5.

Preliminary Engagement Activities

References:
a. Code of Ethics for Professional Accountants in the Philippines
b. PSQC 1, Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and
Other Assurance
and Related Services Engagements
c. PSA 210 (Redrafted), Agreeing the terms of Audit Engagements
d. PSA 220 (Redrafted), Quality Control for an Audit of Financial Statements
Overview
During this phase of audit, the auditor shall undertake the following preliminary engagement activities:
• Performing procedures regarding the acceptance of the client relationship and the specific audit
engagement; including communicating with the predecessor auditor, if applicable; and
• Agreeing the basis of audit engagement, such as:
§ Establishing preconditions for an audit; and
§ Agreeing the terms of the engagement.

Client Acceptance and Continuance

The auditor shall only undertake or continue audit engagement where the auditor:
• is competent to perform the engagement and has the capabilities, time and resources to do so;
• complies with relevant ethical requirements; and
• considers the integrity of the client.

Communication with Predecessor Auditor

For prospective clients that have previously been audited by another CPA firm, the new (successor)
auditor is required, under the code of ethics, to communicate with the predecessor auditor to help the
successor auditor evaluate whether to accept or decline the engagement.
The burden of initiating the communication rests with the successor auditor. The successor auditor
shall advise the client of the intention to contact the predecessor auditor and request permission for
the contact. However, confidentiality requires that the predecessor auditor obtain permission from the
client before the communication can be made.

The successor auditor normally inquires the following from the predecessor auditor about the
prospective client:
(RAID)
• Integrity of management
• Disagreements with management about audit procedures or accounting principles
• Communication with Audit Committee about fraud, illegal acts, or internal control
• Reason for change in auditor
If a client will not permit the communication or the predecessor will not provide a comprehensive
response, the successor should seriously consider the acceptability of a prospective engagement,
without considerable other investigation.

Basis of Audit Engagement

In addition, the auditor shall accept or continue an audit engagement only when the basis of audit
engagement has been agreed, through:
• Establishing preconditions for an audit; and
• Confirming common understanding between the auditor and management and, where appropriate,
those charged with governance (TCWG) on the terms of the audit engagement.

Preconditions for an Audit

The auditor shall establish the presence of the preconditions for an audit by:
• determining that the financial reporting framework (FRF) is acceptable and is available to intended
user applied to FSs; and
• obtaining the agreement of management regarding its responsibility and, where appropriate, TCWG
to the premise on which an audit is conducted. If the preconditions are not present, the auditor shall
discuss the matter with management, if not resolved, the auditor should not accept the engagement
unless required by law or regulation.
Management’s Responsibilities
The following are the management’s responsibilities, which constitute the premise on which the audit
is conducted:
• Preparation and presentation of the financial statements
• Design, implementation and monitoring of internal control to financial statements
• To provide the auditor with:
§ Access to all information relevant to audit
§ Additional information the auditor may request
§ Unrestricted access to persons within the entity

Limitation on Scope Prior to Audit Engagement Acceptance

The auditor shall not accept an audit engagement, if management or those charged with governance
imposes a limitation on the scope of work that will result to disclaimer of opinion unless required by
law or regulation to do so.

Agreement on Audit Engagement Terms

After the auditor has decided to accept or continue an audit engagement, the auditor and the client
should agree the terms of the engagement, preferably through the audit committee, if any. The
agreed terms need to be recorded in an audit engagement letter or other suitable form of contract.
Audit engagement letter is a written terms of an engagement in the form of a letter by the auditor to
the client. An engagement letter documents and confirms the auditor’s acceptance of the
appointment. It is in the interest of both the client and the auditor that the auditor sends the
engagement letter, preferably before the commencement of the audit to help avoid
misunderstandings with respect to the engagement.

Contents of the Audit Engagement Letter

Primary Contents of the Audit Engagement Letter
Engagement letter primarily includes:
• The objective and scope of the audit;
• The responsibilities of the auditor;
• The responsibilities of management;
• Identification of the applicable FRF; and
• Reference to form and content of audit reports and statement regarding deviation from form and
content, in certain circumstances.

Additional Contents of the Audit Engagement Letter

Engagement letter may additionally include:
• Elaboration of the scope of the audit
• The form of any other communication of results of the audit
• Audit and internal control inherent limitations
• Planning and performance of the audit, including the composition of the audit team
• Written representations from management
• Draft financial statements from management
• Audit fees, including computation and billing
• Acknowledgement from management
• Involvement of other auditors and experts
• Involvement of internal auditors and other staff
• Arrangements with the predecessor auditor
• Any restriction of the auditor’s liability
• Further agreements between the auditor and the entity
• Any obligations to provide audit working papers to other parties

Audits of Components
When the auditor of a parent entity is also the auditor of a component, the following factors are
considered whether to send a separate engagement letter to the component:
• 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.
Recurring Audits
New engagement letter may not be sent annually to the same client. However, the auditor should
consider the following factors when sending new engagement letter:
• Misunderstanding of the objective and scope
• Any revised or special terms
• A recent change of senior management
• A significant change in ownership
• A significant change in entity’s nature or size
• A change in legal or regulatory requirements
• A change in the financial reporting framework
• A change in other reporting requirements

Example of an Audit Engagement Letter

To the appropriate representative of management or those
charged with governance of ABC Company

[The objective and scope of the audit]

You have requested that we audit the financial statements of ABC Company, which comprise the
statement of financial position as at December 31, 2021, and the statement of comprehensive
income, statement of changes in equity and statement of cash flows for the year then ended, and a
summary of significant accounting policies and other explanatory information. We are pleased to
confirm our acceptance and our understanding of this audit engagement by means of this letter. Our
audit will be conducted with the objective of our expressing an opinion on the financial statements.

[The responsibilities of the auditor]

We will conduct our audit in accordance with Philippine Standards on Auditing (PSAs). Those
standards require that we comply with ethical requirements and plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures
in the financial statements. The procedures selected depend on the auditor’s judgment, including the
assessment of the risks of material misstatement of the financial statements, whether due to fraud or
error. An audit also includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by management, as well as evaluating the overall
presentation of the financial statements. 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.
In making our risk assessments, we consider internal control relevant to the entity’s preparation of the
financial statements in order to design audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control.
However, we will communicate to you in writing concerning any significant deficiencies in internal
control relevant to the audit of the financial statements that we have identified during the audit.
Our audit will be conducted on the basis that [management and, where appropriate, those charged
with governance] acknowledge and understand that they have responsibility:
(a) For the preparation and fair presentation of the financial statements in accordance with Philippine
Financial Reporting Standards;
(b) 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
(c) To provide us with:
(i) 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;
(ii) Additional information that we may request from [management] for the purpose of the audit; and
(iii) Unrestricted access to persons within the entity from whom we determine it necessary to obtain
audit evidence.
As part of our audit process, we will request from [management and, where appropriate, those
charged with governance], written confirmation concerning representations made to us in connection
with the audit. We look forward to full cooperation from your staff during
our audit.
[Other relevant information]
[Insert other information, such as fee arrangements, billings and other specific terms, as appropriate.]

[Reporting]
[Insert appropriate reference to the expected form and content of the auditor’s report.]
The form and content of our report may need to be amended in the light of our audit findings.
Please sign and return the attached copy of this letter to indicate your acknowledgement of, and
agreement with, the arrangements for our audit of the financial statements including our respective
responsibilities.

XYZ & Co.

Acknowledged and agreed on behalf of ABC Company by
(signed)
Name and Title
Date