ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)
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Chapter 5: Practice management
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Obtaining and charging for professional work
Obtaining professional work
Advertising and publicity
Practice descriptions
Fees
Tendering
Credit control within an audit firm
3 Obtaining and charging for professional work
3.1 Obtaining professional work
Audit practices will want to increase the size of their client base as a means of
increasing the profits of the practice. This can be achieved by:
promoting their (good) reputation in the business community
recommendations from existing clients
advertising
publicity and promotion (such as sponsorship activities).
3.2 Advertising and publicity
Advertising and publicity activities by audit firms are regulated by the ACCA and
IFAC rules. The main requirements are that the advertising and publicity material
used by any firm:
must not bring into disrepute the professional body, the firm or the profession as
a whole
must not be misleading
must not discredit the services provided by other firms
must not break any locally-recognised codes of advertising practice.
In addition, it is recommended that advertising and publicity material should avoid
any reference to fees. If fees are mentioned, there should be a statement of the basis
on which the fees are to be charged. Comments about fees:
must not be misleading
must not offer discounts, and
must not make comparison with the fees of other service providers.
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3.3 Practice descriptions
Unincorporated firms may describe themselves as ‘Chartered Certified
Accountants’ or ‘Certified Accountants’ provided that:
at least half the partners are ACCA members
the principals control at least 51% of the voting rights under the partnership
agreement.
3.4 Fees
The question of setting a ‘price’ for the provision of a service is always a sensitive
matter, because of disputes that may arise if the fees are unreasonable.
In establishing the fee for an audit (or for other professional work), the auditor
should follow professional guidance.
For example the ACCA rules require that:
fees should be mentioned in the engagement letter (see below)
fees should reflect
− the time spent on the audit and the level and experience of staff used
− the importance of the work to the client
− any specific overheads or other costs incurred
fees should not be based on a percentage or on contingency calculations, unless
there is an established convention of doing so (for example, in insolvency work)
Firms must then charge the client the fee that they have quoted or the tender that
the client has accepted, unless extra work is required. If extra work is required that
was not expected when the original fee was agreed, the firm must provide an
explanation to justify the higher fee.
3.5 Tendering
Tendering for audit work is now a widely-used practice, especially by larger
companies. When it invites two or more audit firms to submit a tender for its audit
work, a company may want to change its auditors. However, a company may also
invite firms to tender for the audit work when the term of the appointment for the
current audit firm has come to an end. In this case, if the current auditor wishes to
be re-appointed, it will have to go through a tendering process.
Before submitting a tender, the audit firm should consider several matters. It must
not submit a tender for the work unless it can give satisfactory answers to the
following questions:
Does the firm have the expertise to carry out this audit?
Does the firm have (or could it have) sufficient staff available at the appropriate
time?
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Are there any ethical reasons why the firm could not act (for example, a problem
with independence, or a conflict of interest)?
Are there any problems, of which the firm is aware, with the current audit or
auditors?
Specifically in relation to a tender, the firm should also ask itself:
Why has it been asked to tender?
Could it (and should it?) offer to do the audit for a lower fee than other firms are
likely to quote?
Are there any reasons why this audit is particularly attractive to the firm? For
example, will the work be carried out at a quiet time of year, or is the company
in an industry area where the firm wishes to develop its audit experience and
expertise?
What audit risks might arise with this particular client?
The tendering process
The principal benefit to the client of a tendering process should be lower audit fees,
because several firms are competing for the work.
In response to the pressure to reduce their fees, audit firms have become more
efficient and lowered their costs. Even so, the tendering process can still be ‘high
risk’ for a firm. For example:
The firm needs to be confident that the client is one that it can deal with
professionally and economically if the tender is accepted.
If the tender is not accepted, the time and cost involved in the tendering process
(which may be considerable) has been wasted. The firm needs to be sure that a
sufficiently high proportion of its tenders will be successful, to justify the costs.
The tendering process should be broken down into the following stages (assuming
that a firm is submitting a tender for the audit of a new client):
(1) Collect background information about the possible new client. (This is
necessary when evaluating any new client, whether the fee is to be set by
tender or by any other method.)
