ST.

ANTHONY’S COLLEGE
Business Education Department
San Jose de Buenavista, 5700 Antique
Tel. No. (036) 5409238; 5400898; 5409971 Tel. No.: (036) 5409196
Website: www.sac.edu.ph Email: info@sac.edu.ph; bused@sac.edu.ph
In SAC, we
care!

APC 302
AUDITING AND ASSURANCE:
CONCEPTS AND APPLICATION 1
(WEEK 2 HANDOUT)

Student Name: ___________________________________________

Student No: _____________________________________________

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 ST. ANTHONY’S COLLEGE
Business Education Department
San Jose de Buenavista, 5700 Antique
Tel. No. (036) 5409238; 5400898; 5409971 Tel. No.: (036) 5409196
Website: www.sac.edu.ph Email: info@sac.edu.ph; bused@sac.edu.ph

In SAC, we
APC 302 – AUDITING AND ASSURANCE: CONCEPTS AND APPLICATION 1 care!
PRELIM

WEEK 2: APPLICATION OF THE RISK-BASED AUDIT PROCESS (PHASE I-RISK ASSESSMENT): PRELIMINARY ENGAGEMENT ACTIVITIES

CLIENT ACCEPTANCE AND CONTINUANCE DECISION

 One of the most important decisions that an audit firm can make is determining what engagements to accept or which client relationships
to retain. A poor decision can lead to unbillable time, unpaid fees additional stress on partners and staff, potential lawsuits and worst of all,
loss of reputation.
 Even though obtaining and retaining clients is not easy in a competitive profession such as public accounting, a CPA firm must use care in
deciding which clients are acceptable. The firm's legal and professional responsibilities are such that clients who lack integrity or argue
constantly about the proper conduct of the audit and fees can cause more problems than they are worth. Some CPA firms now refuse
clients in certain high-risk industries, such as savings and loans, health, and casualty insurance companies, and may even discontinue
auditing existing clients in those industries.

New Client Investigation

 Before accepting a new client, most CPA firms investigate the company to determine its acceptability. To extent possible, the prospective
client's standing in the business community, financial stability, and relations with its previous CPA firm should be evaluated. For example,
many CPA firms use considerable caution in accepting new clients in newly formed, rapidly growing businesses. Many of these businesses
fail financially and expose the CPA firm to significant potential liability.
 For prospective clients that have previously been audited by another CPA firm, the new (successor) auditor should endeavor to
communicate with the predecessor auditor. The purpose of the requirement is to help the successor auditor evaluate whether to accept the
engagement. The communication may, for example, inform the successor auditor that the client lacks integrity or that there have been
disputes over accounting principles, audit procedures, or fees.
 Even when a prospective client has been audited by another CPA firm, other investigations are often made. Sources of information include
local attorneys, other CPAs, banks, and other businesses. In some cases, the auditor may hire a professional investigator to obtain
information about the reputation and background of the key members of management. More extensive investigation is appropriate when
there has been no previous auditor, when a predecessor auditor will not provide the desired information, or if any indication of problems
arises from the communication.
 Many practitioners take advantage of the Internet as a search tools to learn more about the potential new client and its key operations by
studying available client web sites and by using search engines for other sites that discuss the potential client.

Continuing Clients
 Many CPA firms evaluate existing clients annually to determine whether there are reasons for not continuing to do the audit, previous
conflicts over such things as the appropriate scope of the audit, the type of opinion to issue, or fees may cause the auditor to discontinue
association. The auditor may also determine that the client lacks integrity and therefore should no longer be a client. If the client files a
lawsuit against a CPA firm or vice versa, the firm cannot do the audit. similarly, if there are unpaid fees for services performed more than 1
year. previously, the CPA firm cannot do the current year audit. To do an audit in either of these circumstances violates the Code of Ethics
for Professional Conduct rules on independence.
 Even if none of the previously discussed conditions exists, the CPA firm may decide not to continue doing audits for a client because of
excessive risk. For example, a CPA firm might decide that there is considerable risk of regulatory conflict between a governmental agency
and a client, which could result in financial failure of the client and ultimately lawsuits against the CPA firm. Even if the engagement is
profitable, the risk may exceed the short-term benefits of doing the audit.
 Investigation of new clients and reevaluation of existing ones is an essential part of deciding acceptable audit risk. Assume a potential
client in a reasonably risky industry, where management has a reputation of integrity, but is also known to take aggressive financial risks. If
the CPA firm decides that acceptable audit risk is extremely low, it may choose not to accept the engagement. If the CPA firm concludes
that acceptable audit risk is low but the client is still acceptable, it is likely to affect the fee proposed to the client. Audits with a low
acceptable audit risk will normally result in higher audit costs, which should be reflected in higher audit fees.

