Ethics and Terms of

11 Audit Engagements
CHAPTER

OVERVIEW

Independence
Independence Auditor's
in Independence
of MIND APPEARANCE

• Auditor’s • Engagement • Responsibilities of the

responsibilities Partner’s irm for establishing
in agreeing the responsibilities policies and procedures
terms of the with respect to regarding compliance
audit relavant ethical with relevant ethical
engagement requirements requirements

SA 210 SA 220 SQC 1

Self-Interest
Threats

Intimidation Self-Review
Threats Threats To Threats
Independence

Familiarity Advocacy
Threats Threats
Human civilization is built upon ethics. We cannot think of our daily lives without ethics. Think of
any endeavour of human activity- be it imparting of education, running a business, engaging in a
profession or carrying out public administration affairs- ethics have a role to play in every field. Ethics
guide us and help in building trust.
Consider the case of business. Can a company which does not take care of its workforce or hear its
customers achieve heights in its respective trade? A business which dishes out substandard products
instead of promised ones would not be able to stay in market for too long. Or take the case of a
lawyer who fails to attend legal proceedings of a client without reasonable cause putting his client’s
interests in jeopardy. Is his conduct ethical? Ultimately, such unprofessional behaviour would tarnish
his reputation and credibility.
Sameer was trying to understand importance of ethics in profession of Chartered Accountancy. He
was wondering whether a code of ethics exists for Chartered accountants and if so, how exhaustive it
would be.
Based upon his understanding of auditing till now, he was certain that an auditor must comply
with ethical requirements while conducting audit of financial statements. He knew that auditor should
be a person of unimpeachable integrity. He gives opinion on financial statements of entities and to
maintain sanctity and credibility of his signatures, it is necessary that an auditor should comply with
ethics.
A parallel stream of thoughts was also gaining momentum in his mind. Should an auditor follow
only those requirements which have been clearly laid down in the rule book? What about situations
for which little has been laid down? Thinking about “independence” of auditors, he seemed pretty sure
that it was not possible to codify every situation affecting independence of auditor. What approach
should auditor follow so that users continue to repose faith? Is there more than one perspective of
concept of “independence”? And most importantly, how should an auditor proceed in a situation
where he finds his “independence” on a sticky wicket due to extraneous factors?
Performing professional work following ethics also leads to qualitative audits conforming to
professional standards. Are there any pronouncements on quality control to be followed by Chartered
Accountants? He was yearning to learn about these.

Notes to Add

858 Auditing & Ethics PW

 MEANING OF ETHICS –A STATE OF MIND

morals

The term “Ethics” means moral principles which govern a person’s behaviour or his conducting
of an activity. It is the branch of knowledge that deals with moral principles. Ethics is something
which comes from an individual intrinsically. It has to be inculcated in the habit and temperament
of an individual, so that there is an overall culture of ethics; the force has to be strong enough to
withstand any selfish motive or temptation. It is a state of mind to act and perform in accordance with
moral principles. Ethics is the science of morals in human conduct. Such moral principles and rules of
conduct impose obligations upon individuals.

Notes to Add

Ethics and Terms of Audit Engagements 859

 NEED FOR PROFESSIONAL ETHICS

Professions like law, medicine have their code of ethics. Auditing profession is no exception.
Rather, in the profession of auditing, requirement of ethics is manifold. It is due to the reason that
society in general, governments, clients, taxing authorities, employees, investors, the business and
financial community in particular, have reposed tremendous trust in services rendered by Chartered
Accountants.
The purpose of assurance engagements is to enhance confidence of the intended users. Therefore,
users need to trust the person who is providing such services.
Professional ethics are based on morality. Human nature being what it is, a man, often, places his
personal gain above service. Therefore, persons who as individuals and as a class, are willing to place
public good above their personal gain have enjoyed respect and honour. But such a relationship can
be maintained or enhanced only if the professional body to which they belong would interpret the
concept of public interest as broadly as possible. The respect and confidence enjoyed by a profession,
to a great extent, is dependent on the strictness and scrupulousness with which such ethics are
adhered to by self-discipline.
A distinguishing feature of the accountancy profession is its acceptance of the responsibility to act in
the public interest. Professional ethics seek to protect the interests of the profession as a whole and
act as a shield that enables us to command respect.
A Chartered Accountant, either in practice or in service, has to abide by ethical behaviours. They
are expected to follow the fundamental principles of professional ethics while performing their
duties. Service users of professionals should be able to feel secure that there exists a framework of
professional ethics which governs the provision of those services.
It is in this spirit of things that the Institute of Chartered Accountants of India (ICAI) requires its
members to comply with the principles of ethics while performing their duties. The ethics for Chartered
Accountants have, therefore, been codified as ethical compliance has always been a philosophy of the
profession. Chartered accountants, whether in practice or in service, are required to comply with the
provisions of Code of Ethics.
Any deviation from the ethical responsibilities brings the disciplinary mechanism into action
against the Chartered Accountants which may result into fines, suspension of membership, removal
from membership or other disciplinary actions.

