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chapter 2

Process of assurance:
obtaining an engagement
Contents
Introduction
Examination context
Topic List
1

Obtaining an engagement

Accepting an engagement

Agreeing terms of an engagement

Summary and Self-test


Technical reference
Answers to Self-test
Answers to Interactive questions

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Introduction

Learning objectives

Be aware of how assurance firms obtain work

Understand the key issues practitioners must consider before accepting engagements

Know what a letter of engagement is and what it does

Tick off

The specific syllabus reference for this chapter is: 1f.

Practical significance
In practice, the matters covered in this chapter are very important to assurance firms. It is important to
know how to obtain clients and therefore secure future revenue. It is important to only accept clients
which the firm is able to serve and engagements which the firm has the resources to carry out. It is
particularly important that all parties understand the nature of the work that will be carried out, as this may
prevent disputes and problems later on.
Another important area for practitioners is the increased client awareness and identification procedures
required to guard against involvement in money laundering. The crime of money laundering includes charges
which accountants may fall foul of. It is vital to practitioners that 'know your client' procedures are
understood by all staff and carried out properly.

Stop and think


Given the problems with assurance noted in the previous chapter, how can assurance firms ensure that
their clients understand the services they are being offered?

Working context
During your training, you are unlikely to be involved in obtaining clients or determining whether an
engagement is going to be accepted. However, if you continue in your career to higher levels, even
partnership, then these will be important practical issues for you.
However, you are the face of the assurance firm when carrying out engagements, and you may be in a
position where it is necessary to clarify the scope of the work that you are carrying out to aid a clients
understanding. In such a case, it might be necessary to refer to the terms of engagement between the firm
and the client, and it will be important that you understand what you are talking about, if asked.

Syllabus links
The issues of obtaining engagements will be looked at in much greater detail in the Audit and Assurance
paper at the Application level.

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PROCESS OF ASSURANCE: OBTAINING AN ENGAGEMENT

Examination context

Exam requirements
This is a fairly minor area for the exam, but you could expect at least one question on the scope of the
engagement (there is a question about engagement letters in the sample paper) and possibly another on the
considerations of the assurance firm when deciding to accept engagements.
In the assessment, candidates may be required to:

Identify acceptance procedures

Identify sources of information about new clients

Select procedures required by money laundering legislation

Determine the purpose of a letter of engagement

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1 Obtaining an engagement
Section overview

Accountants may sometimes be invited to tender for an audit.

How assurance firms obtain clients is an important practical question, but it is largely outside the scope of
this syllabus. In brief, you should be aware that:

Accountants are often invited to tender for particular engagements, which means that they offer a
quote for services, outlining the personnel, usually in competition with other firms which are tendering at
the same time.
In this syllabus, if the topics in this chapter are examined, it will be in the context of an accountant being
invited by a potential client to accept an engagement. We will go on now to look at the things which an
accountant must consider when he is so invited.

2 Accepting an engagement
Section overview

The present and proposed auditors should normally communicate about the client prior to the
audit being accepted.

The client must be asked to give permission for communication to occur. If the client refuses to give
permission, the proposed auditors must consider the reasons for such refusal.

The auditors must ensure they have sufficient resources (time and staff, for example) to carry out the
appointment.

This section covers the procedures that the auditors must undertake to ensure that their
appointment is valid and that they are clear to act.

2.1

Appointment considerations
Schedule C of ICAB Code of Ethics as well as IFAC Code of Ethics sets out the rules under which
accountants should accept new appointments. Before a new audit client is accepted, the auditors must
ensure that there are no independence or other ethical issues likely to cause significant problems with
the ethical code (i.e. significant threats to complying with the fundamental principles of ethical behaviour
see later in this text). Furthermore, new auditors should ensure that they have been appointed in a proper
and legal manner.
The nominee auditors must carry out the following procedures.

Acceptance procedures

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Ensure professionally qualified to act

Consider whether disqualified on legal or ethical grounds,


for example if there would be a conflict of interest with
another client. We will look in more detail at ethical
issues later in this Study Manual.

Ensure existing resources adequate

Consider available time, staff and technical expertise.

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Acceptance procedures
Obtain references

Make independent enquiries if directors not personally


known.