QUALITY CONTROL POLICIES RELATIVE TO CLIENT SELECTION AND RETENTION

a. The firm shall implement policies and procedures for the acceptance and continuance of client relationships and specific engagements,
designed to provide the firm with reasonable assurance that it will only undertake or continue relationships and engagements where the
firm:
 Is competent to perform the engagement and has the capabilities, including time and resources to do so;
 Can comply with relevant ethical requirements; and
 Has considered the integrity of the client, and does not have information that would lead it to conclude that the client lacks
integrity.

The auditor shall be satisfied that appropriate procedures regarding the acceptance and continuance of client relationships and audit engagements
have been followed, and shall determine that the conclusions reached in this regard are appropriate.

b. If the auditor obtains information that would have caused the firm to decline the audit engagement has that information been available
earlier, the engagement partner shall communicate that information promptly to the firm, so that the firm and the engagement partner can
take the necessary action.

c. The auditor shall undertake the following activities prior to starting an initial audit:

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 ST. ANTHONY’S COLLEGE
Business Education Department
San Jose de Buenavista, 5700 Antique
Tel. No. (036) 5409238; 5400898; 5409971 Tel. No.: (036) 5409196
Website: www.sac.edu.ph Email: info@sac.edu.ph; bused@sac.edu.ph

In SAC, we
APC 302 – AUDITING AND ASSURANCE: CONCEPTS AND APPLICATION 1 care!
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 Performing procedures regarding the acceptance of the client relationship and the specific audit engagement; and
 Communicating with the predecessor auditor, where there has been a change of auditors, in compliance with relevant ethical
requirements.

d. Strict client acceptance / continuance guidelines should be established to screen out the following:
 Clients that are in financial and/or organizational difficulty - For example, clients that could go bankrupt or clients with poor internal
accounting controls and sloppy records
 Clients that constitute a disproportionate percentage of the firm's total practice - Clients may attempt to influence the auditor into allowing
unacceptable accounting practices or issuing inappropriate opinions.
 Disreputable clients - External audit firms cannot afford to have their good reputation tarnished by serving a disreputable client or by
associating with a clear that has disreputable management.
 Clients that offer an unreasonably low free for the auditor's services - In response, the auditor may attempt to cut corners imprudently or
lose money on the engagement. Conversely, auditors may bid for audits at unreasonably low prices.

PROCESS TO ACCEPT OR CONTINUE AN AUDIT ENGAGEMENT

-Determine the nature of the engagement and whether it can be undertaken in accordance with the firm's policy. Then address the following
questions, and document the findings and conclusions.

I. Are the engagement risks acceptable to the firm?

1. What are the values ("tone at the top") and future goals of the entity?
2. How competent are the entity's senior management and staff?
3. Has the firm conducted an Internet search and had discussions with firm personnel and other third parties (such as bankers) to identify any
reasons why the firm should not accept the engagement?
4. Are there difficult or time-consuming issues to address (accounting policies, estimates, compliance with legislation, etc.)
5. What changes have taken place this period that will impact the engagement (business trends and initiatives, personnel changes, financial
reporting, IT systems, purchase / sale of assets, regulations, etc.)?
6. Is there a high level of public scrutiny and media interest?
7. Is the entity in good financial health and does it have the ability to pay the firm's professional fees?
8. Will the entity provide help to firm in obtaining information and preparing schedules, analysis of balances, providing data files, etc?
9. For new engagements, has the firm communicated with the predecessor auditor to determine if there are any reasons for not accepting the
engagement?

