5.

0 AUDIT PROCESS: Accepting an Engagement

5.1 Factors Affecting Engagement Acceptance

5.1.1 Preconditions of Audit
In accepting or continuing an engagement, one of the objectives of the auditor is establishing whether the
preconditions for an audit are present. Preconditions of an audit, as defined by PSA 210, pertain to the
use by management of an acceptable financial reporting framework in the preparation of the financial
statements and the agreement of management and, where appropriate, those charged with governance
to the premise2 on which an audit is conducted. In order to establish whether the preconditions for an
audit are present, the auditor shall:
 Determine whether the financial reporting framework to be applied in the preparation of the
financial statements is acceptable; Factors that are relevant to the auditor’s determination of the
acceptability of the financial reporting framework applied by management include:
o The nature of the entity (for example, whether it is a business enterprise, a public sector
entity or a not for profit organization);
o The purpose of the financial statements (for example, whether they are prepared to
meet the common financial information needs of a wide range of users or the financial
information needs of specific users);
o The nature of the financial statements (for example, whether the financial statements
are a complete set of financial statements or a single financial statement); and
o Whether law or regulation prescribes the applicable financial reporting framework.

 Obtain the agreement of management that it acknowledges and understands its responsibility:
o For the preparation of the financial statements in accordance with the applicable
financial reporting framework, including where relevant their fair presentation;
o For such internal control as management determines is necessary to enable the
preparation of FS that are free from material misstatement whether due to fraud or error;
o To provide the auditor with:
 Access to all information of which management is aware that is relevant to the
preparation of the financial statements such as records, documentation, etc.;
 Additional information that the auditor may request from management for the
purpose of the audit; and
 Unrestricted access to persons within the entity from whom the auditor
determines it necessary to obtain audit evidence

5.1.2 Other Factors Affecting Audit Engagement Acceptance

 If management or those charged with governance impose a limitation on the scope of the
auditor’s work in the terms of a proposed audit engagement such that the auditor believes the
limitation will result in the auditor disclaiming an opinion on the FS, the auditor shall not accept
such a limited engagement as an audit engagement, unless required by law or regulation to do so
 If the preconditions for an audit are not present, the auditor shall discuss the matter with
management. Unless required by law or regulation to do so, the auditor shall not accept the
proposed audit engagement:
o If the auditor has determined that the financial reporting framework to be applied in the
preparation of the financial statements is unacceptable. However, even if unacceptable,
if a law or regulation prescribes such, the auditor may nevertheless accept the
engagement, only when the following conditions are present:
 Management agrees to provide additional disclosures
 Terms of the engagement include that the audit report shall contain an
emphasis of a matter paragraph, and shall not include the phrase, “present
fairly in all material aspects”
o If the agreement with regards to management’s responsibility has not been obtained
  If the auditor was only engaged subsequent to the end of the entity’s reporting period, the
auditor should determine whether circumstances permit an audit in accordance with PSAs and
expression of an unmodified opinion. Otherwise, the auditor should discuss with the prospective
client the possibility of rendering a qualified opinion or disclaimer of opinion. However, in some
cases, the auditor may remedy the audit limitations, such as those relating to the existence of
physical inventory.

5.2 Consideration of Quality Controls

Acceptance of Client Relationship
An important element of a firm’s quality control policies and procedures is a system for deciding whether to
accept or reject an audit engagement. In making this decision, the firm should consider:
 Its competence – before accepting an audit engagement, the auditor should obtain a preliminary
knowledge or understanding of the client’s business and industry to determine whether the auditor
has the degree of competence required by the engagement or whether such competence can be
obtained before the completion of the audit.
 Its independence – before accepting an audit engagement, the auditor should consider whether there
are any threats to the audit team’s independence and objectivity, and if so, whether adequate
safeguards can be established
 Its ability to serve the client properly – before accepting an audit engagement, it is necessary to
ensure that there are enough qualified personnel to perform the audit
 The integrity of the prospective client’s management – to minimize the likelihood of association with
clients whose management lacks integrity, before accepting an audit engagement, the auditor should
(a) make inquiries of appropriate parties in the business community, such as prospective client’s
banker, legal counsel or underwriter to obtain information about the client’s reputation, and (b)
communicate with the predecessor auditor, which may either be written or oral.
o Prior to the acceptance of an audit engagement with a client who has terminated the
services of the predecessor auditor, the CPA should advise the client of the intention to
contact the predecessor auditor and request permission for the contact. This is done with
respect to the confidentiality clause of the Code of Ethics. Refusal of the client will raise
questions as to whether the engagement will be accepted.
o Once permission is obtained, the incoming auditor should inquire into matters, such as:
 Predecessor’s understanding as to the reasons for the change of auditors
 Any disagreement between the predecessor auditor and the client
 Facts that might have a bearing on the integrity of prospective client’s management
o The incoming auditor, upon the permission of the predecessor auditor, may also review the
working papers of the latter. Review may cover analyses relating to contingencies and
balance sheet accounts.

Note: The Code of Ethics requires the predecessor auditor to respond fully to the successor
auditor’s inquiry and advise the successor auditor if there any professional reasons why the
engagement should not be accepted. However, the response can be limited to stating that
no information will be provided when there are actual or potential legal problems between
the client and the predecessor.

