ATC f8 materials FF8 AA (int)session05 j08

SESSION 05 – AUDITOR APPOINTMENT OVERVIEW Objective To describe the professional appointment process EXISTING AUDITOR “Professional clearance” NOMINEE New work Communications Relevant matters Unpaid fees Additional work TENDERING PROCESS TERMS OF AUDIT ENGAGEMENTS REAPPOINTMENT Response Transfer books & papers Transfer information Entity’s approach Invitation to tender Selection criteria Response by nominee Purpose Principal contents Procedures Example FEES Audit & assurance Low balling 0501 SESSION 05 – AUDITOR APPOINTMENT NOMINEE 1.1 New professional work 1.1.1 Reasons Reasons why the entity may wish to change their auditor include: the entity is seeking to obtain better value for money in the provision of audit and other professional services and/or a wider range of services; on change of ownership of an entity (eg as a result of takeover, merger or MBO); when audit firms merge (eg a conflict of interests arises, or the entity considers that the new firm is too large to give a “personal service”); users of the financial statements and providers of finance (eg banks) expect organisations achieving a size or status (eg being listed on a recognised Stock Exchange) to have multinational accountancy firms as auditors; if a vacancy arises through the death or incapacity of the auditor The prospective accountant/auditor may be recommended directly to the potential client or they may be asked to compete against other firms as part of a tendering process (see Section 4) 1.1.2 Procedures An accountant/auditor who is asked to accept a new accountancy/audit appointment should: Determine whether there are any professional or other reasons for not accepting the assignment by contacting the current accountant/auditor Obtain a reasonable understanding of the business and its environment, the complexity of the potential client, the management and control environment, related parties, governance procedures, regulatory and other (non-statutory audit) reporting requirements, selection and application of accounting policies (see Session 9) Assess the specific requirements of the engagement and the purpose, nature and scope of the work to be performed (eg possible use of experts, reliance on internal audit) Together with understanding the business (as above) this enables the prospective auditor to assess whether or not they can service the client properly Assess the risks to compliance with the fundamental principles (e.g integrity, objectivity, professional competence, independence, fee level, conflicts of interests, other services required, availability of audit staff, timing of services – see Session 4) Assess the business risk to the auditor of being associated with, conducting business with, and auditing, the new client (eg recovery of fees, integrity of management, risk of business failure) This process is often referred to as ‘client screening’ 0502 SESSION 05 – AUDITOR APPOINTMENT In some jurisdictions it is a legal requirement (eg under money laundering procedures) to undertake procedures to “verify the identity” of the potential client With major, international entities such procedures will be straight forward, but for small entities with, say two directors, extensive checks and references on the entity and its directors may be necessary (eg to verify that the entity is a bona-fide entity and not just a “pocket entity” for the purpose of money laundering) Note that as an audit appointment is generally for one year only, similar procedures will be carried out as part of the review and closedown process of the current audit (see Session 29) and before accepting appointment as auditor for the next year (see Section 6) Commentary The ACCA’s “Professional appointments” references to “accountant” apply equally to “auditor” and “reporting accountant” The term “auditor” is used throughout the remainder of this session 1.2 Communication with current auditor Request prospective client to write to the current auditor to inform them of the proposed change and to give permission for them to discuss the client’s affairs with the prospective auditor Without the client’s permission, the current auditor will not be able to discuss the client’s affairs as it would be a breach of confidentiality Request prospective client’s permission to communicate with the existing auditor This should be in writing If permission is refused by the potential client, decline to accept the appointment With permission, write to existing auditor requesting information relevant to deciding whether or not to accept the appointment, eg if there has been any action by the client which would on ethical grounds mean declining to accept appointment On receipt of a reply, assess any issues raised as they impact upon the acceptance of the engagement and that the prospective client is an entity the auditor wishes to be associated with If current auditor/adviser does not respond within a reasonable time: phone or fax, and if no reply send a final letter by recorded delivery stating that “no matters” will be assumed unless advised otherwise and if still no reply; seek to obtain information about potential threats from other sources (may require client’s permission depending on source), e.g enquiries of third parties, those charged with governance, audit committee; report current auditor to their professional body (eg the ACCA) for unprofessional behaviour Any information received from the current auditor must be treated with the strictest confidence 0503 SESSION 05 – AUDITOR APPOINTMENT 1.3 Relevant matters to consider Any information supplied by existing auditors should be considered carefully before deciding to accept or reject the appointment Prospective auditors should try to find out the reason for the change of auditors They should be careful that by accepting an appointment they are not assisting clients to act improperly or unlawfully For example, prospective auditors may find that the existing auditors have been conscientious in their duty as independent professionals, but have encountered client opposition The existing auditors may have declined to give way on what they consider to be a matter of principle