Communicate with present auditors

Enquire whether there are reasons/circumstances behind


the change which the new auditors ought to know, also as
a matter of courtesy.

Some of the basic factors for consideration are given below.

The integrity of those managing a company will be of great importance, particularly if the company is
controlled by one or a few dominant personalities.

The audit firm will also consider whether the client is likely to be high or low risk to the firm in terms
of being able to draw an appropriate assurance conclusion in relation to that client. The following table
contrasts low and high risk clients.
Low risk

High risk

Good long-term prospects

Poor recent or forecast performance

Well-financed

Likely lack of finance

Strong internal controls

Significant control weaknesses

Conservative, prudent accounting policies

Evidence of questionable integrity, doubtful accounting


policies

Competent, honest management

Lack of finance director

Few unusual transactions

Significant unexplained transactions or transactions with


connected companies

Where the risk level of a company's audit is determined as anything other than low, then the specific risks
should be identified and documented. It might be necessary to assign specialists in response to these risks,
particularly industry specialists, as independent reviewers. Some audit firms have procedures for closely
monitoring audits which have been accepted, but which are considered high risk.
Generally, the expected fees from a new client should reflect the level of risk expected. They should also
offer the same sort of return expected of clients of this nature and reflect the overall financial strategy of
the audit firm. Occasionally, the audit firm will want the work to gain entry into the client's particular
industry, or to establish better contacts within that industry. These factors will all contribute to a total
expected economic return.
The audit firm will generally want the relationship with a client to be long term. This is not only to enjoy
receiving fees year after year; it is also to allow the audit work to be enhanced by better knowledge of the
client and thereby offer a better service.
Conflict of interest problems can be significant; the firm should establish that no existing clients will cause
difficulties as competitors of the new client. Other services to other clients may have an impact here, not
just audit.
The audit firm must have the resources to perform the work properly, as well as any specialist
knowledge or skills. The impact on existing engagements must be estimated, in terms of staff time and
the timing of the audit.

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Sources of information about new clients
Enquiries of other sources

Bankers, solicitors

Review of documents

Most recent annual accounts, listing particulars, credit rating

Previous accountants/auditors

Previous auditors should be invited to disclose fully all


relevant information

Review of rules and standards

Consider specific laws/standards that relate to industry

Prospective auditors should seek the prospective clients permission to contact the previous auditors. If this
permission is not given, the prospective auditors should consider carefully the reason for such refusal when
determining whether or not to accept the appointment. Normally permission will be given, so the
prospective auditors can write to the outgoing auditors.

Example: Initial communication


This is an example of an initial communication.
To:

Retiring & Co
Chartered Accountants

Dear Sirs
Re: New Client Co Ltd
We have pleasure in informing you that we have been appointed as auditors of New Client Co Ltd For
the year XX June, 200X. Since you were the previous auditors of the company, we would like to know
from you if there is any professional reason as to why we should not accept the appointment.
Acquiring & Co
Chartered Accountants
Having negotiated these steps the auditors will be in a position to accept the nomination, or not, as the case
may be.

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Example: Appointment decision chart


Approach by potential
new audit client

Is this the first


audit?

Yes

Prospective auditor can


make own decision

No

Does client give


permission to
contact old
auditor?

No

Yes
Write for all information
pertinent to the
appointment

Does client give


old auditor
permission to
reply?

Prospective auditor should


consider carefully, the
reason for this refusal

No

Yes

Does old auditor


reply with
information
relevant to new
appointment?

No

Give old auditor due


notice then decide on
basis of knowledge
obtained otherwise

Yes
Accept/reject
appointment

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Interactive question 1: Accepting appointment

[Difficulty level: Easy]

Identify whether the following are true or false. The audit firm should consider the following factors when
determining whether to accept an engagement.
True

False

Whether the firm is ethically barred from acting.


Whether the firm has sufficient resources to carry out the engagement.
Whether the firm can make sufficient profit from the engagement.
Whether the client is new to the firm.
Whether the client gives permission to contact the outgoing auditors.
See Answer at the end of this chapter.

The following procedures should be carried out after accepting nomination.

Ensure that the outgoing auditors' removal or resignation has been properly conducted in
accordance with national legislation.
The new auditors should see a valid notice of the outgoing auditors' resignation, or confirm that the
outgoing auditors were properly removed.