II. Does the firm have the competence, resources, and time required?
1. What is the nature and scope of the audit?
2. What accounting framework will be used?
3. How will the auditor's report and financial statements be used?
4. What is the deadline (if any) for completing the audit?
5. Does the firm have sufficient personnel with the necessary competence and capabilities?
6. Do the selected firm personnel have:
 Knowledge of relevant industries or subject matters,
 Experience with relevant regulatory or reporting requirements, or
 Ability to gain the necessary skills and knowledge effectively?
7. Are experts available, if needed?
8. Where applicable, are there qualified persons available to perform the engagement quality control review?
9. Can the firm and the available staff (in light of timing requirements for other clients) complete the engagement within the reporting
deadline?

*An external audit firm should not undertake an engagement that it is not qualified to handle. Doing so is especially important for smaller, growing
firms that may be tempted to agree to conduct an audit for which they are not qualified or not large enough to perform. Statistics show that firms
covered by a professional liability insurance plan that are most susceptible to litigation are those with staffs of eleven to twenty-five auditors. They
appear to become overzealous, leading to low audit quality and exposure to subsequent litigation.

III. Is the firm / staff independent and free from conflict?

1. Can the firm and the engagement team comply with ethical and independence requirements?
2. Where conflicts of interest, lack of independence, or other threats have been identified:
 Has appropriate action been taken to eliminate those threats or reduce them to an acceptable level by applying safeguards, or
 Have steps been taken to withdraw from the engagement?
3. If the entity being audited is a component of a larger group, the group engagement team may request certain work to be performed on the
financial information of the component. In such cases, the group engagement would first obtain an understanding of the following:
 Whether the component auditor understands and will comply with the ethical (including independence) requirements that are
relevant to the group audit,
 The component auditor's professional competence,
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 ST. ANTHONY’S COLLEGE
Business Education Department
San Jose de Buenavista, 5700 Antique
Tel. No. (036) 5409238; 5400898; 5409971 Tel. No.: (036) 5409196
Website: www.sac.edu.ph Email: info@sac.edu.ph; bused@sac.edu.ph

In SAC, we
APC 302 – AUDITING AND ASSURANCE: CONCEPTS AND APPLICATION 1 care!
PRELIM

 Whether the group engagement team will be able to be involved in the work of the component auditor to the extent necessary to
obtain sufficient appropriate audit evidence, and
 Whether the component auditor operates in regulatory environment that actively oversees auditors.

IV. Can the client be trusted?

1. Is there any reason (or recent event) that casts doubt on the integrity of the principal owners, senior management, and those charged with
government of the entity? Consider the entity's operations, including business practices, the business' reputation, and history of any ethical
or regulatory infringements.
2. Are there any indications that the entity might be involved in money laundering or other criminal activities?
3. What is the identity and business reputation of related parties?
4. Does management have a poor attitude toward internal control and an aggressive attitude toward interpretation of accounting standards?
Consider corporate culture, organizational structure, risk tolerance, complexity of transactions, etc.

*To ensure that the information obtained from the entity is accurate, consider what third-party information could be obtained to validate key aspects
of the risk assessment. This simple step could avert problems later on. Examples include information from sources such as previous financial
statements, income tax returns, credit reports, and possibly (after receiving permission from the prospective client) discussion with key advisors such
as bankers, etc.

Before contracting third parties and collecting information on a prospective. client, take steps to ensure that all partners and staff are aware of:
1. The firm's policies to protect confidential information maintained on clients;
2. Requirements of any privacy legislation; and
3. Requirements of the applicable code of ethics.

PRECONDITIONS FOR AN AUDIT

In order to establish whether the preconditions for an audit are present, the auditor shall:
1. Determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable; and
2. Obtain the agreement of management that it acknowledges and understand its responsibility:
a. For the preparation of the financial statements in accordance with the practicable financial reporting framework, including where
relevant their presentation;
b. For such internal control as management determines is necessary to enable the presentation of financial statements that are free
from material misstatement, whether due to fraud or error; and
c. To provide the auditor with:
 Access to all information of which management is aware that is relevant to the preparation of the financial statements such as
records, documentation and other matter;
 Additional information that the auditor may request from management for the purpose of the audit; and
 Unrestricted access to persons within the entity from whom the auditor determines is necessary to obtain audit evidence.