In such circumstances prospective auditors should probably decline appointment If there is a conflicting view between client and current auditor/adviser that has lead to the potential replacement of the auditor, discuss with the client to be satisfied that: client’s view can be accepted as reasonable; and that client will accept that prospective auditor may express a similar opinion to the current auditor If not, the appointment should be declined If the client failed or refused to supply the existing auditor with information properly required by them to fulfil their duties, in all probability they will the same to the new auditor This is effectively a limitation on scope applied by the client and as forewarned, the prospective auditor should probably decline appointment Unlawful acts or defaults by the client (e.g defrauding taxation authorities) place the prospective auditor on guard as to the integrity of the client Such matters must be carefully discussed with the client to establish if they are prepared to accept the advice offered If not, decline appointment 1.4 Unpaid/overdue fees to existing auditor Existence of unpaid/overdue fees is not of itself a reason for not accepting nomination (nor the current auditor refusing to co-operate with the prospective auditor) It is a matter of discussion between the auditors as to how much assistance the new auditor will give to recover the fees of the old auditor Prospective auditors would normally be expected to draw the attention of their client to the fact that fees are due and unpaid and to suggest that they should be paid 1.5 Additional professional work A member invited to undertake work additional to continuing work carried out by the client’s existing auditor who is not being replaced or superseded, should notify the existing auditor of the work they have been asked to undertake, before accepting such work In doing so, the existing auditor will be able to provide any relevant information needed for the proper conduct of the work 0504 SESSION 05 – AUDITOR APPOINTMENT EXISTING AUDITOR 2.1 Response Ensure client’s permission to discuss affairs fully with prospective auditor has been obtained In some jurisdictions, there may be a legal requirement to reply, even if the client’s permission has not been given The existing auditor should answer without delay stating: that the client’s permission has not been given for communication (in which case the prospective auditor should decline appointment); or that there are no matters of which the prospective auditor should be aware; or those factors of which the prospective auditor should be aware; Information should be provided honestly and unambiguously It is not sufficient to state that unspecified factors exist The nature and details of the factors should be specified However in some circumstances, eg money laundering, legal advice may need to be taken before replying to the prospective auditor If an approach to the existing auditor is made by the prospective auditor without notification from the client, inform the client and decline to provide the prospective auditor with any information other than stating the reason why (eg client has not informed current auditor) 2.2 Transfer of books and papers 2.2.1 Documents belonging to the client The former auditor should transfer the client’s books and papers promptly to the client, or to the successor auditor Any completed documents, e.g financial statements, tax returns etc which are the subject of the engagement, must be transferred to the client Where a lien over books and records is being claimed, for example over unpaid fees, great care must be taken that it is in compliance with the jurisdiction’s law In general no lien can be held over such books and records that are required by law for the client to have 2.2.2 Documents belonging to the auditor Working papers and drafts as prepared by the auditor, belong to the auditor Clients and the successor auditor have no right to demand access to documents and working papers that belong to the auditor However, it is not uncommon as part of the transfer of information, for the previous auditor to allow review access of working papers to the new auditor This assists the new auditor, for example, when considering the reliability of opening balances for which they will not have audited (see Session 29) 0505 SESSION 05 – AUDITOR APPOINTMENT 2.3 Transfer information The former auditor should provide the new auditor with all “reasonable transfer information” (lack of which might prejudice the client’s interest) promptly No charge should be made unless a significant amount of work is involved Transfer information is defined as: a copy of the last set of accounts formally approved by the client; and a detailed trial balance that is in agreement with the accounts Any further information is provided at the former auditor’s discretion (who may render a fee) TENDERING PROCESS 3.1 Entity’s approach In “competitive tendering”, several firms are invited to tender to provide audit and/or other services to an enterprise Although the entity is usually seeking to obtain better value for money, there is much more to tendering than “quoting” a fee One of many reasons for the growth in the practice of competitive tendering is that multi-national companies are expected to be audited by one of the “Global Four” when seeking a listing on a recognised stock exchange 3.1.1 Process Choosing the shortlist – commercial clients tend to approach - firms to tender In smaller companies, the decision-maker may be the CEO or a senior director In larger firms, the audit committee may make recommendations to the board Sending the invitation to tender (see below) Evaluation of documentary submission received Selection criteria (see below) may be used to: assess relative strengths and weaknesses of each firm; or as a means of short listing for the presentations stage Notification to firms – either invitation to make a presentation or letter of rejection Oral presentations – typically one hour (say 15-20 minutes for the actual presentation and the remainder for questions and discussion) Notification of decision Usually later, by letter or telephone 3.2 