Ensure that the new auditors' appointment is valid. The new auditors should obtain a copy of
the resolution passed at the general meeting appointing them as the company's auditors.

Set up and submit a letter of engagement to the directors of the company.

Where the outgoing auditors have fees still owing by the client, the new auditors need not decline
appointment solely for this reason. They should decide how far they may go in aiding the former auditors to
obtain their fees, as well as whether they should accept the appointment.
Once a new appointment has taken place, if applicable, the new auditors should obtain all books and
papers which belong to the client from the outgoing auditors. The outgoing auditors should ensure
that all such documents are transferred, unless they have a lien (a legal right to hold on to them) over the
books because of unpaid fees. The outgoing auditors should also pass any useful information to the new
auditors if it will be of help, without charge, unless a lot of work is involved.

2.2

Other assurance engagements


Similar considerations will be required for any assurance engagements. The legal considerations relating to
audit will not be relevant to other assurance engagements, but the ethical, risk and practical considerations
will be just as valid.

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3 Agreeing terms of an engagement


Section overview

An engagement letter should be sent to all clients to clarify the terms of the engagement.

Agreement of audit engagement terms must be in writing.

It must include an explanation of the scope of the audit, the limitations of an audit and the
responsibilities of auditors and those charged with governance.

It may contain other information concerning practical details of the audit.

The purpose of an engagement letter is to:

Define clearly the extent of the firm's responsibilities and so minimise the possibility of any
misunderstanding between the client and the firm

Provide written confirmation of the firms acceptance of the appointment, the scope of the
engagement and the form of their report

If an engagement letter is not sent to clients, both new and existing, there is scope for argument about the
precise extent of the respective obligations of the client and its directors and the auditors. The elements of
an engagement letter should be discussed and agreed with management before it is sent.
An engagement letter for any type of assurance engagement will contain the same contents as an audit
engagement letter (discussed below). Clearly details will be different (for instance, it will cover the scope of
the engagement, but the scope of an audit and the scope of a review of forecast information, for example,
will be different). An engagement letter for an assurance engagement other than audit is likely to refer to
specific fees for the engagement. As you will see below, as an audit engagement is often recurring, specific
fees are initially not mentioned.

3.1

Audit engagement letters


Auditing standards require that the auditor and the client should agree on the terms of the engagement. The
agreed terms must be in writing and the usual form would be a letter of engagement. Any other form of
appropriate contract, however, may be used.
Even in countries where the audit objectives and scope and the auditor's obligations are established by law,
an audit engagement letter may be informative for clients.
The auditors should send an engagement letter to all new clients soon after their appointment as
auditors and, in any event, before the commencement of the first audit assignment. They should also
consider sending an engagement letter to existing clients to whom no letter has previously been sent as
soon as a suitable opportunity presents itself.
The engagement letter must document and confirm the auditor's acceptance of the appointment, and
include a summary of the responsibilities of those charged with governance and the auditor, the scope of
the audit and the form of any reports. The form and remaining content of audit engagement letters may
vary for each client, but they would generally include reference to the following.

The objective of the audit of financial statements.

Management's responsibility for the financial statements.

The scope of the audit, including reference to applicable legislation, regulations, or pronouncements
of professional bodies to which the auditor adheres.

The form of any reports or other communication of results of the engagement.

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The fact that 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 misstatement may remain undiscovered.

Unrestricted access to whatever records, documentation and other information is requested in


connection with the audit.

The auditor may wish to include in the letter the following items.

Arrangements regarding the planning of the audit.

Expectation of receiving from management written confirmation of representations made in


connection with the audit.

Request for the client to confirm the terms of the engagement by acknowledging receipt of the
engagement letter.

Description of any other letters or reports the auditor expects to issue to the client.

The confidentiality of any reports issued, and, if relevant, the terms under which they can be shared
with third parties.

Basis on which fees are computed and any billing arrangements.

When relevant, the following points could also be made.

Arrangements concerning the involvement of other auditors and experts in some aspects of the
audit.

Arrangements concerning the involvement of internal auditors and other client staff.

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 client.

