ANDINET INTERNATIONAL COLLEGE

Department of accounting and finance

Course title: - Auditing principle and practice
Extension Program Individual assignment

Prepared by: - Mulu desalegn

Id no: - 1129/13
Contents
CLIENT ACCEPTANCE AND AUDIT PLANNING................................................................................1
CLIENT ACCEPTANCE PROCEDURES.................................................................................................1
1. OBTAINING AND ACCEPTING A NEW AUDIT ENGAGEMENT...................................................1
1.1. Accepting an Audit Appointment.....................................................................................................1
1.3. Communication between Predecessor and Successor Auditors........................................................1
2.1. Preconditions....................................................................................................................................2
2.2. Engagement Letters..........................................................................................................................2
AUDIT PLANNING...................................................................................................................................3
1. MAKE CLIENT ACCEPTANCE DECISIONS AND PERFORM INITIAL AUDIT PLANNING.......4
2. UNDERSTAND THE ENTITY AND ITS ENVIRONMENT................................................................5
3. ASSESS CLIENT BUSINESS RISK......................................................................................................5
4. PERFORM PRELIMINARY ANALYTICAL PROCEDURES..............................................................5
5. SET MATERIALITY AND ASSESS ACCEPTABLE AUDIT RISK AND INHERENT RISK............6
6. UNDERSTAND INTERNAL CONTROL AND ASSESS CONTROL RISK........................................7
7. DEVELOP OVERALL AUDIT PLAN AND AUDIT PROGRAM........................................................8
Multiple choice questions...........................................................................................................................8

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 CLIENT ACCEPTANCE AND AUDIT PLANNING

CLIENT ACCEPTANCE PROCEDURES

1. OBTAINING AND ACCEPTING A NEW AUDIT ENGAGEMENT

Audit practices are businesses, and their objective is to make a profit. However, this does not
mean that the practitioner should automatically accept every audit engagement that is offered to
it, in order to maximize profit. Circumstances may arise where it is appropriate to decline the
offer of an audit appointment, for either commercial or ethical reasons. Several commercial and
ethical matters should be considered by an external auditor when considering the acceptance of a
new audit engagement.

1.1. Accepting an Audit Appointment

Client Acceptance
Before accepting an appointment, the audit firm should:
Assess whether acceptance would create any threats to compliance with the fundamental
principles and consider the significance of any threat identified. For example, a personal
relationship between a partner at the firm and a senior member of the client’s staff could create a
threat to objectivity. Lack of technical expertise could create a threat to professional competence
and due care.
After accepting the appointment as auditor, the audit firm should take the following measures:
 It should ensure that the current auditor (if any) has resigned from the audit in a proper
manner, or has been removed from office in accordance with any appropriate local legislation.
 It should ensure that its appointment is valid in law and is properly documented.
It should prepare and submit an engagement letter to the board of the new client

1.3. Communication between Predecessor and Successor Auditors

The firm should communicate with the current auditors (if there are any) to establish if there are
any matters that it should be aware of when deciding whether or not to accept the appointment.
 Client permission is required for any such communication. If the client refuses to give its
permission, the appointment as auditor should not be accepted.

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If the client does not give the current auditor permission to reply to any relevant questions, the
appointment as auditor should not be accepted.
If the current auditor does not provide any information relevant to the appointment, the new
auditor should accept or reject the engagement based on other available knowledge.
If the current auditor does provide such information, the new auditor should assess all the
available information and take a decision about whether or not to accept the audit work.
2. AGREEING THE TERMS OF AUDIT ENGAGEMENTS
The objective of the auditor, per ISA 210 Agreeing the terms of audit engagements, is to 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

2.1. Preconditions
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, for example IFRS or IPSAS; and
Obtain the agreement of management that it acknowledges and understands its responsibility
(the ‘premise’):
For the preparation of the financial statements;
For internal controls to ensure that the financial statements are not materially misstated; and
To provide the auditor with all relevant and requested information and unrestricted access to all
personnel

2.2. Engagement Letters

Having accepted an appointment as auditor of a client company, the audit firm should submit an
engagement letter to the board of directors of the client company. The engagement letter can be
seen as the basis for the contract between the company and the auditor.
The content of the engagement letter
The engagement letter should include details of the following:
The objective and scope of the audit
The responsibilities of the auditor
The responsibilities of management

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Identification of the underlying financial reporting framework
Reference to the expected form and content of any reports to be issued
In addition to the above, the auditor may feel that it is appropriate to include additional points in
the engagement letter, such as: more details on the scope of the audit, such as reference to
applicable legislation, 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 performed in accordance with ISAs;
Arrangements regarding the planning and performance of the audit, including the composition
of the audit team;
The expectation that management will provide written representations;
The basis on which fees are computed and any billing arrangements; a request for management
to acknowledge receipt of the engagement letter and to agree to its terms;

