Chapter 1. ~ Overview of Audit Process and Pre-engagement Activities CHAPTER 1 OVERVIEW OF AUDIT PROCESS AND PRE-ENGAGEMENT ACTIVITIES TOPIC OVERVIEW: This chapter discusses the definition of audit, phases of audit and the different considerations of auditor in accepting an audit engagement. LEARNING OBJECTIVES: After studying this chapter, you should be able to: 1. Describe what an audit is, 2. Enumerate and describe different phase of an audit. 3. Identify and explain pre-engagement activities, 4._ Identify the different considerations in accepting an audit. AUDIT An audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between these assertions and established criteria and communicating the results thereof. (American Accounting Association) AUDIT PROCESS The audit process is the sequence of different activities involved in an audit. This process normally includes the following steps: 1 PHASE DESCRIPTION [1Pre-engagement | This phase will require a decision from the auditor | | whether or not to accept a new client or continue | relationship with an existing one. This process would | require evaluation not only of the auditor's qualification, | but also the integrity and auditability of the client's | financial statements, | Primary objective: To minimize the likelihood of being | associated to a client whose management lacks integrity | 2.Audit planning | Audit planning involves the development of an overall | audit strategy, audit plan and audit program. The auditor | usually obtained more detailed knowledge about the client’s business and industry in order to understand the transactions and events affecting the financial statements. made during this phase. | | | | | Preliminary assessment of risk and materiality is also L 1Chapter 1 - Overview of Audit Process and Pre- 3. Consideration of internal controls | 4. Evidence: gathering (Substantive testing) |S.Completing the audit | 6.Issuance of the audit report Activities | Primary objective: To ‘assess the el associated with the audit to determine @ soporte fe an and extent of further audit procedures performed arecily affects the! | Since entity's rectly propriate to reliability of the fl study and evaluate these His | ary objective: To estab! rE in determininy engagement internal control nancial statements, controls. ha basis fo1 g the nature, reliance on timing and internal controls, : extent of ee Te planning and iT the ell Using the information ol aul peer ag ternal controls, it determine whether entity's financia} esented fairly in accordance with Substantive procedures standards. A lytical procedures oF test of details of consideration of int substantive test to statements are Pr financial reporting could either be ana transactions and balances. always be performed by the auditor. Primary objective: To ascertain the degree of correspondence between the financial statements prepared by client’s management and the financial reporting framework. With this, the auditor will be able to conclude whether or not the financial statements are presented fairly in accordance with financial reporting standards. Wrapping-up procedures are performed; conclusions reached are reviewed; and an overall opinion is formed during this phase. Primary objective: To assist the auditor in assessing conclusion reached is consistent with evidence gathered In this stage, auditor prepares and issues audit report which describes the scope of the audit and states the auditor’s conclusion regarding the fairness of the financial statements, This phase will Primary objective: To communicate the conclusions | reached by the auditor to various intended users | pecigcoriction of the audit engagement, auditor eo ia procedires that will enable him/her identify engagements, Provement in the current and futur?| Pri i mary objective: To assess and evaluate the quality of | Services delivered by the engagement team —— 2chapter 1 - Overview of Audit Process and Pre-engagement Acti prt- ENGAGEMENT Acceptance of an engagement tn making a decision whether to accept or reject an engagement, an auditor should consider the following: 1, Its competence; 2. Its independence; 3, Its ability to serve the client properly; and 4, The integrity of the prospective client's management. Furthermore, the auditor is expected to perform the following: 1, Obtain a preliminary knowledge of the client’s business and industry to determine whether the auditor has the degree of competence required by the engagement. 2. Consider whether there are any threats to the firm’s independence and objectivity, and if so, whether adequate safeguards can be established. 3. Evaluation of the firm's ability to serve the prospective client. 4. Evaluate auditability. 