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 PRINCIPLES BASED APPROACH VS RULES BASED APPROACH TO ETHICS
(ETHICAL OR LEGAL)
Ethical guidance follow
Principles Based Approach Rule Based Approach
(1) Essence = Requires compliance (1) Strictly follows
 
With sprit of ethics Clearly established rules
(2) Accountants  exercise (2) Narrow outlook
  (3) Spirit of ethics
Every situation Prof. Judgement 
 Overlooked
Based on (4) Rigid
(5) May not possible
Prof. knowledge skill Expertise 
Every situation
Winner

Ethical guidance may follow principles-based approach or rules-based approach. The essence of
principles-based approach to ethics is that it requires compliance with spirit of ethics. It requires
accountants to exercise professional judgment in every situation based upon their professional
knowledge, skill and expertise. It requires that accountants should use professional judgment to
evaluate every situation to arrive at conclusions.
However, rules-based approach to ethics strictly follows clearly established rules. It may lead to a
narrow outlook and spirit of ethics may be overlooked while strictly adhering to rules. Further, rules-
based approach is somewhat rigid as it may not be possible to deal with every practical situation
relying upon rules.
Therefore, it is necessary that spirit of code is followed.

Notes to Add

Ethics and Terms of Audit Engagements 861

 FUNDAMENTAL PRINCIPLES OF PROFESSIONAL ETHICS

The fundamental principles of ethics establish the standard of behaviour expected of a professional
accountant. A professional accountant shall comply with each of the fundamental principles. The
fundamental principles of professional ethics are as under: -

Conidentiality

Professional
Integrity Professional competence
Behaviour and due care

Objectivity

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 1. Integrity: A professional accountant shall comply with the principle of integrity, which requires
an accountant to be straightforward and honest in all professional and business relationships.
Integrity implies fair dealing and truthfulness.

A professional accountant shall not knowingly be associated with reports, returns, communications
or other information where the accountant believes that the information contains a materially
false or misleading statement; contains statements or information provided negligently or omits
or obscures required information where such omission or obscurity would be misleading.
2. Objectivity: The principle of objectivity requires an auditor not to compromise professional
judgment because of bias, conflict of interest or undue influence of others. It requires that a
professional accountant shall not undertake a professional activity if a circumstance or relationship
unduly influences the accountant’s professional judgment regarding that activity.
3. Professional competence and due care: A professional accountant shall comply with the
principle of professional competence and due care, which requires an accountant to attain and
maintain professional knowledge and skill at the level required to ensure that a client or employing
organization receives competent professional service, based on current technical and professional
standards and relevant legislation; and act diligently and in accordance with applicable technical
and professional standards.

Diligence includes responsibility to act carefully, thoroughly and on a timely basis in accordance
with requirements of an assignment.
4. Confidentiality: Confidentiality principle requires a professional accountant to respect the
confidentiality of information acquired as a result of professional or business relationships.
Confidentiality serves the public interest because it facilitates the free flow of information
from the professional accountant’s client or employing organization to the accountant with the
understanding that the information will not be disclosed to a third party.

However, such confidential information may be disclosed, for example, when it is required by law,
when it is permitted by law and is authorised by the client or employer or there is a professional
duty or right to disclose when not prohibited by law.
5. Professional Behaviour: It requires an accountant to comply with relevant laws and regulations
and avoid any conduct that the accountant knows or should know might discredit the profession.
A professional accountant shall not knowingly engage in any employment, occupation or activity
that impairs or might impair the integrity, objectivity or good reputation of the profession, and
as a result would be incompatible with the fundamental principles.

Test Your Understanding

1. CA P. Suryakantam has conducted audit of accounts of an entity for a particular year. ICAI has
issued a letter to him relating to certain matters concerning audit. He didn’t even bother to reply
to the letter despite reminders. Discuss which fundamental principle governing professional
ethics is disregarded by him.
Ans. Failure to reply to professional body smacks of lack of courtesy and professional responsibility.
The principle of “Professional behaviour” is disregarded.

Ethics and Terms of Audit Engagements 863

 2. A Chartered accountant in practice issued a certificate showing original cost of plant and
machinery installed in premises of a client for Rs. 9 crores to save some regulatory fees for his
client. However, original cost of plant and machinery was Rs.15 crore as per records of client.
Which fundamental principle governing professional ethics is violated in this case?
Ans. “Integrity” requires that a professional accountant shall not knowingly be associated with
reports, returns, communications or other information where the accountant believes that
the information contains a materially false or misleading statement; contains statements
or information provided negligently or omits or obscures required information where such
omission or obscurity would be misleading.
In the given case, a false certificate is knowingly issued showing misstated original cost of
machinery. Therefore, fundamental principle of “integrity” is violated.

