When accepting a new audit engagement, you may encounter the following risks:
- you’ll make a mistake;
- key issues will be overlooked;
- the client will question the value of the service; or
- the service will be unprofitable.
This is particularly important in a competitive environment where there’s often significant pressure to deliver services at a competitive price. Accepting an audit engagement without performing appropriate due diligence can result in real issues down the track.
IFAC’s Code of Ethics for Professional Accountants states: ‘Before accepting a new client relationship, a professional accountant in public practice shall determine whether acceptance would create any threats to compliance with the fundamental principles (integrity, objectivity, professional competence and due care, confidentiality and professional behaviour). Potential threats to integrity or professional behaviour, for example, may be created from questionable issues associated with the client (its owners, management or activities).’
This means that when approached to take on a new client, the Firm should gain an understanding of the potential client, its owners, management and business activities to evaluate the integrity of the potential client and identify areas which may create unacceptable risk. Clearly, it’s often not possible to ‘know your client’ until they become your client, so it’s even more important to take precautionary steps up front to ensure that risks are minimised.
What procedures should you have in place to ensure that you enter into a new client engagement with eyes ‘wide open’?
Arrange a preliminary meeting to discuss requirements
A formal briefing is essential to understand the client and their requirements. At a minimum, you should be prepared to discuss client requirements (both needs and wants). You should also provide information regarding your Firm’s capabilities and competence within the client’s industry as well as other types of professional services performed. At the conclusion of the meeting, you should know whether a previous auditor exists and whether the appointment is competitive.
Clearly outline the required scope of work associated with the engagement
A traditional audit engagement will comprise the following stages:
Stage 1: Risk Assessment
- Preliminary Engagement Activities
- Plan the Audit
- Risk Assessment Procedures
Stage 2: Risk Response
- Substantive tests of detail
- Substantive analytical procedures
- Internal control tests
Stage 3: Conclusion and Reporting
- Preparation of Financial Statements
- Independent Auditor’s Opinion
- Communication with management
In scoping the work, it’s critical to identify all steps involved as well as the expected outcomes. Often, the real value (and cost) of audit services is not understood or is overlooked by the client, simply because it’s presented as a commoditised service. Do you take the time to explain what people and processes you will use to complete the engagement?
Identify any potential work that would be considered ‘out of scope’
The best way to ‘frame’ the engagement is to explain to the prospective client what’s included, and not included, in the project. This helps the client to ‘compare you with you’ rather than simply make comparisons with another quote that’s not really comparable. It also allows the client to better understand what you can do beyond audit and assurance. Other services may include:
- Corporate governance
- Financial reporting
- Fraud examination and control
- Internal control reviews
- IT systems assessment
- Management accounting
- Risk management
Ensure that the fee is consistent with the identified scope of work
A formal cost analysis based on hours and charge out rates at different levels of expertise is essential to ensure that the engagement is not under-quoted. Expect that, for a new client, there will be minor matters arising that are either out of scope or under-costed in the engagement. Often the best way to address this is to establish a fee ‘multiplier’ of between 1.1 and 1.2 times the time-cost to ensure that you have some room to move.
Finally, you should confirm in writing that ‘an updated quote will be provided in the event of a material change in services or fees.’
Conduct a formal pre-acceptance evaluation
Whilst you won’t necessarily have access to all information you need to make a formal assessment of the risks and value associated with a prospective client, you should implement the following actions before engagement:
- Ask the client for permission to contact the outgoing auditor (reject engagement if the client refuses);
- Contact the outgoing auditor and ask for any reasons why you should not accept appointment (if a reply is not received, you may still choose to accept the engagement, however, you should proceed with care);
- Ensure the legal requirements for the removal of the outgoing auditor and the appointment of the Firm have been met;
- Perform pre-acceptance procedures to confirm your Firm is independent, competent and has the necessary resources to complete the audit;
- Assess whether the work is suitably low risk;
- Assess the integrity of the client’s Directors and key management personnel;
- As a commercial organisation, the Firm should also ensure that this is a desirable client (e.g. right industry, suitable profit margin etc); and
- Where it is known that a limitation will be placed on the scope of the audit, the engagement may not be acceptable.
Finally, it’s important the engagement document makes reference to the following:
- The unavoidable risk that material misstatements may go undetected due to the inherent limitations in an audit;
- Arrangements regarding the planning and performance of the audit;
- The expectation that management will provide written representations;
- The agreement of management to make available to the auditor draft financial statements and other information in time to complete the audit in accordance with the proposed timetable;
- The agreement of management to inform the auditor of facts that may affect the financial statements;
- The basis on which fees are computed and billing arrangements;
- A request for management to acknowledge receipt of the engagement letter and to agree to the terms outlined;
- Agreements concerning the involvement of auditor experts and internal auditors; and
- Restrictions to the auditor’s liability.
You are known and valued by the Company you keep
A major objective of many pre-acceptance procedures is to minimise the likelihood of association with a client whose management or principals lack integrity. Usually the simplest and most effective way a Firm can protect its professional reputation, and its practice, is to avoid questionable client associations in the first place. Use these steps to enter into a new client engagement with eyes ‘wide open,’ understand the risks you know and be prepared for those you’re not unaware of yet.
The National Audits Group is always keen to work with accounting Firms looking for experts to help their clients in meeting assurance requirements and providing strong corporate governance. Contact Steven Watson to discuss your needs further.
Steve Watson | National Audits Group
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