5. Investigation of the integrity of the client's management through inquiry to appropriate parties or communication with the predecessor auditor. Matters to be discussed with predecessor auditor include the es (RID) The predecessor’s understanding as to the Reasons for change in auditors; b. Information that might bear on the Integrity of the management; and c. Disagreements between the predecessor auditor and management as to accounting principles, auditing procedures, etc. Note: Every time communication is made to parties other than the client, the auditor shall seek permission from the client and document the items discussed. 6. Agree on the terms of the engagement and prepare an engagement letter. Agreeing the Terms of Audit Engagements The auditor and the client shall agree on the terms of engagement. The agreed terms would need to be recorded in an audit engagement letter or other suitable form of contract.Chapter 1 — Overview of Audit Process and Pre-engagement Activities itis in the interest of both clientand the auditor that the auditor sends ay engagement letter, preferably before the commencement of the engagement to hel avoid misunderstandings with respect to the engagement. The engagement letter documents and confirms: a Auditor's acceptance of the engagement b, Objective and scope of the audit Extent of auditor's responsibilities to the client d. Form of any reports Contents of engagement letter (RA FORMS) The form and content of audit engagement letters may vary for each client, but they would generally include reference to: The presence of audit Risk Unrestricted Access to whatever records The financial reporting Framework used Objective of the audit The form of any Reports or other communication Management's responsibility g. The Scope of the audit The auditor may also wish to include in the letter: (FRAP Reports) a. Basis in which Fees are computed and any billing arrangements b. Expectation of receiving Representation letter c. Acknowledgment of management of terms of agreement d. Arrangements regarding the Planning of the audit e. Description of any other letters or Reports When relevant, the following points could also be made: * Arrangements concerning the involvement of other auditors and experts in some aspects of the audit. ¢ Arrangements concerning the involvement of internal auditors and other staff. * Arrangements to be made with the predecessor auditor, if any, in the case of initial. * Any restriction of the auditor's liability when such possibility exists. * Areference to any further agreements between the auditor and the client. Peangee Audit of Components When the auditor of a parent entity is also the auditor of its subsidiary. branch, or division (component), the factors that influence the decision whether to send a separate engagement letter to the component include the following: * Who appoints the Component auditor; © Legal requirements in relation to audit appointments; 4ter 1 - Overview of Audit Process and Pre-engagement Activities e of Ownership by parent; ie ether a Separate auditor's report is to be {ssued on the component; «Ww and Degree of Independence of the component's management from the parent entity. Recurring Audits ‘on recurring audits, the auditor should consider whether circumstances require the terms of the engagement to be revised and whether there is a need to remind the client of the existing terms of the engagement. ‘The auditor may decide not to send a new engagement letter each period. However, the following factors may make it appropriate to send a new letter: Any indication that the client misunderstands the objective and scope of the audit. « Any revised or special terms of the engagement. « Arecent change of management, board of directors or ownership. © Asignificant change in ownership. « Asignificant change in nature or size of the client’s business. e Achange in legal or regulatory requirements. ¢ Achange in financial reporting framework adopted in the preparation of the financial statements. « Achange in other reporting requirements. Acceptance of a Change in Engagement a, Stop performing the old engagement b. Stop referring to the old engagement, except Yes when the new engagement involves agreed- upon procedures c. Start performing the new engagement Istherea reasonable justification? [——_,} @ Continue the original audit engagement No b. When prohibited to continue, withdraw from the audit engagement Note: Every time withdrawal is made, the auditor should consider the necessity of communicating the reasons to appropriate level of management.Chapter 1 - Overview of Audit Process and Pre-engagement Activities ' Circumstances that could lead to Change in Engagement + Circumstances Justifiable | 1. Change in circumstances affecting the need for the service v /2.A misunderstanding as to the nature of an audit or related Vv |__services originally requested | 3.A restriction on the scope of the engagement, whether x |_imposed by management or caused by clrcums oe a T41f the change relates to information that incorrect, x incomplete or otherwise unsatisfactory _ “ | 5.The auditor is unable to obtain sufficient a propriate audit evidence regarding assertions