Invitation to tender The letter of invitation will need to give a broad indication of the information required to be included in the audit firms’ written responses Some general background to the organisation’s activities (eg an annual report) may be enclosed with the invitation 0506 SESSION 05 – AUDITOR APPOINTMENT 3.2.1 Information required (for example) Background information on the audit firm including location of offices, the extent of international coverage and overseas representation if relevant The firm’s relevant experience in relation to the different components of the organisation’s activities in a changing market place The team including relevant experience of the individuals – their qualities and training An indication of the range of services most relevant to the organisation and the firm’s capability to deliver these services The approach to the audit, eg organisation of audit teams, overview of audit methodology, reporting relationships, working with audit committees, use of internal audit etc Fees broken down in a manner specified (eg between grades of staff or between audit and tax compliance work) for the first and subsequent years 3.2.2 Deadline for responses A clear deadline should be set for responses If audit firms invited to tender are to be given access to the organisation’s management and those charged with governance, any “protocol” for arranging meetings should also be set out in the invitation 3.3 Selection criteria Evident understanding of the business by the nominee auditor: its objectives how it works aspirations of management its people Demonstrable knowledge and experience of the sectors in which the business operates Range and quality of services provided by the nominee auditor: sufficient to meet needs clear coordination and communication lines Audit methodology used: high level of planning understanding of audit issues and risks how the issues will be reported to client management cost effective approach 0507 SESSION 05 – AUDITOR APPOINTMENT Evidence of the nominee auditor’s: high quality work speed of delivery reliability and accuracy pro-activity (ie being active, not passive, in addressing client issues) Calibre of proposed team: high level of partner input availability of partner and staff experience relevant to client’s needs access to relevant specialists Good personal rapport (“chemistry”) between the auditor and entity management Did they listen with interest to us? Did they show enthusiasm? Did they understand our business issues? Would we enjoy working with them? Standing of the firm within the professional community Demonstrable ability to add value to the business, eg: understanding of tax issues able to provide practical, cost-effective solutions proactive and innovative Competitive fees – evidence of value for money 3.4 Responding to the invitation to tender It should not be assumed that every firm invited to submit a proposal or fee quote for an audit will so For example, it may be immediately apparent to the practice partner with primary responsibility for new engagements that the audit assignment is in an industry sector and will go to an audit firm which is recognised as having particular expertise in that sector (eg banking or hotels) 3.4.1 Matters to be considered Technical proficiency of the firm to carry out this audit engagement, eg: in a particular computer based environment; of a company involved in e-commerce; in a specialized industry (eg financial services, pension schemes, charities, advertising) Whether it is worth investing in a new sector (eg e-commerce) 0508 SESSION 05 – AUDITOR APPOINTMENT Geographical and international aspects, eg: a nationally wide spread organisation; overseas subsidiaries (or parent); listing on an international stock exchange Other commitments to existing client base and whether, given the timescales involved is it feasible to take on a client of the sort under consideration and to provide the requisite standard of work? Staffing arrangements must be seriously considered Ethical issues such as conflicts of interest or the 10% or 15% gross fee limitations (on public interest and other clients respectively), which could preclude entering a bid Unusual circumstances such as adverse publicity attached to the company’s decision to leave their former auditors or activities of the company itself which would not be compatible with the image of the audit firm Other issues such as whether acquiring the company a client fits the audit practice’s strategic plan 3.4.2 Presentation checklist Plan appropriate staff to carry out familiarisation visit to prospective client: confirm the that firm is aware of all major geographical, technological, organisational, financial and market-based factors relevant to the presentation Prepare an internal report suggesting particular strategies for this particular prospective client Estimate the expected audit fee based upon reasonable assumptions concerning quality of accounting and internal control systems – the estimate should be based on an outline time budget for the audit Identify the staff members who will make the presentation and the staff who will be responsible for the client in the future If they not include those who carried out the familiarisation work ensure they are fully briefed Plan the bid document (quality is essential since the tendering enterprise will be comparing several such documents) It should include: budget and timing data; statements regarding the quality of service the audit firm undertakes to provide – these can include evidence of familiarity with clients in a similar industry and biographical details of the staff who would be assigned to the audit; statements regarding the philosophy employed, for instance, a “total audit” (ie guaranteeing an in-depth review of activities as part of the general financial audit); 0509 SESSION 05 – AUDITOR APPOINTMENT information concerning other services which the audit firm can provide – these would include: − − − − − − taxation; corporate finance advice; recruitment services; share registration and company secretarial services; management consultancy; and the provision of technical literature and back-up via a client liaison