*Where management does not acknowledge its responsibilities or agree to provide the written representations, the auditor will not be able to obtain
sufficient appropriate reporting framework audit evidence. is not acceptable, In such the circumstances, or where the financial reporting framework is
not acceptable, the auditor is required or where by PSA to decline the engagement unless required by law or regulation.

*Likewise, the auditor should determine whether management or those charged with governance imposes any type of limitation on the scope of the
audit. This could include unrealistic deadlines, not accepting certain firm's staff to perform the work, and denial of access to a facility, key personnel,
or relevant documents. If such a limitation would result in a disclaimer of opinion, the firm would decline the engagement, unless the firm is required
by law or regulation to proceed with the engagement.

AGREEING THE TERMS OF ENGAGEMENT

Engagement Letter
-A clear understanding of the terms of the engagement should exist between the client and the CPA firm. PSA requires that auditors must document
their understanding of an engagement in the working papers, including the engagement's objectives, the responsibilities of the auditor and
management, and the engagement's limitations. This is typically done with an engagement letter.
-The engagement letter is an agreement between the CPA firm and the client for the conduct of the audit and related services.
-The engagement letter states the scope of the work to be done on the audit so that there should be no doubt in the mind of the client, external
auditor, or the court system as to the expectations agreed to by the external auditor and the client.

The agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable form of written agreement and shall
include:
1. The objective accounting framework, and the form of auditor's report resulting from scope of the audit of the financial statements;
2. Identification of the applicable financial reporting framework for the preparation of the financial statements;
3. Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in
which a report may differ from its expected form and content;

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 ST. ANTHONY’S COLLEGE
Business Education Department
San Jose de Buenavista, 5700 Antique
Tel. No. (036) 5409238; 5400898; 5409971 Tel. No.: (036) 5409196
Website: www.sac.edu.ph Email: info@sac.edu.ph; bused@sac.edu.ph

In SAC, we
APC 302 – AUDITING AND ASSURANCE: CONCEPTS AND APPLICATION 1 care!
PRELIM

4. The responsibilities of the auditor;

5. The responsibilities of management; and
6. Arrangements on how the audit will be conducted, involvement of other auditors and experts, if any, dispute resolution, obligation and the
basis on the computation of fees and billing.

*The client should confirm the terms of the engagement by acknowledging receipt of the engagement letter.
*If the terms of the audit engagement are changed, the auditor and management shall agree on and record the new terms of the engagement in an
engagement letter or other suitable form of written agreement.
*If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted by management to continue the original audit
engagement, the auditor shall:
1. Withdraw from the audit engagement where withdrawal is possible under applicable laws or regulations; and
2. Determine whether there is any obligation, either contractual or otherwise, to report the circumstances to other parties, such as those
charged with governance, owners or regulators.

Illustrative Questionnaire that could be used in Assessing Client Acceptance / Continuance (Partial)

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 ST. ANTHONY’S COLLEGE
Business Education Department
San Jose de Buenavista, 5700 Antique
Tel. No. (036) 5409238; 5400898; 5409971 Tel. No.: (036) 5409196
Website: www.sac.edu.ph Email: info@sac.edu.ph; bused@sac.edu.ph

In SAC, we
APC 302 – AUDITING AND ASSURANCE: CONCEPTS AND APPLICATION 1 care!
PRELIM

5
 ST. ANTHONY’S COLLEGE
Business Education Department
San Jose de Buenavista, 5700 Antique
Tel. No. (036) 5409238; 5400898; 5409971 Tel. No.: (036) 5409196
Website: www.sac.edu.ph Email: info@sac.edu.ph; bused@sac.edu.ph

In SAC, we
APC 302 – AUDITING AND ASSURANCE: CONCEPTS AND APPLICATION 1 care!
PRELIM