Philippine School of Business Administration

Manila

Integrated Review - Auditing BLD

2nd Semester 2021-2022

Agreeing the Terms of the Audit Engagement

PSA 210

Introduction
The objective of the auditor is to accept or continue an audit engagement only when the basis upon which it is
to be performed has been agreed, through:
a. Establishing whether the preconditions for an audit are present; and
b. Confirming that there is a common understanding between the auditor and management and, where
appropriate, those charged with governance of the terms of the audit engagement.

Scope of this PSA

Assurance engagements, which include audit engagements, may only be accepted when the practitioner
considers that relevant ethical requirements such as independence and professional competence will be
satisfied, and when the engagement exhibits certain characteristics.

This PSA deals with those matters (or preconditions) that are within the control of the entity and upon which it
is necessary for the auditor and the entity’s management to agree.

Preconditions for an Audit

In order to establish whether the preconditions for an audit are present, the auditor shall:

(a) Determine whether the financial reporting framework to be applied in the preparation of the financial
statements is acceptable; and

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

Limitation on Scope Prior to 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 financial statements, the auditor shall not accept such a limited engagement as an
audit engagement, unless required by law or regulation to do so.

Other Factors Affecting Audit Engagement Acceptance

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:
(a) If the auditor has determined that the financial reporting framework to be applied in the preparation of the
financial statements is unacceptable, or
(b) If the agreement has not been obtained.

Agreement on Audit Engagement Terms

The auditor shall agree the terms of the audit engagement with management or those charged with governance,
as appropriate.

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Agreeing the Terms of the Audit Engagement

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:
a. The objective and scope of the audit of the financial statements;
b. The responsibilities of the auditor;
c. The responsibilities of management;
d. Identification of the applicable financial reporting framework for the preparation of the financial
statements; and
e. 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.

When relevant, the following points could also be made in the audit engagement letter:
• Arrangements concerning the involvement of other auditors and experts in some aspects of the audit.
• Arrangements concerning the involvement of internal auditors and other staff of the entity.
• Arrangements to be made with the predecessor auditor, if any, in the case of an initial audit.
• Any restriction of the auditor’s liability when such possibility exists.
• A reference to any further agreements between the auditor and the entity.
• Any obligations to provide audit working papers to other parties.
• Also, may make reference to:
• Elaboration of the scope of the audit,
• The form of any other communication of results of the audit engagement.
• 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.
• Arrangements regarding the planning and performance of the audit, including the
composition of the audit team.
• The expectation that management will provide written representations
• The agreement of management to make available to the auditor draft financial
statements and any accompanying other information in time to allow the auditor 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, of which management may become aware during the period from
the date of the auditor’s report to the date the financial statements are issued.
• The basis on which fees are computed and any billing arrangements.
• A request for management to acknowledge receipt of the audit engagement letter and
to agree to the terms of the engagement outlined therein.

Relevant Ethical Requirements

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:

1. competence, independence, ability to serve the client properly, and

2. the integrity of the prospective client’s management.

Integrity of management

The recent wave of litigation involving auditors has made pre-acceptance investigation procedures very
important. PSA 220 requires the firm to conduct a background investigation of the prospective client in order to
minimize the likelihood of association with clients whose management lacks integrity. This task would involve:

• Communication to third parties

Making inquiries of appropriate parties in the business community such as prospective client’s banker, legal
counsel, or underwriter to obtain information about the reputation of the client.
• Communicating with the predecessor auditor

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Communication with the predecessor auditor is not only a matter of courtesy to the predecessor auditor.
This communication allows the incoming auditor to obtain information about the client that will be useful in
determining whether the engagement will be accepted.

But before the incoming auditor contacts the predecessor auditor, the incoming auditor should obtain client’s
permission to communicate with the predecessor auditor. This is a necessary procedure because the code of
ethics prevents an auditor from disclosing any information obtained about the client without the client’s explicit
permission. Refusal of the prospective client’s management to permit this will raise serious questions as to
whether the engagement will be accepted.

Once permission of the client is obtained, the incoming auditor should inquire into matters that may affect the
decision to accept the engagement. This includes question regarding:

§ The predecessor auditor’s understanding as to the reasons for the change of auditors.
§ Any disagreement between the predecessor auditor and the client.
§ Any facts that might have a bearing on the integrity of the prospective client’s management.