department Plan the presentation itself a full rehearsal if time permits; graphics/visuals should be professionally prepared; presenting staff should be expert communicators; ensure reasonable familiarity with background history of those who will be attending the presentation from the client side TERMS OF AUDIT ENGAGEMENTS [ISA 210] The auditor and the client should agree on the terms of the assurance engagement The agreed terms need to be recorded in an engagement letter or other suitable form of contract As with any other contract, the terms of the engagement letter will be referred to in any dispute Where other services are provided, engagement letters should also be used for each separate service 4.1 Purpose of engagement letter To help avoid misunderstandings between client and auditor, to document and confirm: auditor’s acceptance of the appointment objective and scope of the work (audit) respective responsibilities of the auditor and directors form of any reports, limitation of such reports and to whom reports will be delivered 4.2 Principal contents Objective of the audit of financial statements Management’s responsibility for the financial statements Management’s responsibility for establishing and maintaining effective internal control The financial reporting framework adopted by management in preparing the financial statements 0510 SESSION 05 – AUDITOR APPOINTMENT 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 The fact that there is an unavoidable risk that even some material misstatement may remain undiscovered Unrestricted access to whatever records, documentation and other information requested in connection with the audit Other matters Arrangements regarding the planning of the audit Expectation of receiving from management written confirmation concerning 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 Basis on which fees are computed and any billing arrangements When relevant, arrangements concerning other auditors and experts internal auditors and other client staff predecessor auditor Any restriction of the auditor’s liability when such possibility exists A reference to any further agreements between the auditor and the client 4.3 Procedures Send an engagement letter, preferably before commencement of the engagement Audit of components – consider whether a separate engagement letter is needed Recurring audits – a revised letter or a reminder of existing terms may be appropriate e.g on change of client management, new directors, issue of new auditing standards (eg revised auditor’s report), change in legislation or regulations Where the auditor is required to confirm re-acceptance of their appointment each year, the engagement letter must be reviewed to ensure it is still appropriate Changes in nature of engagement – if appropriate, revised terms of engagement should be agreed in writing 0511 SESSION 05 – AUDITOR APPOINTMENT 4.4 Example The sample letter is for use as a guide in conjunction with the considerations outlined in the ISA and will need to be varied according to individual requirements and circumstances 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 statement of financial position as at ., 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 notes We are pleased to confirm our acceptance and our understanding of this engagement by means of this letter Our audit will be conducted with the objective of our expressing an opinion on the financial statements We will conduct our audit in accordance with International Standards on Auditing Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance 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 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 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 expect to provide you with a separate letter concerning any material weaknesses in the design or implementation of internal control over financial reporting that come to our attention during the audit of the financial statements We remind you that the responsibility for the preparation of financial statements that present fairly the financial position, financial performance and cash flows of the company in accordance with International Financial Reporting Standards is that of the management of the company Our auditors’ report will explain that management is responsible for the preparation and the fair presentation of the financial statements in accordance with the applicable financial reporting framework and this responsibility includes: Designing, implementing and maintaining internal control relevant to the preparation of financial statements that are free from misstatement, whether due to fraud or error; Selecting and applying appropriate accounting policies; and Making accounting estimates that are appropriate in the circumstances 0512 Addressed to ID of statements Objective Standards followed Detail of what an audit is about Limitation because of nature of an audit Management letter Management’s responsibility SESSION 05 – AUDITOR APPOINTMENT As part of our audit process, we will request from management written confirmation concerning representations made to us in connection with the audit Representation letter We look forward to full cooperation from 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.] 