Example: Audit engagement letter


To the Board of Directors or the appropriate representative of senior management
You have requested that we audit the financial statements of . . . . . . . . . . . . . . . which comprise the balance
sheet as at . . . . . . . . ., and the profit and loss account, statement of recognised gains and losses, and cash
flow statement for the year then ended, and a summary of significant accounting policies and other
explanatory notes. We are pleased to confirm our acceptance and our understanding of this engagement by
means of this letter. Our audit will be made with the objective of our expressing an opinion on the financial
statements.
Responsibilities of directors and auditors
As directors of . you are responsible for ensuring that the company maintains proper
accounting records and for preparing financial statements which give a true and fair view and have been
prepared in accordance with the Companies Act 1994. You are also responsible for making available to us,
as and when required, all the company's accounting records and all other relevant records and related
information, including minutes of all management and shareholders' meetings. We are entitled to require
from the company's officers such other information and explanations as we think necessary for the
performance of our duties as auditors.
We have a statutory responsibility to report to the members whether in our opinion the financial
statements give a true and fair view, whether they have been properly prepared in accordance with the
Companies Act 1994 and whether the information given in the directors report is consistent with the

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financial statements. In arriving at our opinion, we are required to consider the following matters, and to
report on any in respect of which we are not satisfied:

Whether proper accounting records have been kept by the company and proper returns adequate
for our audit have been received from branches not visited by us

Whether the company's balance sheet and profit and loss account are in agreement with the
accounting records and returns, and

Whether we have obtained all the information and explanations which we consider necessary for the
purposes of our audit.

In addition, there are certain other matters which, according to the circumstances, may need to be dealt
with in our report.
We have a professional responsibility to report if the financial statements do not comply in any material
respect with applicable accounting standards, unless in our opinion the non-compliance is justified in the
circumstances. In determining whether or not the departure is justified we consider:

Whether the departure is required in order for the financial statements to give a true and fair view,
and

Whether adequate disclosure has been made concerning the departure.

Our professional responsibilities also include:

Including in our report a description of the directors' responsibilities for financial statements where
the financial statements or accompanying information do not include such a description, and

Considering whether other information in documents containing financial statements is consistent


with those financial statements.

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Scope of audit
Our audit will be conducted in accordance with the Bangladesh Standards on Auditing issued by the ICAB,
and will include such tests of transactions and of the existence, ownership and valuation of assets and
liabilities as we consider necessary. We shall obtain an understanding of the accounting and internal control
systems in order to assess their adequacy as a basis for the preparation of the financial statements and to
establish whether proper accounting records have been maintained by the company. We shall expect to
obtain such appropriate evidence as we consider sufficient to enable us to draw reasonable conclusions
therefrom.
The nature and extent of our procedures will vary according to our assessment of the company's
accounting system, and may cover any aspect of the business's operations that we consider appropriate.
Our audit is not designed to identify all significant weaknesses in the company's systems but, if such
weaknesses come to our notice during the course of our audit which we think should be brought to your
attention, we shall report them to you. Any such report may not be provided to third parties without our
prior written consent. Such consent will be granted only on the basis that such reports are not prepared
with the interests of anyone other than the company in mind and that we accept no duty or responsibility
to any other party as concerns the reports.
As part of our normal audit procedures, we may request you to provide written confirmation of certain
oral representations which we have received from you during the course of the audit on matters having a
material effect on the financial statements. In connection with representations and the supply of information
to us generally, we draw your attention to s 397A of the Companies Act 1994 under which it is an offence
for an officer of the company to mislead the auditors.
In order to assist us with the examination of your financial statements, we shall request sight of all
documents or statements, including the chairman's statement, operating and financial review and the
directors' report, which are due to be issued with the financial statements. We are also entitled to attend
all general meetings of the company and to receive notice of all such meetings.
The responsibility for safeguarding the assets of the company and for the prevention and detection of fraud,
error and non-compliance with law or regulations rests with yourselves. However we shall endeavour to
plan our audit so that we have a reasonable expectation of detecting material misstatements in the financial
statements or accounting records (including those resulting from fraud, error or non-compliance with law
and regulations), but our examination should not be relied upon to disclose all such material misstatements
or frauds, errors or instances of non-compliance as may exist.
(Where appropriate) We shall not be treated as having notice, for the purposes of our audit
responsibilities, of information provided to members of our firm other than those engaged on the audit (for
example, information provided in connection with accounting, taxation and other services).
Once we have issued our report we have no further direct responsibility in relation to the financial
statements for that financial year. However, we expect that you will inform us of any material event
occurring between the date of our report and that of the Annual General Meeting which may affect the
financial statements.
We look forward to full cooperation with your staff and we trust that they will make available to us
whatever records, documentation and other information are requested in connection with our audit.
[insert additional information here regarding fee arrangements and billings as appropriate]

