AUDIT PRE ENGAGEMENT PAPER

MIDTERM EXAM AUDIT, ASSURANCES, AND PROFESSIONAL ETHICS

By:

Ezra Lxxxxxxx
143xxxxxx

UNIVERSITAS AIRLANGGA
FAKULTAS EKONOMI DAN BISNSI
PROGRAM STUDI PROFESI AKUNTAN
PROGRAM STUDI AKUNTANSI
202x
Introduction
In conducting audits and other assurance services, the accounting firm and its clients must make
a letter of approval in advance. In the approval letter, the auditor and his client must include the
duties and responsibilities of management, the purpose of the audit of financial statements, other
forms of reports or communications that will be used by the firm, and an explanation of the
scope of the audit. This approval letter is called an Audit engagement, where the purpose of the
audit engagement for an accounting firm is to get to know the client company and discuss how
the engagement partners perform their services, and the audit engagement is also carried out to
minimize the audit expectation gap. There are two stages in conducting an audit engagement,
namely the acceptance and management of the audit engagement. In accepting the audit
engagement audit firms must first conduct a business risk assessment of its clients and assess the
audit risk. In the management of audit engagement, the accounting firm will conduct audit
engagement quality control procedures and engagement team assignments
The auditor conducts risk-based audits to focus the auditor on examining the risks of impacting
the company's objectives. Risk-based auditing is essential to implement because it is very
impractical if the auditor examines risks that do not affect the company's objectives. In
conducting a risk-based audit, the auditor must first conduct a risk assessment of both the client's
business risk and audit risk. By determining the risks, the auditor can better understand the risks
in the client's industry and focus more on the risks that can affect the decisions of financial report
users
Discussion
Receive new clients and retain old clients
In the pre-engagement, the auditor must analyze the acceptability and sustainability of the
relationship with the client. Accounting firms will have to decide whether they should accept
new clients or retain their current clients. Accounting firms must be careful in accepting new
clients because if the auditor chooses the wrong client then the firms will receive many problems
compared to the benefits.
When audit firms receive a new client, Kap investigates the new client company to determine the
level of acceptability. Accounting firms will do so by examining, to the extent possible, this
prospective client within the business community, his or her financial stability, and his or her
relationship with the previous firm. Most audit firms will be careful in choosing a newly formed
clientele and the development is very fast. Most of these businesses are experiencing financial
problems that provide potential problems for the firms. Accounting firms must also be sure that
the client has competencies, such as knowledge of the industry, and has all the requirements of
independence. If, for example, this new client has already been audited by the previous firm, the
new firm (successor auditor) is required to communicate with the previous firm (predecessor
auditor), the purpose of which is to find out whether the successor auditor will accept the
assignment. Although the predecessor auditor is required to communicate with the successor
auditor, the “Code of Professional Conduct” requires that the predecessor auditor must obtain
prior permission from the client. In unusual cases such as legal issues or disputes between clients
and previous auditors, the previous auditor may provide limited information or may not provide
information at all. If, for example, the client does not allow communication or the predecessor
auditor does not provide information, the new KAP can seriously consider its desire to accept the
engagement, without taking into account other investigations.
In accepting new clients, an accounting firm must first examine and analyze the risks that can
occur when conducting audits such as business risks and audit risks, in addition, KAP must also
check its clients ' compliance with applicable laws. This is called a Legal Audit. Legal Audit is
an examination and/or assessment of legal issues concerning or relating to a company
The purpose of this legal audit is:
1. Obtaining the legal status of audited documents. By obtaining the legal status of the
document, the auditor can ensure that the document is legally valid and has sufficient
power to strengthen the position or claim made by the audited business entity. Obtaining
the legal status of the audited documents is also important to increase transparency and
accountability in the company's operations.
2. The legality of a business entity refers to legal eligibility and compliance with various
applicable rules and regulations. By conducting a legal audit, the auditor can find out the
legal entity of the company, in addition, the Auditor will check the incorporation
documents of the business entity, such as the deed of incorporation, amendments to the
articles of association or company deed, as well as other legal documents related to the
 company's operations. Its purpose is to ensure that these documents are legally valid and
meet the requirements of applicable legislation.
