Professional Documents
Culture Documents
Chapter 3:
Section 1: Pre-Engagement Activities
Professional Standards state that the auditor should perform the following activities:
1. Perform procedures regarding the acceptance or continuance of the audit client
relationship
2. Determine compliance with independence and ethics requirements
3. Reach a contractual understanding with the client for the terms and conditions of the
audit engagement
Client Acceptance or Continuance
The public accounting firm that has been terminated or has voluntarily withdrawn from
the engagement is known as the Predecessor Auditor
Form 8-K, is required whenever certain significant events such as changes in control and
legal proceedings occur
In addition to communication with the predecessor auditor, client acceptance and
continuance policies and procedures generally include:
Obtaining and reviewing financial information about the prospective client:
annual reports, interim statements, registration statements, Form 10-Ks, and
reports to regulatory agencies
Acquiring detailed criminal background checks of all senior managers
Requesting the prospective client's bankers, legal counsel, underwriters,
analysts, or other persons who do business with the entity to provide
information about it and its management
Considering whether the engagement would require special attention or involve
unusual risks to the public accounting firm
Evaluating the public accounting firm's independence with regard to the
prospective client
Considering the need for individuals possessing special skills or knowledge to
complete the audit
Compliance with Independence and Ethical Requirements
The "state of mind" is often referred to as the auditor possessing Independence in Fact
Independence in Appearance relates to others' perceptions of auditors' independence
Engagement Letters
When a new client is accepted or when an audit engagement continues from year to
year, an Engagement Letter should be prepared
This letter sets forth the understanding with the client, including in particular:
1. The objectives of the engagement
2. Management's responsibilities
3. The auditors' responsibilities
4. Any limitations of the engagement
Many public accounting firms also have policies about sending a Termination Letter to
former clients
Such a letter is a good idea because it provides an opportunity to deal with the
subject of future services, in particular:
1. Access to audit documentation by successor auditors
2. Reissuance of the auditors' report when required for SEC reporting or
comparative financial reporting
3. Fee arrangements for such future services
Section 3: Materiality
Given the range permitted, some amount of inaccuracy is allowed in financial statements
This is because:
1. Unimportant inaccuracies do not affect users' decisions and hence are not
material
2. The cost of finding and correcting small misstatements is too high
3. The time taken to find them would delay issuance of the financial statements
As a result, to plan the nature, timing, and extent of further audit procedures to be performed,
an auditor "should establish a Materiality level for the financial statements as a whole that is
appropriate in light of the particular circumstances
Therefore, auditors use Performance Materiality to make sure that the aggregate of uncorrected
and undetected immaterial misstatements does not exceed materiality for the financial
statements as a whole
Materiality Calculation
Some examples of commonly used benchmarks per industry are noted below:
Asset based entities - total net assets
Profit based companies, such as manufacturing - PBT
High technology start-up companies - total revenue
Nonprofit entities - gross revenue or total contributions
Nature of the Item or Issue
Engagement Circumstances
Possible Cumulative Effects
To summarize, on an audit engagement, the audit team uses materiality three ways:
As a guide to planning substantive testing procedures
As a guide for determining performance materiality
Asa guide for making decisions about the audit report