The Code of Ethics requires the predecessor auditor to respond fully to the incoming auditor’s inquiry and advise
the incoming auditor if there are any professional reasons why the engagement should not be accepted.

Audits 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.
If law or regulation prescribes in sufficient detail the terms of the audit engagement, the auditor need not
record them in a written agreement, except for the fact that such law or regulation applies and that
management acknowledges and understands its responsibilities, ofcourse except if the law provides it to be
exactly in writing.

Recurring Audits
On recurring audits, the auditor shall assess whether circumstances require the terms of the audit engagement
to be revised and whether there is a need to remind the entity of the existing terms of the audit engagement.
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 financial statements.
• A change in other reporting requirements.

Acceptance of a Change in the Audit Engagement

The auditor shall not agree to a change in the terms of the audit engagement where there is no reasonable
justification for doing so.

Request to Change the Terms of the Audit Engagement

A request from the entity for the auditor to change the terms of the audit engagement may result from a change
in circumstances affecting the need for the service, a misunderstanding as to the nature of an audit as originally
requested or a restriction on the scope of the audit engagement, whether imposed by management or caused
by other circumstances. The auditor is required to consider the justification given for the request, particularly
the implications of a restriction on the scope of the audit engagement.

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Agreeing the Terms of the Audit Engagement

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. An example might be where the auditor is unable to obtain
sufficient appropriate audit evidence regarding receivables and the entity asks for the audit engagement to be
changed to a review engagement to avoid a qualified opinion or a disclaimer of opinion.

Request to Change to a 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.

Before agreeing to change an audit engagement to a review or a related service, an auditor who was engaged to
perform an audit in accordance with PSAs may need to assess, any legal or contractual implications of the
change.

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:

a. The original audit engagement; or

b. 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.

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:
1. (a) Withdraw from the audit engagement where possible under applicable law or regulation; and
2. (b) 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.

MULTIPLE CHOICE QUESTIONS

1. Prior to the acceptance of an audit engagement with a client who has terminated the services of the
predecessor auditor, the CPA should
a. Obtain the client’s signature in the engagement letter.
b. Obtain an understanding regarding the client’s industry and business.
c. Not communicate with the predecessor auditor because this would in effect be asking the auditor to
violate the confidential relationship between auditor and client.
d. Advise the client of the intention to contact the predecessor auditor and request permission for the
contact.

2. Before accepting an audit engagement, a successor auditor should make specific inquiries of the
predecessor auditor regarding the predecessor’s
a. Opinion of any subsequent events occurring since the predecessor’s audit report was issued.
b. Understanding as to the reasons for the change of auditors.
c. Awareness of the consistency in the application of GAAP between periods.
d. Evaluation of all matters of continuing accounting significance.

3. A successor auditor most likely would make specific inquiries of the predecessor auditor regarding
a. Specialized accounting principles of the client’s industry.
b. The competency of the client’s internal audit staff.
c. The uncertainty inherent in applying sampling procedures.
d. Disagreements with management as to auditing procedures.

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Agreeing the Terms of the Audit Engagement

4. Which of the following should an auditor obtain from the predecessor auditor prior to accepting an audit
engagement?
a. Analysis of balance sheet accounts
b. Analysis of income statement accounts
c. All matters of continuing accounting significance
d. Facts that might bear on the integrity of management

5. When an independent auditor is approached to perform an audit for the first time, he or she should make
inquiries of the predecessor auditor. Inquiries are necessary because the predecessor may be able to
provide the successor with information that will assist the successor in determining whether
a. The predecessor’s work should be used.
b. The company rotates auditors.
c. In the predecessor’s opinion, control risk is low.
d. The engagement should be accepted.

6. If permission from client to discuss its affairs with the proposed auditor is denied by the client, the
predecessor auditor should:
a. Keep silent of the denial.
b. Disclose the fact that the permission to disclose is denied by the client.
c. Disclose adequately to proposed auditor all noncompliance made by the client.
d. Seek legal advice before responding to the proposed auditor

7. The objective and scope of the audit and the extent of the auditor’s responsibilities to the client are best
documented in
a. Independent auditor’s report c. Client’s representation letter
b. Audit engagement letter d. Audit program

8. Arrangements concerning which of the following are least likely to be included in engagement letter?
a. A predecessor auditor.
b. Fees and billing.
c. CPA investment in client securities.
d. Other services to be provided in addition to the audit.