3. So by conducting legal audits we can evaluate compliance risks, identify potential
violations, and provide recommendations to improve control and compliance processes at
companies that are our clients.
Accounting firm annually evaluates current clients to determine whether they are still worth
retaining or not. Previous conflicts experienced by an accounting firm and its clients regarding
the proper scope of the audit, the type of opinion to be given, unpaid fees, or other matters that
may result in the auditor terminating his cooperation. An accounting firm may terminate its
cooperation with clients who are at very high risk. So the evaluation of the old client is important
in deciding the acceptable audit risk.
Human Resources
In The Quality Control Standard No. 1 (SPM 1) paragraphs 29 – 31 states that:
 The accounting firm shall establish policies and procedures designed to provide sufficient
assurance that the firm has a sufficient number of personnel with the competence,
capability, and commitment to the principles of professional ethics necessary to:
 Carry out the engagement by professional standards, as well as the provisions of
applicable laws and regulations;
 Allows the accounting firm or engagement partner to issue a report appropriate to its
condition.
This quality control standard explains that accounting firms must have policies and procedures
that ensure that they have sufficient personnel and meet standards of competence, ability, and
commitment to professional ethics. This is necessary so that the firm can carry out its duties by
the standards of the profession, as well as ensure that the reports issued are by their conditions.
For example, accounting firm assigns experienced auditors who already know and understand
audit standards very well, they will know what to include in their audit reports.
The accounting firm must assign the right staff at the time of assignment. The staff must have
sufficient competence and ability to carry out the audit. In larger audit assignments, one or more
partners and staff with varying levels of experience may be required. Specialists in statistics and
computer risk assessment may also be placed. In smaller audits, only one or two staff members
may be required.
Determining The Initial Materiality
Auditing standards require auditors to decide on aggregate misstatements in the financial
statements, which will be considered material at the beginning of the audit while developing an
overall audit strategy. Preliminary consideration of materiality is the maximum amount that
makes the auditor believe that the financial statements will be misstated but does not affect the
decisions of the users of the financial statements. The Auditor establishes preliminary
considerations of materiality to help plan the proper collection of evidence. The lower the
monetary value of the judgment, the more audit evidence is required. During the conduct of the
audit, the auditor often changes the preliminary consideration of materiality, which is referred to
as the consideration of revised materiality. Several factors will affect the auditor's preliminary
consideration of the materiality of a particular set of financial statements. The most important
factors are:
a) Materiality is a concept that is relative rather than absolute
A misstatement of a certain amount may be material for a small company, but it may not be
material for a large company. Thus, it is not possible to establish dollar-value guidelines for
preliminary consideration of materiality that can be applied to all audit clients,
b) Benchmarks needed to evaluate materiality
Because of its relative nature, a benchmark is needed to determine whether a misstatement is
material. Net income before tax is often the yardstick in determining the amount of profit-
oriented material, because the amount is considered an important information item for users.
Some companies use different main benchmarks because net income often fluctuates quite a lot
from one year to another, to the point of not providing a stable benchmark
c) Qualitative factors that also affect materiality
Certain types of misstatements may be more important to users than others,for example:
a) the amount involved in fraud is usually considered more important than unintentional
errors of the same value because the fraud reflects the honesty and reliability of the
management or others involved
b) actually minor misstatements can be material if there are consequences that may arise
from contractual obligations
c) an immaterial misstatement may become material if it affects the profit trend
Preliminary Analytical Procedure
The Auditor carries out preliminary analytical procedures to better understand the client's
business and assess the client's business risks. One such procedure is to compare client ratios
with industry benchmarks or to indicate a company's performance. Such preliminary testing may
reveal unusual changes in ratios compared to the previous year, or to industry averages, thus
helping the auditor identify areas of increased risk of misstatement that require further attention
during the audit.
The analytical procedure can be executed at any of the three times during the assignment:
A. analytical procedures are required in the planning phase to help determine the nature,
extent, and timing of audit procedures
B. analytical procedures are often performed during the audit testing phase as substantive
tests to support account balances
C. analytical procedures are also required during the completion of the audit
Various analytical procedures allow auditors to compare client data with similar data from one
more previous period, here are some common examples:
  Comparing the current New Year balance with the previous year
 Compare the details of the total balance with similar details for the previous year
 Calculates ratios and percentage relationships to compare with previous year
Understand client's business and Industry
The Auditor identifies and assesses the risk of material misstatement, whether the risk of
misstatement is due to fraud or error, to understand the cause, the auditor must understand the
entity and its client environment, including an understanding of the entity's internal controls. The
nature of the client's business and industry influences the client's business risk as well as the risk
of material misstatements in the financial statements.