Continuance of Client Relationship

Clients should be evaluated at least once a year, or upon occurrence of major events, such as changes in
management, directors, ownership, nature or client’s business, or other changes that may affect the scope of
the examination.
5.3 Audit Engagement Terms and Engagement Letter
5.3.1 Initial Agreement of Terms
The auditor shall agree the terms of the audit engagement with management or those charged with
governance, as appropriate, and document them in an engagement letter (must be written). Such
engagement letter is normally signed by a board of directors representative.
 PSA 210 par. 10 provides that the agreed terms of the audit engagement shall be recorded in an
audit engagement letter or other suitable form of written agreement and shall include:
o The objective and scope of the audit of the financial statements;
o The responsibilities of the auditor, including his/her responsibility to communicate to
those charged with governance significant internal control deficiencies that may be
discovered during the audit;
o The responsibilities of management, including its compliance with laws and regulations;
o Identification of the applicable financial reporting framework for the preparation of the
financial statements; and
o Reference to the expected form and content of any reports to be issued by the auditor
and a statement that there may be circumstances in which a report may differ from its
expected form and content
 PSA 210 par. A23 and A24 provides that the engagement letter may include:
o The fact that because of the inherent limitations of an audit, together with the inherent
limitations of internal control, there is an unavoidable risk that some material
misstatements may not be detected, even though the audit is properly planned and
performed in accordance with PSAs
o The expectation that management will provide written representations
o The basis on which fees are computed and any billing arrangements
o Arrangements concerning the involvement of other auditors, external or internal, and
experts in some aspects of the audit
o Arrangements to be made with the predecessor auditor, if any
o Forms of report to be issued

Audit of Components
When the auditor of a parent entity is also the auditor of a component, the factors that may influence the
decision whether to send a separate audit engagement letter to the component include the following:
 Who appoints the component auditor;
 Whether a separate auditor’s report is to be issued on the component;
 Legal requirements in relation to audit appointments;
 Degree of ownership by parent; and
 Degree of independence of the component management from the parent entity

5.3.2 Special Circumstances for Recurring Audits

The auditor may decide not to send a new audit engagement letter or other written agreement each
period. However, the following factors may make it appropriate to revise the terms of the audit
engagement or to remind the entity of existing terms:
 Any indication that the entity misunderstands the objective and scope of the audit
 Any revised or special terms of the audit engagement.
 A recent change of senior management.
 A significant change in ownership.
 A significant change in nature or size of the entity’s business.
 A change in legal or regulatory requirements.
 A change in the financial reporting framework adopted in the preparation of the FS
 A change in other reporting requirements
 5.3.3 Change of Terms
The auditor shall not agree to a change in the terms of the audit engagement where there is no
reasonable justification for doing so. A change in circumstances that affects the entity’s requirements or a
misunderstanding concerning the nature of the service originally requested may be considered a
reasonable basis for requesting a change in the audit engagement. In contrast, a change may not be
considered reasonable if it appears that the change relates to information that is incorrect, incomplete or
otherwise unsatisfactory.
 If the terms of the audit engagement are changed, the auditor and management shall agree on
and record the new terms of the engagement in an engagement letter or other suitable form of
written agreement.
 If the auditor is unable to agree to a change of the terms of the audit engagement and is not
permitted by management to continue the original audit engagement, the auditor shall:
o Withdraw from the audit engagement where possible under applicable law or
regulation; and
o Determine whether there is any obligation, either contractual or otherwise, to report
the circumstances to other parties, such as those charged with governance, owners or
regulators.

Request to Change from an Audit to Review or a Related Service

If, prior to completing the audit engagement, the auditor is requested to change the audit engagement to
an engagement that conveys a lower level of assurance, the auditor shall determine whether there is
reasonable justification for doing so.
 Any legal or contractual implications of the change should be considered by the auditor.
 If the auditor concludes that there is reasonable justification to change the audit engagement to
a review or a related service, the audit work performed to the date of change may be relevant to
the changed engagement; however, the work required to be performed and the report to be
issued would be those appropriate to the revised engagement. In order to avoid confusing the
reader, the report on the related service would not include reference to:
o The original audit engagement; or
o Any procedures that may have been performed in the original audit engagement, except
where the audit engagement is changed to an engagement to undertake agreed-upon
procedures and thus reference to the procedures performed is a normal part of the
report.

5.4 Preliminary Engagement Activities (PSA 300)

The auditor’s consideration of client continuance and ethical requirements, including independence, occurs
throughout the audit engagement as conditions and changes in circumstances occur. Performing initial
procedures on both client continuance and evaluation of ethical requirements (including independence) at the
beginning of the current audit engagement means that they are completed prior to the performance of other
significant activities for the current audit engagement. For continuing audit engagements, such initial
procedures often occur shortly after (or in connection with) the completion of the previous audit.

Upon acceptance of the client, the auditor shall undertake the following activities at the beginning of the
current audit engagement:
 Performing procedures required by PSA 220 regarding the continuance of the client relationship and
the specific audit engagement;
 Evaluating compliance with ethical requirements, including independence, as required by PSA 220;
 Establishing an understanding of the terms of the engagement, as required by PSA 210

Note: Performing the preliminary engagement activities at the beginning of the current audit engagement
assists the auditor in identifying and evaluating events or circumstances that may adversely affect the
auditor’s ability to plan and perform the audit engagement.