(2) Establish the precise scope of the work to be performed and the specific
requirements of the prospective client.
(3) Carry out a preliminary audit risk assessment and prepare a preliminary plan
for the audit. The plan must cover the staffing requirements and the time
requirements for the work.
(4) Estimate a fee.
(5) Prepare a submission document for the potential client. The contents of this
document will typically include:
− an outline of the key characteristics of the firm
− clarification of the nature of the audit work or other non-audit work to be
performed
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− a statement of the requirements of the client and how the firm will comply
with them
− an outline of how the work will be performed
− the proposed fee and the basis of its calculation
− the range of other services which the firm could offer to the client.
(6) If required, prepare and give a presentation to the potential client.
Evaluating the tender
In evaluating the tender, the client (company) is likely to consider the following
issues:
Fees
The services that the firm is able to provide
Geographical locations and coverage of the firm’s offices
Expertise of the firm and its staff
Reputation of the firm
Whether the senior management of the company think that they will be able to
work well (on a personal level) with the potential engagement partner and key
audit staff
The formal presentation itself by the audit firm
The extent to which the company wants to change its audit firm, and its
dissatisfaction with the current audit firm.
Lowballing
Lowballing is the practice of tendering for the audit work at a very low fee, with the
objective of winning the audit. If it is successful in obtaining the audit, the firm will
hope that:
it will be able to raise the audit fee in future years, or
it will be able to recover losses on the audit fee by providing other, more
lucrative non-audit services.
Although there is no evidence that lowballing leads to a poor-quality audit, the fact
that it exists does nothing to improve the reputation of the auditing profession. The
existence of low fees may suggest to the business community and to the general
public that audit work is of a low quality. All fees should be sufficiently adequate to
compensate a firm for the work that it carries out.
3.6 Credit control within an audit firm
An audit firm does not just charge fees. It has to collect the fees that it charges. A
failure to invoice clients promptly or a failure to collect payment within a reasonable
time after the invoice date would be an indication of poor credit management. Any
such management weaknesses should be corrected if they occur.
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Occasionally, non-payment of fees may be due to the fact that the audit client is in
financial difficulties and cannot pay.
Overdue fees are a threat to the independence and objectivity of the auditor,
because it might be argued that audit work has been provided free of charge. If
the unpaid amount has been overdue for a long time, it could be regarded as a
form of loan by the audit firm to the client.
The risk to auditor independence could be significant if the unpaid amount is
material.
When a client is in temporary financial difficulties it is permissible for an auditor
to make commercial arrangements for staged payments of the fees receivable.
The client should be made aware, however, of the ethical problems that non-
payment or late payment create for the audit firm.
For future audits, if the audit engagement is retained, the auditor should pay
particular attention to the going concern assumption. If the client still has
continuing cash flow problems, the going concern assumption may be
challenged.
When unpaid fees are owed by a client, and the period of late payment is in excess
of what might be regarded as commercially acceptable, the audit firm should
consider whether it would be ethically appropriate to resign as auditors.
The ethics partner of the firm should be asked to assess the ethical threat to the
firm’s independence and integrity.
If the decision is to continue as auditor of the client, the reason should be
documented.
The most recent audit papers should be checked to ensure that sufficient
appropriate evidence was obtained to support the going concern assumption in
the financial statements.
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Agreeing the terms of audit engagements: ISA 210
The objective of the engagement letter
The content of the engagement letter
Annual review of the engagement letter
Acceptance of a change in the terms of the engagement
4 Agreeing the terms of audit engagements: ISA 210
4.1 The objective of the engagement letter
The objective of the auditor, per ISA 210 Agreeing the terms of audit engagements is
accept or continue an audit engagement only when the basis upon which it is to be
performed has been agreed. This is done by:
establishing whether the preconditions for an audit are present; and
confirming that there is a common understanding between the auditor and
management.
To establish if the preconditions for an audit are present ISA 210 requires the
auditor to:
establish if the financial reporting framework to be used in the preparation of the
financial statements is acceptable
obtain the agreement of management that it acknowledges and understands its
responsibility:
- for the preparation of the financial statements
- for internal controls to ensure that the financial statements are not materially
misstated
- to provide the auditor with all relevant and requested information and
unrestricted access to all personnel.
