LECTURE 4:

CLIENT ACCEPTANCE

Learning objectives
After studying this chapter, you should be able to:
 Explain what is meant by client acceptance.
 Describe the seven primary procedures involved in the client
acceptance process.
 Understand the main reasons for obtaining an understanding of
client’s business and industry.
 Know the sources of client information and the methods for
gathering the information.
 Discuss the ethical and competency requirements of the audit
team.
 Know what is required in using the work of another auditor.

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 Learning objectives (cont.)
 Understand the auditor’s responsibility in using the work of an
expert.
 Describe the procedures for communicating with an existing
(predecessor) auditor.
 Know the contents of a client audit engagement proposal.
 Explain on what basis audit fees are negotiated.
 Understand what an audit engagement letter includes and why its
contents are important.

4.1. Client acceptance: The first step on

Journey to an Opinion
 Client acceptance phase objectives
 Examination of the proposed client to determine if there
is any reason to reject the engagement (acceptance OF
the client) and convincing the client to hire the auditor
(acceptance BY the client)
 Decide on acquiring a new client or continuation of the
relationship with an existing client
 Determine the type and amount of staff.

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 4.1. Client acceptance: The first step on
Journey to an Opinion
 Client acceptance procedures
 Evaluate the client’s background and reasons for the audit.
 Determine whether the auditor is able to meet the ethical
requirements regarding the client.
 Determine need for other professionals.
 Communicate with predecessor auditor (someone who was
previously the auditor of an entity and who has been replaced by
an incoming auditor).
 Prepare client proposal.
 Select staff to perform the audit.
 Obtain an engagement letter.
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4.2. Evaluate the Client’s Background

 Auditor’s main reasons for obtaining an understanding of a
client’s business
 To evaluate the engagement risks associated with accepting the
specific engagement
 To help the auditor in determining whether all professional and
ethical requirements (including independence, competence, etc.)
regarding this client can be met.

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 4.2. Evaluate the Client’s Background
 Preliminary examination of clients

 New and existing clients

 visiting their premises
 reviewing annual reports
 having discussions with client’s management
and staff
 accessing public news and public information databases,
usually via the Internet.
 For an existing one, prior years’ working papers should be
reviewed.
 For a new client, consult prior auditors and increase preliminary
information search.
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4.2. Evaluate the Client’s Background

 Evaluate governance, internal controls and possible risks
with client’s management and staff
Topic of discussion including:
 Changes in management, organisational structure and activities of the
client
 Current government regulations
 Current business developments
 Current or impending financial difficulties or accounting problems
 Susceptibility of the entity’s financial statements to material
misstatement due to error or fraud (ISA 240 and ISA 315)
 Existence of related parties (ISA 550)
 New or closed premises and plant facilities
 Recent or impending changes in technology, types of products or
services and production or distribution methods
 Changes in the accounting system and the system of internal control. 8

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 4.2. Evaluate the Client’s Background
 Sources of information for client evaluation

Illustration 5.3 Three Major Influences on the Continuance of the Relationship

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 4.3. Ability to Meet Ethical and Specific
Competence Requirements
 Ethics Requirement
 Litigation and Independent
 Specific Competences
 Partner Rotation

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4.3. Ability to Meet Ethical and Specific

Competence Requirements
 Ethics Requirement:
 The auditor will ensure that the members of the auditor team
as well as the entire audit firm meet the relevant ethics
requirements (see Lecture 2). This will require procedures
to:
 check personal financial investments of partners and employees
and the business relationships with the potential audit client.
 Review the non-audit services his audit firm are providing or
have recently been providing to this potential client.
 Review audit fees

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 4.3. Ability to Meet Ethical and Specific
Competence Requirements
 Litigation and Independence
 If the client is involved in litigation with the auditor, to
continue to audit the client could jeopardise independence.
 The commencement by a client or other third party of
proceedings against the auditor would compromise
independence.
 On the other side of the legal fence, acting as an advocate on
behalf of an assurance client in litigation or in resolving
disputes with third parties is an ‘advocacy threat’ to
independence.

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4.3. Ability to Meet Ethical and Specific

Competence Requirements
 Specific Competences
 Audit team members must have a degree of technical
training and proficiency required in the circumstances.
 There should be sufficient direction, supervision and
review of work at all levels in order to provide reasonable
assurance that the work performed meets appropriate
standards of quality.

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 4.3. Ability to Meet Ethical and Specific
Competence Requirements
 Specific Competences (cont.)
 Reviewing existing partner and staff competencies, for:
• knowledge of relevant industries or subject matters;
• experience with relevant regulatory or reporting requirements,
or the ability to gain the necessary skills and knowledge in an
effective manner;
• ability to complete the engagement within the reporting
deadline; experts are available, if needed;
• individuals meeting the criteria and eligibility requirements to
perform engagement
• quality control review are available.