AUDIT PLANNING
Audit Planning is one of the basic audit standards to be followed in the conduct of an audit.
International Standards on Auditing (ISA) 300, “Planning an Audit of Financial Statements,”
states, the objective of the auditor is to plan the audit so that it will be performed in an effective
manner… The auditor shall establish an overall audit strategy that sets the scope, timing and
direction of the audit, and that guides the development of the audit plan”. The objective of the
auditor, per ISA 300 Planning an audit of financial statements is to plan the audit work so that
the audit will be performed in an effective manner.
Preparing an audit plan is the first stage in the conduct of an audit engagement.
The plan sets out answers to three main questions (the ‘3Ws’):
Who will perform the audit work? (Staffing)
When will the work be done? (Timing)
What work is to be done? (The scope of the audit)
There are three reasons why proper planning of an engagement is crucial:
 To obtain sufficient competent evidence,
 To keep audit costs reasonable, and
 To avoid misunderstanding with the client

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Ultimately, planning the audit pays off in minimizing legal entanglements and maintaining good
relations with your customer--the client.
Audit planning consists of Seven Steps:

1. MAKE CLIENT ACCEPTANCE DECISIONS AND PERFORM INITIAL AUDIT

PLANNING
This first step can be broken down in to four tasks:
Client Acceptance and Continuance: Not every client is acceptable. The auditor must consider
the client's integrity, as well as the industry in which the client operates. In short, the audit risk
must be measured against the auditor's threshold. The audit firm should conduct an investigation
of a company to assess its desirability as a client. If the would-be client has been audited
previously by another audit firm that firm must be contacted, with the client's permission. The
auditor may even go further in the investigation by contacting other entities that have had
dealings with the client, in order to further assess the client's situation.
For a continuing client, the auditor must reflect upon previous relations with the client, evidence
of the client's integrity, whether the audit fees have been paid (which could introduce an
independence violation if the fees are one year or more in arrears), and the industry in which the
client operates.
Identify the Client's Reasons for an Audit: Two factors will affect audit risk--the likely statement
users and their intended use of the statements. If the statements are to be used widely, the auditor
will need to collect more information in the audit.
Obtain an Understanding with the Client: The auditor must document the understanding of the
engagement by submitting an engagement letter to the client. The engagement letter will
carefully specify what work the auditor will perform (audit, compilation, review, tax return
preparation) and should indicate that there is no guarantee of fraud discovery.
Select Staff for the Engagement: The staffing of the audit must meet the audit standard relating
to adequate technical training and proficiency. Additional specialists should also be considered,
if appropriate. Auditing standards sets requirements for selecting and reviewing the work of
specialists. Also, continuity of personnel from year to year may help to improve efficiency of the
audit.

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2. UNDERSTAND THE ENTITY AND ITS ENVIRONMENT
In the client acceptance phase, the auditors review material that is readily available about the
entity and the entity’s environment (annual reports, public news, and public information
databases). However, in the planning phase the auditor understands of the entity and its
environment should grow significantly. As ISA 315 points out, this understanding is an essential
aspect of carrying out an ISA audit. It establishes a frame of reference within which the auditor
plans the audit and exercises professional judgment about assessing risks of material
misstatement of the financial statements and responding to those risks.
Auditors use the strategic systems approach to understand the client's business. This approach
examines a number of dimensions:
1. Industry and the external environment
2. Business operations and processes
3. Management and governance
4. Objectives and strategies
5. Measurements and performance

3. ASSESS CLIENT BUSINESS RISK

Client business risk is the risk that the client will fail to achieve its objectives. Client business
risk can arise from any of the factors affecting the client and its environment. For example, a
new technology may erode a client's competitive advantage, or the client may fail to execute its
strategies as well as competitors.
The auditor's primary concern is the risk of material misstatements in the financial statements
due to client business risk. The client's industry and other external factors and the client's
business strategies, processes, and other internal factors are considered in the auditor's
assessment of client business risk.

4. PERFORM PRELIMINARY ANALYTICAL PROCEDURES

The fourth step in the audit planning process is to perform preliminary analytical procedures.
This step involves comparison of the client's ratios to industry standard ratios, both to see how
the client compares to its industry, as well as to determine if the client's ratios have changed from
previous years.

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Analytical procedures are defined as "evaluations of financial information made by a study of
plausible relationships among financial and nonfinancial data...involving comparisons of
recorded amounts to expectations developed by the auditor." In other words, do the ratios and
balances calculated appear to be reasonable?
Analytical procedures are performed at least once in an audit – near the end of the audit. ISA 520
states, “The objectives of the of auditor are ... to design and perform analytical procedures near
the end of the audit that assist the auditor when forming an overall conclusion as to whether the
financial statements are consistent with the auditor’s understanding of the entity.”
In addition, most practicing accountants recommend analytical procedures also are applied
during Phase I (planning) and Phase III (testing and evidence).
Thus, analytical procedures are performed at three stages of the audit:
1) In the planning phase,
2) During the testing phase, and
3) During the completion phase of the audit.
It is vital that the auditor develop an expectation of what the calculations should look like, based
on information from prior periods, industry trends, and other information. The auditor will use
one or more of the following analytical procedures:
1. Compare client with industry data
2. Compare client data with similar prior-period data
3. Compare client data with client-determined expected results
4. Compare client data with auditor-determined expected results
5. Compare client data with expected results, using nonfinancial data

