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Ch05_Principles Of Auditing Lecture notes (AIC22A2)
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Principles Of Auditing
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unoconv_4056618051.docx 1Chapter 5
CLIENT ACCEPTANCE
5.1 Learning Objectives
After studying this chapter, you should be able to:
1. Explain what is meant by client acceptance.
2. Describe the seven primary procedures involved in the client acceptance process.
3. Understand the main reasons for obtaining an understanding of client’s business and industry.
4. Know the sources of client information and the methods for gathering the information.
5. Discuss the ethical and competency requirements of the audit team.
6. Know what is required in using the work of another auditor.
7. Understand the auditor’s responsibility in using the work of an expert.
8. Describe the procedures for communicating with an existing (predecessor) auditor.
9. Know the contents of a client audit engagement proposal.
10. Express the differences between items covered in an audit engagement proposal to existing
clients and one for new clients.
11. Explain on what basis audit fees are negotiated.
12. Understand what an audit engagement letter includes and why its contents are important.
13. Describe the differences between items covered in an audit engagement proposal to existing
clients and one for new clients.
5.2 Client Acceptance: the First Step on the Journey to an Opinion
The client acceptance phase of the audit has two objectives:
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1 Examination of the proposed client to determine if there is any reason to reject the engagement
(acceptance of the client);
2 Convincing the client to hire the auditor (acceptance by the client).
The procedures towards acceptance of the client are: acquiring knowledge of the client’s
business; examination the audit firm’s ethical requirements and technical competence; determining
possible use of other professionals (including outside specialist) in the audit; communication with
the predecessor auditor; preparation of client proposal; assignment of staff and the submission of
the terms of the engagement in the form of an audit engagement letter. See Illustration 5.1.
ILLUSTRATION 5.1
STANDARD AUDIT PROCESS MODEL – PHASE I CLIENT ACCEPTANCE
Objective Determine both acceptance of a client and acceptance by a client. Decide
on acquiring a new client or continuation of relationship with an existing
one and the type and amount of staff required.
Procedures 1 Evaluate the client’s background and reasons for the audit [sec.5.3].
2 Determine whether the auditor is able to meet the ethical requirements
regarding the client [sec.5.4].
3 Determine need for other professionals [sec.5.5].
4 Communicate with predecessor auditor [sec.5.6].
5 Prepare client proposal [sec.5.7].
6 Select staff to perform the audit.
7 Obtain an engagement letter [sec.5.8].
An auditor must exercise care in deciding which clients are acceptable. An accounting firm’s
legal and professional responsibilities are such that clients who lack integrity can cause serious and
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expensive problems. Some auditing firms refuse to accept clients in certain high-risk industries. For
example, in the 1990s many large auditing firms in the USA and Northern Europe were very
careful when accepting audit engagements of financial institutions after the legal judgments and
fines resulting from audits of Lincoln Savings, Standard Charter Bank, and International Bank of
Credit and Commerce (BCCI). At the beginning of the twenty-first century, there were great
problems in the energy business (Enron, Dynergy, Pacific Gas and Electric, the State of California),
the telecommunications industry (WorldCom, Global Crossing, Qwest), and health care (Health
South, ImClone), investment banks and hedge funds (Bear Sterns, Lehman Brothers, MF Global)
and even in old-line industries such as retailing (K-mart, Ahold) and food products (Parmalat).
Audit Clients
The client – audit firm relationship is not a one-way street where the audit firm evaluates the
client and then, judging the client “acceptable”, sends out an engagement letter closing the deal.
The market for audit services is competitive and, like in any other business, there are highly
desirable clients with whom any audit firm would like to have an audit relationship. Although not
always the case, audit firms prepare and submit engagement proposals to many of their (potential)
clients, especially the large ones.
Steps in the Client Acceptance Process
The next section in this chapter discusses the importance of obtaining a preliminary
understanding of the client, in order to both evaluate the client’s background and the risks
associated with accepting the engagement. There must also be an understanding of the auditors’
relationship to the client to enable the auditor to consider if the ethical and professional
requirements (independence, competence, etc.) typical to the specific engagement can be met. That
is the second step in the client acceptance process.
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The balance of the chapter concerns acceptance by the client (called responsible party in
assurance services terms). The audit firm must write and present to the client an engagement
proposal (some auditors consider this a beauty contest). The chapter also discusses the components
of a client engagement proposal for existing and new clients; and briefly discusses the International
Standard Organization (ISO) quality control standard 9000 and how that applies to an auditing firm
and its engagement services.
5.3 Evaluate the Client’s Background
The auditor should obtain knowledge of the client’s business that is sufficient to enable him to
identify and understand the events, transactions, and practices that may have a significant effect on
the financial statements or on the audit report. More specifically, the ISAs1 put client acceptance
in terms of identifying threats that may emerge in taking on clients, and suggest that safeguards be
put in place to mitigate those risks. The main reasons for obtaining this understanding, from the
auditors view, are (1) to evaluate the engagement risks associated with accepting the specific
engagement and (2) to help the auditor in determining whether all professional and ethical
requirements (including independence, competence, etc.) regarding this client can be met.
Auditors do not just obtain knowledge of the client preliminary to the engagement, during the
client acceptance phase (Phase I of the audit process model). Once the engagement has been
accepted, auditors will do a more extensive search for knowledge of the client, its business and
industry in the planning phase (Phase II of the model – see Chapter 6 Main Audit Concepts and
Planning the Audit (ISA 300, 315, 320).
Auditors may do a preliminary examination of both new and existing clients by visiting their
premises, reviewing annual reports, having discussions with client’s management and staff, and
accessing public news and public information databases, usually via the internet. If the client is an
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