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4.3. Ability to Meet Ethical and Specific

Competence Requirements
 Partner Rotation

In some countries audit partners must be rotated every

specified number of years:
 In the European Union Guidelines, audit partners should
rotate once every seven years.
 The Sarbanes–Oxley Act of the USA requires that audit
partners rotate at least every five years.

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 4.4. Use of Other Professionals in the Audit
 Using the Work of another Auditor

 If a group auditor, decides to use the work of a component

auditor on the audit, the group auditor determines the scope
of the work to be performed and communicates the plan to
the component auditor.
• Component auditor – An auditor who, at the request of the
group engagement team, performs work on financial
information related to a component for the group audit.
 Generally, the group auditor takes sole responsibility for
the audit opinion on the group financial statements and does
not refer to the other auditor in the auditor’s report.
(In some countries under certain conditions, a division of
responsibilities is allowed.)
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4.4. Use of Other Professionals in the Audit

 Using the Work of another Auditor (cont.)

When the group auditor decides to use the work of another

auditor she should consider:
 the professional qualifications, independence, professional
competence and resources of the other auditor;
 the quality control processes of the other auditor’s firm.

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 4.4. Use of Other Professionals in the Audit
 Using the Work of an Expert
• If the auditor requires special expertise or lack the expertise
of a person trained for another profession, the auditor should
consider hiring an expert to assist in gathering the necessary
evidence.
ISA 620 defines an expert as an individual or organisation
possessing expertise in a field other than accounting or
auditing, whose work in that field is used by the auditor to
assist the auditor in obtaining sufficient appropriate audit
evidence.

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4.4. Use of Other Professionals in the Audit

 Using the Work of an Expert (cont.)
When using an expert’s work the auditor MUST:
 Determine expert’s
• Competence (professional certifications)
• Capabilities (experience and reputation)
• Objectivity.
 The auditor should write instructions to the auditor’s expert
which cover:
• The nature, scope and objectives of that expert’s work
• The respective roles and responsibilities of the auditor and that
expert
• The nature, timing and extent of communication
• The need for the auditor’s expert to observe confidentiality.
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 4.4. Use of Other Professionals in the Audit
 Using the Work of an Expert (cont.)
Reference to the auditor’s expert in the auditor’s report

 The auditor shall not refer to the work of an auditor’s expert

in an auditor’s report containing an unmodified
(unqualified) opinion unless required by law or regulation to
do so.
 If the auditor makes reference to the work of an auditor’s
expert in the auditor’s report because such reference is
relevant to an understanding of a modification to the
auditor’s opinion, the auditor shall indicate in the auditor’s
report that such reference does not reduce the auditor’s
responsibility for that opinion.
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4.5. Communicating With the Predecessor

(Existing) Auditor
 when a new auditor will replace an existing auditor, the code of
ethics advises the new, proposed auditor to communicate with
the existing accountant (auditor).
 The purpose of this communication is to reduce or eliminate
threats by getting information on any facts or circumstances
that, in the existing accountant’s opinion, the proposed
accountant needs to be aware of before deciding whether to
accept the engagement.

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 Which two of the following are auditors always required to
do on being invited to accept an audit engagement?
A. Ensure they are professionally qualified to act
B. Ensure they have adequate existing resources to carry
out the audit
C. Obtain references for key personnel within the entity to
be audited
D. Communicate with the predecessor auditors to discover
any reasons they should not accept appointment

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4.5. Communicating With the Predecessor

(Existing) Auditor
 Request Permission of Client

• The proposed auditor should request permission from the client to

communicate with the existing auditor.
• When the prior auditor receives the communication, he should
ordinarily reply advising of any reasons why the proposed auditor
should not accept the engagement.
• If the client denies the existing auditor permission to discuss its
affairs with the proposed successor auditor or limits what the
existing auditor may say, that fact should be disclosed to the
proposed successor auditor.

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 4.6. Acceptance by the Client – The
Engagement Proposal

The auditor needs to send an engagement proposal to the

client to convince the client to hire the auditor

Two basic types of audit engagement proposals:

 those to continuing clients and
 those for new clients.