The auditor is required to refuse the engagement where:
a limitation on scope is imposed by management such that he auditor would be
unable to express an opinion on the financial statements, or
the financial reporting framework to be used in the preparation of the financial
statements is unacceptable, or
management do not agree to the above responsibilities.
4.2 The content of the engagement letter
The engagement letter should include reference to the following:
The objective and scope of the audit.
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The responsibilities of the auditor.
The responsibilities of management.
Identification of the underlying financial reporting framework.
Reference to the expected form and content of any reports to be issued.
Because it specifies what the auditor will be doing and what the auditor’s exact
responsibilities will be, the engagement letter is also seen to be an important way of
reducing the ‘expectation gap’. This is the difference between:
the view of the role and responsibilities of the auditors that is held by the users
of financial statements, and
the auditor’s actual (statutory) role and responsibilities.
In addition to the above, the auditor may feel that it is appropriate to include
additional points in the engagement letter, such as:
Regulations, ISAs, and ethical pronouncements.
The fact that because of the inherent limitations of an audit, and the inherent
limitations of internal control, there is an unavoidable risk that some material
misstatements may not be detected even though the audit was properly planned
and
performedinaccordancewithISAs.
Arrangements regarding the planning and performance of the audit, including
the composition of the audit team.
Theexpectationthatmanagementwillprovidewrittenrepresentations.
Thebasisonwhichfeesarecomputedandanybillingarrangements.
Arequestformanagementtoacknowledgereceiptoftheengagementletterand
toagreetoitsterms.
Arrangementsconcerningtheinvolvement ofotherauditors,expertsorinternal
auditors(orotherstaffoftheentity).
Any restriction of the auditor’s liability when such possibility exists.
Best practice also recommends that the engagement letter should include an
explanation of the auditor’s responsibility with regard to anti-money laundering
checks and procedures.
4.3 Annual review of the engagement letter
The engagement letter that is issued on the initial appointment of the firm as
auditors may specify that its provisions will apply to all future audits, until it is
revised.
However, ISA 210 requires the auditor, for recurring audits, to assess whether:
circumstances mean that the terms of engagement need to be revised
management need to be reminded of the existing terms of the engagement.
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The ISA suggests that the following factors may indicate that the above is
appropriate:
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.
4.4 Acceptance of a change in the terms of the engagement
The entity might, in certain circumstances, ask the auditor to change the terms of the
audit engagement. This might result from a genuine change in circumstances or
from a misunderstanding as to the nature of an audit as originally requested.
However, it could result from a situation where the auditor is unable to obtain
sufficient appropriate audit evidence regarding a material item. The entity might
then ask for the audit engagement to be changed to a review engagement to avoid a
qualified opinion or a disclaimer of opinion.
ISA 210 requires the auditor to consider the justification for the request and whether
it is “reasonable”.
If the auditor considers that it is a reasonable request then revised terms should
be agreed and recorded.
If the auditor is unable to agree to a change of terms he should withdraw from
the engagement and consider whether there is any obligation to report the
circumstances to those charged with governance, owners or regulators.
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Paper P7 (INT)
Advanced audit and assurance
CHAPTER
6
The audit approach
Contents
1 Audit strategies
2 The business risk approach
3 The systems-based approach
4 The statement of financial position approach
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Audit strategies
A choice of audit strategies
Summary of available audit strategies
Factors in the choice of audit strategy
1 Audit strategies
1.1 A choice of audit strategies
An audit strategy is the overall approach that the auditor decides to take for an
audit, from which a detailed audit plan can be developed.
Several possible audit strategies are available:
a business risk approach, or risk-based approach
a systems-based approach
a substantive testing approach
a statement of financial position approach (usually for small entities).
These strategies are not mutually exclusive, and they may be used in combination.
For example, although most of the work on a particular audit might be ‘systems-
based’, the auditor will also carry out some substantive testing on balances and
transactions.
The different approaches describe the emphasis of the audit approach, and where
the auditor expects to find most of the evidence that he needs to reach an audit
opinion about the ‘fair presentation’ or ‘true and fair view’ in the financial
statements.