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5. SET MATERIALITY AND ASSESS ACCEPTABLE AUDIT RISK AND INHERENT
RISK
The auditor considers materiality from a reasonable user perspective and follows a five-step
process in applying materiality on an audit. The auditor restricts audit risk at the account balance
level in such a way that, at the end of the engagement, he or she can express an opinion on the
financial statements, taken as a whole, at an acceptable level of audit risk. the auditor assesses
the level of risk of material misstatement of assertions in relation to financial statement accounts.
The risk of material misstatement is used to determine the acceptable level of detection risk and
to plan the auditing procedures to be performed.
The auditor is required by ISA 315 to identify and assess the risks of material misstatement at
both the financial statement and assertion levels. The financial statement level refers to risks
which are pervasive to the financial statements as a whole and which potentially affect many
assertions. An example might be if management has a tendency to override internal controls –
this would affect all areas of the accounting systems.
6. UNDERSTAND INTERNAL CONTROL AND ASSESS CONTROL RISK
ISA 315 requires the auditor to obtain an understanding of internal controls relevant to the
audit. Although most of the entity’s internal controls will relate to financial reporting, not all will
be relevant to the audit.
If the entity has an internal audit function then auditor shall obtain an understanding of the nature
of the internal audit function’s responsibilities, its organizational status, and the activities
performed, or to be performed.
The auditor should try to reach a judgments about how strong (or weak) the internal controls are,
in order to make a decision about the amount of testing that should be carried out in the audit. He
should consider:
 His previous knowledge of the client company
 Any recent changes
 Any known problems in the internal controls of the client
 The effect of any new auditing or accounting requirements
Control Risk is the risk that material misstatements will not be prevented or detected by internal
controls. The auditor evaluates the effectiveness of internal control for preventing material
misstatements in the financial statements and prepares a preliminary assessment of control risk.

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A preliminary assessment of control risk is necessary for the auditor to plan the nature, timing,
and extent of testing. A primary concern is the extent to which information technology is used in
processing accounting information.
In evaluating the effect of information technology on the client's accounting systems, the auditor
needs information on the following:
 The extent to which information technology is used in each significant accounting system
or business process
 The complexity of the client's computer operations.
 The organizational structure of the information technology activities.
 The availability of data
 The need for information technology-assisted techniques to gather data and conduct audit
procedures
The presence of complex information technology may require the use of an information
technology specialist.

7. DEVELOP OVERALL AUDIT PLAN AND AUDIT PROGRAM

The final step in the planning process is to prepare an audit planning memorandum and an audit
plan. The audit planning memorandum summarizes the overall audit strategy and contains the
decisions regarding the overall scope, emphasis, and conduct of the audit, planned audit
responses at the overall financial statement level, along with a summarization of significant
matters documented in the audit plan.

Multiple choice questions

1. Which of the following is NOT a benefit of an audit?

A) An audit may detect fraud and may act as a deterrent for fraud

B) An audit confirms the financial statements are correct and accurate

C) An audit increases the credibility and reliability of the financial statements

2. ________ is the risk that the financial statements contain a material misstatement due to fraud
or error prior to the audit.
A) Inherent risk
B) Client business risk

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C) Acceptable audit risk
D) Risk of material misstatement

3. The first phase in planning an audit and designing an audit approach is

A) accept the client and perform initial audit planning.
B) Set the preliminary judgment of materiality.
C) Understand the client's business and industry.
D) Perform preliminary audit procedures.

4. In what order should the following steps occur?

A. Set preliminary judgment of materiality and performance materiality.
B. Understand the client's business and industry.
C. Perform preliminary analytical procedures.
D. Accept the client and perform initial audit planning.
A) D, B, C, A
B) B, A, C, D
C) B, D, A, C
D) D, C, B, A

5. A written understanding detailing what the auditor expects from the client in performing an audit will
normally be expressed in the
A) management letter requested by the auditor.
B) Engagement letter.
C) Audit plan.
D) Audit strategy for the client.

6. Which of the following statements is true regarding communications between predecessor and
successor auditors?
A) The burden of initiating the communication rests with the predecessor.
B) The predecessor's response can be limited to stating that no information will be provided.
C) The predecessor should communicate with the successor only if the client is public.
D) The predecessor auditor of a public company does not need permission from the client before
communicating with the successor auditor.

7. Initial audit planning involves four matters. Which of the following is not one of these?
A) Develop an overall audit strategy.
B) Request that bank balances be confirmed.
C) Schedule engagement staff and audit specialists.
D) Identify the client's reason for the audit.

8. The auditor uses knowledge gained from the understanding of the client's business and industry to
assess
A) client business risk.
B) Control risk.

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C) Inherent risk.
D) Audit risk.

9. The two major factors affecting acceptable audit risk are

A) inherent risk and the intended uses of the financial statements.
B) Control risk and the intended uses of the financial statements.
C) The likely statement users and their intended uses of the statements.
D) The audit firm and the intended uses of the statements.

10. The process of financial audit begins with---------

A) Planning

B) Reporting

C) Testing
D) Internal control

Answer
1. A 2. D 3. A 4. A 5. B 6. B 7. B 8. A 9. C 10. A

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