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 Sign and return XYZ & Co Acknowledged on behalf of ABC Company by (signed) Name and Title Date FEES 5.1 Audit and assurance work 5.1.1 Basis of fees The auditor is in business As a business they will expect to earn a reasonable return for their work, effort and expertise and thus make a profit The level of fees charged for each assignment is basically a commercial decision The standard approach is to base the fees quoted and/or charged to reflect the time spent and the skills/experience of the staff involved, eg the more complex and/or higher risk the entity, the greater the level of experience/expertise (eg manager and partner level) and time input by each level of staff, resulting in a higher fee The basis of the fee should be stated within the engagement letter together with any arrangements for the timing of and delivery of documents, processes, information and other audit requirements by the client (eg books and records, schedules to be audited) Where the expected fee level is exceeded (eg because of spending more time on a particular area of the assignment) the recoverability of the additional fees will need to be discussed with the client Good client management will involve notification of the possibility of additional fees because of factors caused directly by the client (eg nondelivery of items as agreed in the engagement letter resulting in additional work by the auditor) or outside of the control of the auditor and client (additional requirements imposed by regulations) 0513 SESSION 05 – AUDITOR APPOINTMENT For new clients, it is important that a sustainable fee is initially quoted This will require a reasonable understanding of the business and the level of work that will be required (eg initial time and service level budgets) 5.1.2 Contingency fees It is unacceptable to charge audit and assurance fees on the basis of a percentage of profits or on a contingency basis eg, “if we qualify our report, then no fee” Special offers, eg “Buy one and get one free” etc are also strictly prohibited Such action calls into doubt the professional’s integrity and independence, and may also be considered as bringing the profession into disrepute In areas other than audit and assurance, contingency or flat rate fees may be charged, provided such action does not bring the profession into disrepute Examples include: Fixed fees for standard preparation of accounts and completion of tax returns Contingency fees for certain consultancy services, eg management buy-outs or raising of venture capital, where the ability to pay depends on the success or failure of the project 5.2 Lowballing “Lowballing” (also “low balling”) or “predatory pricing” is where a firm seeks to increase its market share or retain a client by dropping its quote for an audit fee to undercut its competitors or pre-empt a possible tender There is usually a public perception that such action means that the quality of the audit will invariably decline (eg because the quoted fee is below cost) especially where in a competitive tender the current auditor retains the client after a significant reduction in fees compared to prior years In addition, there is the argument that by keeping a client through a low audit fee, any “loss” will be more than compensated for by the fees obtained through additional services, thus a self-interest threat to independence However “loss leadership” may no longer be an effective strategy because of Sarbanes-Oxley prohibiting US listed company auditors providing other services to their clients and corporate governance codes requiring greater oversight of what other services auditors can provide (eg UK Combined Code) Initial research has shown that average audit fees have increased since corporate governance changes giving some evidence of a historical “loss leadership” approach Under the ACCA Professional Code of Ethics, lowballing is not specifically barred However, it is clear that the quality of any audit or assurance engagement cannot be compromised (or perceived as such) because of low fees If there is the perception (real or otherwise) that quality has been compromised, then the integrity and independence of the professional is under threat The only safeguard against this is for the professional to be able to clearly demonstrate that no compromise has occurred, otherwise the engagement should be declined 0514 SESSION 05 – AUDITOR APPOINTMENT The level of fees from year to year (especially on new clients and where reappointment results in a reduction) is one aspect covered by the RSB monitoring of firms Particular attention will be paid to the time spent, level of work and seniority of staff assigned to the audit in such cases If, in the course of an investigation by the RSB into unsatisfactory work, there is evidence of the work having been obtained or retained through quoting a fee that is not economic (eg at below cost) such evidence will be taken into account in deciding the disciplinary procedures to be followed RE-APPOINTMENT The appointment of an entity’s auditor is usually just for one year After completion of the audit, the auditor will usually “offer themselves for re-appointment” at the annual general meeting of the members of the entity Before doing so, the auditor must carry out similar procedures to those when they first accepted appointment, eg: From the work carried out during the course of the audit just completed and their findings, re-assess their understanding of the business and its environment, the complexity of the client, the management and control environment, related parties, governance procedures, regulatory and other (non-statutory audit) reporting requirements, selection and application of accounting policies Re-assess the specific requirements for the continuing engagement and the purpose, nature and scope of the work to be performed (these may well change compared to the prior audit) Together with the updated understanding of the business, this enables the auditor to assess whether or not they can continue to service the client properly Re-assess the risks to compliance with the fundamental principles (e.g integrity, objectivity, professional competence, independence, fee level, conflicts of interests, other services required, availability of audit staff, timing of services) Assess the business risk to the auditor of continuing to be associated with, conducting business with, and auditing, the client (eg recovery of fees, integrity of management, risk of business failure) Basically, from their experience and findings during the prior audit and expected changes over the next audit period, are the auditors still fit & proper, willing and able to continue their relationship with the client 0515 SESSION 05 – AUDITOR APPOINTMENT FOCUS You should now be able to: discuss the requirements of professional ethics and other requirements in relation to the acceptance of new audit engagements; discuss the process by which an auditor obtains an audit engagement; explain the importance of engagement letters and state their contents 0516