Auditing – Study Notes Chapter 8 Agreeing on audit engagement

CHAPTER EIGHT
AGREEING ON AUDIT ENGAGEMENT
ICAP'S STUDY TEXT
LO # LEARNING OBJCTIVE REFERENCE*
PART A – AGREEING ON AUDIT ENGAGEMENT

LO 1 PURPOSES/OBJECTIVES OF ENGAGEMENT LETTER N/A

LO 2 FORM AND CONTENTS OF ENGAGEMENT LETTER 2.2.2

ACCEPTANCE OF CHANGE IN THE TERMS OF AUDIT
LO 3 2.2.2
ENGAGEMENT
LO 4 ENGAGEMENT LETTER ON RECURRING AUDITS 2.2.2
PART B – PRECONDITIONS FOR AUDIT

LO 5 MATERIALITY 2.2.1

*Explanation of Reference:
First digit in Study Text’s Reference represents chapter number, second and third digits represents
section and sub-section number. Contents in brackets (if any) represent part of the sub-section
which is covered by the learning objective.

Coverage from Question Bank:

After completion of this chapter, you will be able to attempt following questions in ICAP's Question
Bank:
 Q. # 16a  Q. # 27
 Q. # 17  Q. # 28
 Q. # 23

1 By: Muhammad Asif, ACA

Auditing – Study Notes Chapter 8 Agreeing on audit engagement

PART A – AGREEING TERMS OF ENGAGEMENT

LO 1: PURPOSES/OBJECTIVES OF ENGAGEMENT LETTER:

Engagement Letter:
Engagement letter is a written agreement between auditor and client
(through appropriate representative e.g. CFO, CEO) on terms and
conditions of audit engagement.

Purposes of Engagement Letter:

 It confirms appointment of auditor.
 It removes expectation gap.

LO 2: FORM AND CONTENTS OF ENGAGEMENT LETTER:

Audit Engagement Letter shall include:
a) The objective and scope of the audit;
b) Identification of the AFRF;
c) The responsibilities of the auditor;
d) The responsibilities of management (also called Premise);
e) Expected form and content of reports to be issued by the auditor and a statement that there
may be circumstances in which a report may be different from its expected form and
content.

An audit engagement letter may also include following:

a) Elaboration of the scope of the audit.
b) Inherent limitations of an audit
c) Inherent limitations of internal control.
d) Arrangements regarding the planning and performance of the audit, including composition
of the audit team and timing.
e) Fee or Basis of fee.
f) Agreement of management to inform the auditor of subsequent events affecting financial
statements (after date of auditor’s report till issuance of financial statements).
g) The expectation that management will provide written representation letter.
h) Reference to any other communication as a result of the audit engagement (e.g. Letter of
Weakness).
i) Arrangements concerning involvement of predecessor auditor, component auditor, expert,
internal auditor, quality control reviewer.

LO 3: ACCEPTANCE OF CHANGE IN THE TERMS OF AUDIT ENGAGEMENT:

Circumstances leading to change in terms of audit engagement:
Client can request auditor to change terms of audit engagement in following circumstances:
1. If there is change in circumstances affecting need for audit.
2. If there was a misunderstanding of client about nature of audit.
3. If auditor is unable to obtain sufficient appropriate audit evidence on a material or
pervasive item.

2 By: Muhammad Asif, ACA

Auditing – Study Notes Chapter 8 Agreeing on audit engagement

Factors to be considered by auditor before accepting change:

Factors to be considered Explanation

Legal or Contractual Change should not violate any legal or contractual requirements.
implications of the change
1. A change is considered reasonable if it is due to change in
circumstances affecting need for audit or a misunderstanding of
Whether there is a
client about nature of audit.
reasonable justification for
2. A change is considered unreasonable if it is due to
the change
incomplete/incorrect information (indicating inappropriate
scope limitation or risk of fraud).

Acceptance of Change by Auditor:

If auditor accepts the change
1. Revised terms of engagement shall be agreed.
2. Procedures to be performed and Report to be
issued shall be according to revised
engagement.
3. Report shall NOT refer to:
 Original audit engagement or
 Any procedures performed in original
audit engagement
If auditor does not accept the change
Auditor shall continue to perform the audit
engagement as per original terms of engagement.
If management does not permit auditor to
continue original engagement, auditor shall:
 withdraw from engagement where possible
under local laws and regulations.
 Determine whether there is any contractual
or other obligation to report the
circumstances to other parties (e.g. TCWG,
Shareholders, Regulatory or Professional
bodies).

LO 4: ENGAGEMENT LETTER ON RECURRING AUDITS:

Auditor should consider following factors in deciding whether to sent a new engagement letter on
recurring audit:
1) Legal requirements.
2) Any indication that client misunderstands the objective and scope of the audit.
3) Any major change in entity’s ownership.
4) Any major change in entity’s senior management.
5) Any major change in entity’s nature or size of business.
6) Any major change in entity’s applicable financial reporting framework.
7) Changes in terms of engagement

PART B – PRECONDITIONS FOR AUDIT

LO 5: PRECONDITIONS FOR AUDIT:

What are Preconditions for audit:
 AFRF used by management in preparation of F/S is acceptable.
 Management, and TCWG where applicable, agrees to the premise on which an audit is
conducted.

3 By: Muhammad Asif, ACA

Auditing – Study Notes Chapter 8 Agreeing on audit engagement

Establishing Preconditions for Audit:

1. Auditor shall determine whether financial reporting framework adopted by management in
preparation of financial statements is acceptable, considering, nature of F/S, purpose of F/S,
nature of entity, legal requirements.
2. Auditor shall obtain agreement of management (via engagement letter) that it understands
and acknowledges its responsibilities:
a. For the preparation of financial statements in accordance with AFRF. This
responsibility includes:
b. For design, implementation and operating effectiveness of internal control which is
necessary to prepare financial statements in accordance with AFRF; and
c. to provide the auditor with all relevant and requested information and unrestricted
access to all personnel.

Course of Action of Preconditions are NOT present:

If management does not agree to premise on which audit is conducted:
Auditor shall not accept the proposed audit engagement.

If AFRF is not acceptable:

Auditor shall refuse the engagement unless AFRF is required by law.

If AFRF is required by law, auditor shall accept engagement under ISAs only if following conditions
are met:
1. Management agrees to provide additional disclosure (which will explain deficiencies in
framework to avoid F/S being misleading), and
2. It is mentioned in Engagement Letter that:
 auditor’s report will not include phrases “give a true and fair view” or “present
fairly, in all material respects”.
 auditor’s report will include additional paragraph (to draw users’ attention towards
additional disclosure)

If AFRF is required by law, and above conditions are also NOT met:
1. Auditor shall evaluate the effect of misleading F/S on auditor’s report.
2. Auditor shall refer to this effect in engagement letter.

4 By: Muhammad Asif, ACA