Chapter 9

Risk Assessment- Part 1

Phase 1 Performance of Preliminary

Engagement Activities
 Phase 1 Risk Assessment
This phase involves the following activities:
1. Performance of Preliminary engagement activities to decide whether to accept/ continue an
audit engagement.
2. Planning the audit to develop an overall audit strategy and audit plan.
3. Performance of risk assessment procedures to identify/ assess risk of material misstatement
through understanding the entity.

I.   Introduction:

At the beginning of the current audit engagement, the auditor should perform the following
activities:
1. Perform procedures required by PSA 220, “ Quality Control of an Audit of Financial
Statements” regarding the continuance of the client relationship and the specific audit
engagement.
2. Evaluate compliance with ethical requirements, including independence as required by PSA
220.
3. Establish an understanding of the terms of engagement as required by PSA 210,” Agreeing the
Terms of Audit Engagements”.
 
Scope of this PSA 220
This Philippine Standard on Auditing (PSA) deals with the specific responsibilities of the auditor
regarding quality control procedures for an audit of financial statements. It also addresses, where
applicable, the responsibilities of the engagement quality control reviewer. This PSA is to be read in
conjunction with relevant ethical requirements.
 
I. Preliminary Engagement Activities
Before performing any significant audit activities, PSA 300 requires the auditor to undertake
the following preliminary engagement activities:
 
 Performing procedures regarding the continuance of the client relationship and the specific
audit engagement.
 Evaluating compliance with ethical requirements, including independence.
 Establishing an understanding of the terms of the engagement.
Preliminary Engagement Activities are performed to determine whether the auditor is qualified to
handle the engagement and to evaluate whether the client’s financial statements are auditable or
not. In making this assessment, the firm should consider:
 Its competence
 Its independence
 Its ability to serve the client properly, and
 The integrity of the prospective client’s management.

Preliminary engagement activities also includes the whether to accept or retain the clients.
 
Clients Acceptance/ Retention
Another element of quality-control deals with accepting and retaining clients. This decision
should involve more than just a consideration of management’s integrity. Strict client
acceptance/ continuance guidelines should be established to screen out the following:
 Clients that are in financial and/or organizational difficulty-
 Clients that constitute a disproportionate percentage of the firm’s total practice
 Disreputable clients
 Clients that offer an unreasonable low fee for the auditor’s services
 
Retention of Existing Clients
The auditor’s evaluation of clients is not one-time consideration. Client should be
evaluated at least once a year or upon occurrence of major events such as
changes in management, directors, ownership, nature of clients business, or other
changes that may affect the scope of the examination.
 
In summary before accepting an engagement with a new client, the CPA firm shall
assess whether it
 Is competent to perform the engagement and has the capabilities, including
time and resources to do so,
 Can comply with the 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.
 
I. Engagement Letter
Audit Engagement Letters
The engagement letter documents and confirms the auditor's acceptance of the
appointment, the objective and scope of the audit, the extent of the auditor's responsibilities
to the client and the form of any reports.
 
 The purpose of the engagement letter is to inform the auditee of the nature of
the engagement and to clarify the responsibilities of the parties involved. ... Public
sector auditors have to give serious consideration to issuing audit engagement
letters when undertaking an audit.
 
After accepting the audit engagement, an engagement letter should be prepared. This
serves as the written contract between the auditor and the client. This letter set forth:
 The objective of the audit of financial statements which is to express an opinion on
the financial statements.
 The management responsibility for the fair presentation of the financial statements.
 The scope of the audit.
 The forms or any report or other communication that the auditor expects to issue
 The fact that because of the limitations of the audit, there is an unavoidable risk
that material misstatements may remain undiscovered.
 The responsibility of the client to allow the auditor to have unrestricted access to
whatever records, documentation and other information requested in connection
with the audit.
In addition, the auditor may also include the following items in the engagement letter:
 Billing arrangements
 Expectations or receiving management representation letter
 Arrangements concerning the involvement of others ( experts, other auditors,
internal auditors and other client personnel)
In addition, the auditor may also include the following items in the engagement letter:
 Billing arrangements
 Expectations or receiving management representation letter
 Arrangements concerning the involvement of others ( experts, other auditors, internal
auditors and other client personnel)
 Request for the client to confirm the terms of the engagement.
 
Importance of the engagement letter
 
It is the interest of both the auditor and client that the auditor sends
engagement letter in order to :
 Avoid misunderstandings with respect to the engagement.
 Document and confirm the auditor’s acceptance of the appointment.
I. Recurring Audits
The auditor does not normally send new engagement letter every year. However, the
following factors may cause the auditor to send a new engagement letter.
 
 Any indication that the client misunderstands the objective and scope of the audit.
 Any revised or special terms of the engagement
 A recent change of senior management, board of directors or ownership
 A significant change in the nature or size of the client’s business
 Legal requirements and other government agencies pronouncements
 
When the auditor decides not to send a new engagement letter, it may be appropriate for
the auditor to remind the client of the original arrangements.
PHASE 1 B PLANNING THE AUDIT TO DEVELOP AN OVERALL
AUDIT STRATEGY AND AUDIT PLAN