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4.6. Acceptance by the Client – The

Engagement Proposal
 Continuing Client Audit Proposal
• a review of how the auditing firm can add value, both to the
company in general and to those directly responsible for the
engagement of the auditor, for example the Audit
Committee;
• plans for further improvement in value added including
discussion of present regulatory trends, audit scope, and any
recent changes in the company that may affect the audit;
• a description of the audit team and any changes in the audit
team from the previous year;
• a detailed fee proposal.
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 4.6. Acceptance by the Client – The
Engagement Proposal
 New Client Audit Proposal
 An executive summary
 Client’s business and audit expectations
 Strengths of the audit firm
 Audit team
 Audit approach
 Client’s internal auditors
 Transition needs
 Other services of the audit firm
 After service monitoring
 Fee details
 Appendix
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4.6. Acceptance by the Client – The

Engagement Proposal
 Professional fees should be a fair reflection of

 The skill and knowledge required for the type of

professional services involved
 The level of training and experience of the persons
performing the services
 The time necessarily to perform services
 The degree of responsibility that performing those services
entails
 Contingency fees (no fee will be charged unless a specified
finding or result is obtained) are not allowed for audits in
many countries.
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 4.6. Acceptance by the Client – The
Engagement Proposal
 Commissions and referral fees
 An auditor may receive a referral fee or commission
• For example, when she does not provide the specific service
required, a fee may be received for referring a client to
another auditor or other expert.
• However, accepting such fees creates a self-interest threat. If
the treat is significant, safeguards should be applied.
 A auditor may also pay a referral fee to obtain a client
• For example, where the client requires specialist services not
offered by the existing auditor.
• The payment of such a referral fee also creates a self-interest
threat to objectivity and professional competence and due care
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4.7. The Audit Engagement Letter

 Definition of Engagement Letter:

An engagement letter is an agreement

between the accounting firm and the client for
the conduct of the audit and related
services.

 Auditor sends an engagement letter, preferably before the commencement

of the engagement, to help in avoiding misunderstandings with respect to
the engagement.
 An auditor’s engagement letter documents and confirms his acceptance of
the appointment, the objective and scope of the audit, the extent of auditor
responsibilities to the client, and the form of any reports
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 4.7. The Audit Engagement Letter
Contents of the Engagement Letter:
The following items shall be included in the engagement letter:
 Objective of the audit of financial statements
 Scope of the audit, which could include reference to applicable
legislation, regulations, or pronouncements of professional
bodies to which the auditor adheres
 Auditor’s responsibility
 Reporting framework that is applicable for the financial
statements being prepared, for example IFRSs.
 Management’s responsibility to prepare the financial statements
and to provide the auditor with unrestricted access to whatever
records, documentation and other information is requested in
connection with the audit
 Form of any reports of results of the engagement
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4.7. The Audit Engagement Letter

Contents of the Engagement Letter:
Auditor may wish to include in the letter the following items:
 Form of any other communication of the results of the engagement
 The fact that because of the test nature and other inherent
limitations, there is an unavoidable risk that some material
misstatements may remain undiscovered
 Arrangements regarding the planning of the audit
 Expectation of receiving from management written confirmation of
representations
 Agreement of the client to provide the auditor with information in
time
 Basis on which fees are computed and any billing arrangements
 Request for the client to confirm the terms of the engagement by
acknowledging receipt of the engagement letter 32

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 4.7. The Audit Engagement Letter
Contents of the Engagement Letter:
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 client staff
 Arrangements to be made with the predecessor auditor, if any,
in the case of an initial audit
 Any restriction of the auditor’s liability when such possibility
exists
 A reference to any further agreements between the auditor and
the client
 Any obligations to provide audit working papers to other parties
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4.7. The Audit Engagement Letter

Sample Audit Engagement Letter:

Illustration 5.5 (Textbook, page 172)

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 4.7. The Audit Engagement Letter
 Recurring audits

 The auditor may decide not to send a new engagement letter

each year.
 However, he should consider sending a letter in any of the
following circumstances:
• where there is an indication that the client misunderstands the
objective and scope of the audit
• where the terms of the engagement are revised;
• where there has been a recent change in management;
• where the size or nature of the business has changed; and
• where there are legal requirements that an engagement letter be
written
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Which three of the following may be contained within

a letter of engagement?
A. Responsibilities of the auditors
B. Responsibilities of the directors
C. The names of the staff assigned to the
engagement
D. The scope of the audit

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 For each of the following statements, select whether they are
true or false in respect of the audit engagement letter.
1) The engagement letter should be sent before acceptance
of appointment.
2) The engagement letter should be sent after the
appointment of the auditor but before the
commencement of the audit.
3) The engagement letter should be sent after the
commencement of the audit but before the signing of the
auditor’s report.
4) An engagement letter should be sent to all new clients

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Which two of the following must be included in the

engagement letter?
A. The responsibilities of the auditor
B. Arrangements regarding the planning and
performance of the audit
C. The form of any reports
D. Basis on which fees are computed

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 Which three of the following are purposes of a letter of
engagement?
A. Setting out the form of any report to be issued
B. Providing constructive suggestions to management
concerning improvements in internal control
C. Documenting and confirming acceptance of the
appointment
D. Narrowing the expectations gap
E. Providing evidence on matters where other evidence
is not expected to exist

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