9. The following are valid reasons why an auditor sends to his client an engagement letter:
A B C D

a. Avoid misunderstanding with respect to Yes Yes No Yes

engagement
b. Confirms the auditor’s acceptance of the Yes Yes Yes No
appointment
c. Objective and scope of the audit Yes Yes Yes Yes

d. Assures CPA’s compliance to GAAS Yes No No Yes

10. Which of the following is appropriately included in an audit engagement letter?

I. Because of the test nature and other inherent limitations of an audit, together with the inherent
limitations of any accounting and internal control system, there is an unavoidable risk that even some
material misstatements may remain undiscovered.
II. The audit will be made with the objective of expressing an opinion on the financial statements.
III. An audit also includes assessing the accounting procedures used and significant estimates made by
management.
a. I and II c. II and III
b. I and III d. I, II and III

11. Which of the following is least likely included in an audit engagement letter?
a. The objective of financial reporting.
b. Management responsibility for the financial statements.
c. The form of any reports or other communication of the results of the engagement.
d. Arrangement concerning the involvement of other auditors or experts in some aspects of the audit.

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12. An audit engagement letter least likely includes

a. A reference to the inherent limitation of an audit that some material misstatements may remain
undiscovered.
b. Identification of specific audit procedures that the auditor needs to undertake.
c. Description of any letters or reports that the auditor expects to submit to the client.
d. Arrangements concerning the involvement of internal auditors and other client’s staff.

13. Which of the following least likely requires the auditor to send a new engagement letter?
a. An indication that the client misunderstands the objective and scope of the audit.
b. Any revised or special terms of the engagement.
c. A recent change in the audit firm’s management.
d. Legal requirements and other government agencies’ pronouncements.

14. Which of the following least likely influence the auditor’s decision to send a separate engagement letter to
a component of parent entity client?
a. Legal requirements
b. Degree of ownership over a component entity by parent company
c. Location of the principal place of business of the component entity
d. Who appoints the auditor of the component

15. According to PSA 210, which of the following statements is correct?

a. The auditor and the client need not agree on the terms of the engagement.
b. Where the terms of the engagement are changed, the auditor and the client need not agree on the
new terms if they already agreed on the old terms.
c. The engagement letter assists in the supervision and review of the audit work.
d. The auditor may agree to a change of engagement where there is reasonable justification for doing so.

16. Which of the following is a NOT valid reason for a change of the engagement to a lower “level of
assurance”?
a. Change in circumstances affecting the need for the service.
b. Restriction on the scope of the engagement.
c. Misunderstanding as to the nature of the engagement originally requested.
d. The client’s need is satisfied by an engagement that provides lower level of assurance.

17. When a change in the type of engagement from higher to lower level of assurance is reasonably justified,
the report based on the revised engagement
a. Should contain a separate paragraph that refers to the original engagement.
b. Should always refer to any procedures that may have been performed in the original engagement.
c. Should qualify the opinion due to scope limitation.
d. Omits reference to the original engagement.

18. Which of the following actions may be appropriate if the auditor is unable to agree to a change of the
engagement and is not permitted to continue the original engagement
I. Issue a qualified opinion due to a significant scope limitation.
II. Auditor should withdraw from the engagement.
III. Consider whether there is any obligation to report to the board of directors or shareholders the
circumstances necessitating withdrawal
a. I only c. II and III
b. I and II d. I, II and III

19. The auditor should document the understanding established with a client through a(n)
a. Oral communication with the client.
b. Written communication with the client.
c. Written or oral communication with the client.
d. Completely detailed audit plan.

20. Which of the following factors most likely would influence an auditor’s determination of the auditability of
an entity’s financial statements?
a. The complexity of the accounting system.

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Agreeing the Terms of the Audit Engagement

b. The existence of related-party transactions.

c. The adequacy of the accounting records.
d. The operating effectiveness of control procedures.

“You have to train your mind to be stronger than your emotions or else you’ll lose yourself every
time”

-Anonymous

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