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This letter will be effective for future years unless it is terminated, amended or superseded.
Please sign and return the attached copy of this letter to indicate that it is in accordance with your
understanding of the arrangements for our audit of the financial statements.
XYZ & Co
Acknowledged on behalf of
ABC Company by
(signed)
...............
Name and Title
Date

Interactive question 2: Engagement letters

[Difficulty level: Exam standard]

Which three of the following will normally be contained within a letter of engagement?
Responsibilities of the auditors
Responsibilities of the directors
The staff assigned to the engagement
The scope of the audit
See Answer at the end of this chapter.

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Summary and Self-test

Summary
Auditors will often be invited to tender
for audits

When an audit firm is invited to accept an engagement (usually as a result of a


tender), it must:
- Consider whether it is ethically barred from acting
- Consider whether it has resources available to undertake the engagement
- Obtain permission to contact the outgoing auditors, and do so

When an audit firm accepts and engagement it must:


- Check the outgoing auditors removal was carried out properly
- Ensure its appointment is valid
- Set up Letter of Engagement

Clarifies terms of engagement

Must be sent prior to first audit

Self-test
Now answer the following questions.
1

An audit firm must not accept an engagement if the client is not previously known to them.
True
False

If a prospective client declines permission to contact the previous auditors, the audit firm should:
A
B
C
D

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Report the client to the Companies Registrar


Contact the previous auditors anyway
Accept the engagement provisionally and continue to request permission
Consider carefully the reasons for refusal

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PROCESS OF ASSURANCE: OBTAINING AN ENGAGEMENT

Complete the questions that should be in the diagram.


Approach by new audit
client

Yes

No need to follow
professional rules the
auditor can make own
decision

No

No

Yes
Write for all information
pertinent to the
appointment

Prospective auditor
should consider carefully
the reason for refusal

No

Yes

No

Give old auditor due


notice then decide on
basis of knowledge
obtained otherwise

Yes
Accept/reject
appointment
decision

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An engagement letter is only ever sent to a client before the first audit.
True
False

An engagement letter defines the scope of the engagement.


True
False

Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off.

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Technical reference
IFAC and ICAB Code of Ethics

1 Accepting an engagement
2 Agreeing terms of an engagement

Agree the terms in writing

BSA 210.2

Send letter before first audit

BSA 210.5

Contents of engagement letter

Recurring audits

BSA 210.10-11

Change in engagement

BSA 210.12-19

BSA 210.6-8

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Answers to Self-test

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False. However, if the client is unknown to the audit firm, they should seek references in respect of
key personnel associated with the client, and must carry out customer due diligence (as they must
with all clients).

D. Consider carefully the reasons for the refusal. It is helpful to the firm that the client allows this
contact, as the firm needs to know if there is an ethical reason that would bar them from taking up the
appointment. The auditors must not contact the previous auditors without permission as this would
be a breach of confidentiality.

False. It should be re-issued if there is a change in circumstances.

True

Is this the first audit?


Does the client give permission to contact the old auditor?
Does the client give old auditor permission to reply?
Does the old auditor reply with information relevant to the new appointment?

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PROCESS OF ASSURANCE: OBTAINING AN ENGAGEMENT

Answers to Interactive questions

Answer to Interactive question 1


The auditors should consider all these factors except whether the client is new to the firm. This is
irrelevant in making the decision, although the firm may have to carry out additional procedures to get to
know the client if it is a new client. The auditors must consider if they are ethically qualified to act, whether
they have sufficient resources and whether the client gives permission to contact the previous auditors (if
this is declined, the auditors must consider carefully the reasons for the refusal). As the audit firm is also a
commercial enterprise, it must consider whether taking on the engagement is commercially viable.

Answer to Interactive question 2


The specific staff assigned to the engagement will not normally be referred to (as the auditors will reserve
the right to change their arrangement and the client should not have influence over assurance staff anyway).
The other three items will normally be included.

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