There are three reasons to gain a good understanding of the client's industry and its environment:
 Risks related to the client's particular industry and business may affect the auditor's
assessment of the client's business risk and acceptable audit risk and may even affect the
auditor's acceptance of an assignment to a risky industry
 An understanding of the inherent risks of the client's industry will assist the auditor in
assessing their relevance to the client
 There are unique accounting requirements for each industry that must be understood by
the auditor to evaluate whether the client's financial statements are following accounting
standards.
Many litigation cases are caused because auditors do not fully understand the nature of
transactions in the client's industry. The Auditor must understand the client's external
environment, including such things as the volatility of economic conditions, the level of
competition, and regulatory requirements. The Auditor should factor in factors such as major
sources of revenue, customers, key suppliers, sources of financing, and information about related
parties that can indicate areas where the client's business risks are increasing. To be able to
understand this the auditor can visit the client's facility, this can help the auditor understand
better about the client's business activities, as the visit will provide an opportunity to observe the
company's activities directly and meet with key management. Transactions with related parties
are very important to the auditor because generally accepted accounting principles require that
transactions be disclosed on financial statements if they are material. A related party is defined in
the audit standards as an affiliate company, principal owner of a client company, or other party
concerned with that client, which either party may influence the other party's management or
operating policies. Transactions with related parties are any transactions between clients and
related parties.
Audit Risk
The Auditor handles the risks in planning the collection of audit evidence primarily by applying
the audit Risk model. The audit Risk Model helps the auditor decide how much and what type of
evidence should be collected in each cycle. This Model is usually expressed as follows:
  Risk of planned detection
Planned detection risk is the risk that audit evidence for an audit purpose will fail to detect
misstatements that exceed the materiality of the performance. The planned detection risk
determines the amount of substantive evidence that the auditor plans to collect, the amount of
which is opposite to the planned detection risk.
 Inherent risks
Inherent risk measures the auditor's assessment of the vulnerability of material misstatement
assertions, before accounting for the effectiveness of internal controls. If the auditor concludes
that there is likely to be a misstatement, ignoring internal controls, the auditor will conclude that
the inherent risk is high
 Controlling Risk
Control risk measures the auditor's assessment of the risk that material misstatement will occur
in an assertion and cannot be prevented or detected in a timely manner by the client's internal
controls.
 Acceptable audit risk
Acceptable audit risk is a measure of the auditor's willingness to accept that financial statements
may be subject to material misstatement after the audit has been completed and an unqualified
opinion has been issued
Conclusion
Before accepting an audit engagement, the auditor first decides whether to accept new clients or
retain their site clients. For this reason, the auditor must investigate the new client and the auditor
can avoid potential problems by investigating the client. If the auditor wants to keep the old
client then the auditor needs to evaluate the business or industry of the old client, any kind of
conflict that arises between the client and the auditor can be a consideration of whether the
auditor still wants to work with the problematic client.
Audit firms must place the right staff at the time of assignment. The staff must have sufficient
competence and ability to carry out the audit. By assigning the right staff, the tasks assigned will
be carried out following applicable standards.
Preliminary consideration of materiality is the maximum amount that makes the auditor believe
that the financial statements will be misstated but does not affect the decisions of the users of the
financial statements. These considerations are made in the initial planning of auditors
The Auditor must understand the client's business and industry so that the auditor can know the
business risks that exist in the client's industry by knowing that the auditor will carry out
planning and auditing techniques. To find out more details about the client's industry, the auditor
can perform a preliminary analytical procedure
Sources
Arens, A., Elder,J, dan Beasley, S. 2014. Auditing dan Jasa Assurance (Judul Asli: Auditing and
Assurance Services).Edisi Kelimabelas. Erlangga. Jakarta.
Institusi Akuntan Publik Indonesia. 2013. Standar Pengendalian Mutu (SPM 1). Jakarta :
Salemba Empat