusions and findings during an audit. They serve as a record of the audit process, including the evidence collected, the procedures performed, and the rationale for decisions made. Working papers are essential for engagement planning, gathering audit evidence, documenting procedures, and ensuring quality control.