Question 1 - Notes

Auditors and Risk

Auditors face significant risk when expressing opinions on financial statements. To mitigate this, they must understand the entity and its environment, creating an audit plan to detect material misstatements.

Key Objectives of an Audit Plan

1. Reduce audit risk to an acceptable level.

2. Identify audit risks.

3. Ensure appropriate consideration of audit areas.

4. Promote efficient work.

5. Ensure proper team supervision.

Client Evaluation Importance

Client evaluation is the initial phase of an audit. The audit partner takes on professional responsibilities to the client and the public. Acting in the client's best interest with competence and professional skepticism is crucial, alongside the responsibility to act in the public interest. A thorough client evaluation reduces the firm's professional liability risk.

ISA 220 Requirements

• Engagement Partner Responsibilities:

  • Confirm firm policies for client acceptance and continuance are followed.

  • Ensure conclusions reached are appropriate.

  • Consider information from the acceptance and continuance process when planning and performing the audit in accordance with ISAs (NZ).

PES 3 Quality Objectives

• Acceptance and Continuance Decisions based on:

  • Information about the nature and circumstances of the audit engagement, including the entity's structure, operations, governance, integrity, ethical values, industry, and the underlying subject matter and applicable criteria.

  • Availability of appropriate resources and access to information to perform the engagement in accordance with professional standards, legal, and regulatory requirements.

• Financial and operational priorities (profitability, market share) should not lead to inappropriate acceptance or continuance decisions.

Steps in Evaluating a Client

The decision to accept an assurance engagement is typically made months before the client’s financial year-end.

Obtaining Clients

Auditing services rely on integrity and competence and are not marketed like commercial services. High-quality service delivery is the most effective promotion (Gay & Simnett, 2018).

PES 1 allows marketing if it's not misleading or deceptive and avoids unsubstantiated claims.

Tendering is a good practice for ensuring high-quality, cost-efficient audits. However, debates exist regarding the potential loss of credibility due to compromised auditor independence (mind and appearance).

Ethical Clearance from Previous Auditor

When replacing a previous auditor, the proposed auditor should communicate with them to gather necessary information before accepting the client. The previous auditor should provide clear, accurate information with client consent. If the client refuses permission, the proposed auditor should consider this unwillingness when deciding whether to accept the client.

Evaluate Integrity of Management

The auditor's role is to provide assurance on financial information prepared by management. A lack of integrity increases the risk of material misstatements. Auditors seek reasonable assurance of management trustworthiness through inquiries with third parties and communication with the previous auditor. They also consider previous experience with the client’s management.

Special Circumstances and Unusual Risks

The auditor must identify intended users of the audit report to determine if general-purpose financial statements suffice or if special reports are needed. This includes assessing the client's legal and financial stability and associated risks.

For example, clients facing lawsuits, investigations, or inability to meet debt payments pose a higher risk of litigation and reputational damage to the auditor.

Evaluate Independence

PES 1 requires identifying and mitigating threats to independence. The audit firm must assess potential threats before accepting a new client and implement safeguards to eliminate or reduce them to an acceptable level.

Assess Competence to Perform Audit

The audit partner must ensure the audit team has the capability, competence, and capacity to provide the assurance service in accordance with regulatory, legal requirements, and auditing standards.

Audit Team Composition

• Audit Partner: Overall responsibility, client relationship management, and report signing.

• Audit Manager: Coordinates and supervises the execution of the audit plan.

• Senior Auditors: Plan and review the auditing process, ensuring task assignment and completion.

• Junior Auditors: Perform audit procedures and prepare audit findings under supervision.

Prepare the Engagement Letter

After analysis, the auditor decides whether to accept the engagement. If accepted, the terms must be stated in an engagement letter. This letter confirms acceptance, defines the engagement's objective, scope, and the auditor's report format.

Key Steps for Engagement Acceptance

• Obtain ethical clearance from the previous auditor.

• Evaluate management integrity.

• Identify unusual circumstances and/or risks.

• Evaluate independence.

• Assess competence and capacity.

ISA(NZ) 210 requires providing the client with an engagement letter to confirm the terms. ISA(NZ) 210.NZ10.1 and ISA(NZ) 210.A26 outline the contents of the audit engagement letter, which varies for each client.