Notes to Add

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 INDEPENDENCE OF AUDITORS
 Wishes
Judgement of a person  Not subordinate Another person
direction 
Engaged

As per the code :– Auditor should be INDEPENDENT To own self interest

Independence of Mind Independence in Appearance

 
State of mind that permits the Avoidance of facts &
provision of an opinion  circumstances
without being affected by 
inluences That are so Signiicant

Professional integrity and independence are essential characteristics of all the professions but are
more so in the case of accountancy profession. Independence implies that the judgement of a person
is not subordinate to the wishes or direction of another person who might have engaged him, or to
his own self-interest.
It is not possible to define “independence” precisely. Rules of professional conduct dealing with
independence are framed primarily with a certain objective. The rules, by themselves, cannot create
or ensure the existence of independence. Independence is a condition of mind as well as personal
character and should not be confused with the superficial and visible standards of independence which
are sometimes imposed by law. These legal standards may be relaxed or strengthened but the quality of
independence remains unaltered.
There are two interlinked perspectives of independence of auditors, one, independence of mind
and two, independence in appearance.
Ethics and Terms of Audit Engagements 865
 Independence is:
(a) Independence of mind: The state of mind that permits the provision of an opinion without
being affected by influences that compromise professional judgment, allowing an individual
to act with integrity, and exercise objectivity and professional skepticism; and
(b) Independence in appearance: The avoidance of facts and circumstances that are so
significant that a reasonable and informed third party, having knowledge of all relevant
information, including any safeguards applied, would reasonably conclude a firm’s, or a
member of the assurance team’s, integrity, objectivity or professional skepticism had been
compromised.
Independence of the auditor has not only to exist in fact, but also appear to so exist to all reasonable
persons. The relationship between the auditor and his client should be such that firstly, he is himself
satisfied about his independence and secondly, no unbiased person would be forced to the conclusion
that, on an objective assessment of the circumstances, there is likely to be an abridgement of the
auditors’ independence.
Independence of an auditor assumes significance in context of providing confidence to users of
financial statements. As statutory auditor of a listed company, for example, the Chartered Accountant
would cease to perform any useful function if the persons who rely upon the accounts of the company
do not have any faith in the independence and integrity of the Chartered Accountant. In such cases,
he is expected to be objective in his approach, fearless, and capable of expressing an honest opinion
based upon the performance of work such as his training and experience enables him to do so.
Independence is dependent on the state of mind and character of a person and is a very subjective
matter. One person might be independent in a particular set of circumstances, while another
person might feel he is not independent in similar circumstances. It is therefore the duty of every
Chartered Accountant to determine for himself whether or not he can act independently in the given
circumstances of a case and quite apart from legal rules, in no case to place himself in a position which
would compromise his independence.

Notes to Add

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 THREATS TO INDEPENDENCE

Intimidation

Many different circumstances, or combination of circumstances, may be relevant and accordingly it

is impossible to define every situation that creates threats to independence and specify the appropriate
mitigating action that should be taken. In addition, the nature of assurance engagements may differ
and consequently different threats may exist requiring the application of different safeguards.
Following five types of threats to independence of auditors are discussed below:-
1. Self-interest threats
Self-interest threats occur when an auditing firm, its partner or associate could benefit from a
financial interest in an audit client. Examples include
(i) direct financial interest or materially significant indirect financial interest in a client
(ii) loan or guarantee to or from the concerned client
(iii) undue dependence on a client’s fees and, hence, concerns about losing the engagement
(iv) close business relationship with an audit client
(v) potential employment with the client and
(vi) contingent fees for the audit engagement
2. Self-review threats
Self-review threats occur when during a review of any judgement or conclusion reached in a
previous audit or non-audit engagement, or when a member of the audit team was previously a
director or senior employee of the client. Non audit services include any professional services
provided to an entity by an auditor, other than audit or review of the financial statements. These
include management services, internal audit, investment advisory service etc. Instances where
such threats come into play are: -
(i) when an auditor having recently been a director or senior officer of the company.
(ii) when auditors perform services that are themselves subject matters of audit.
3. Advocacy threats
Advocacy threats occur when the auditor promotes, or is perceived to promote, a client’s opinion
to a point where people may believe that objectivity is getting compromised, e.g., when an
auditor deals with shares or securities of the audited company, or becomes the client’s advocate
in litigation and third party disputes. In such situations, auditor can be perceived as backing
and championing causes of auditee client and it may lead to belief that auditor is not acting and
working objectively.

Ethics and Terms of Audit Engagements 867

 4. Familiarity threats
Familiarity threats are self-evident, and occur when auditors form relationships with the client
where they end up being too sympathetic to the client’s interests. This can occur in many ways
including:
(i) close relative of the audit team working in a senior position in the client company
(ii) former partner of the audit firm being a director or senior employee of the client
(iii) long association between specific auditors and their specific client counterparts and
(iv) acceptance of significant gifts or hospitality from the client company, its directors or employees.
Provisions in Companies Act, 2013 regarding rotation of auditors mainly address these very
familiarity threats. Such provisions prescribe that auditor is rotated after a certain number of
years so that auditors do not become too familiar with their clients.
5. Intimidation threats
Intimidation threats occur when auditors are deterred from acting objectively with an adequate
degree of professional skepticism. Basically, these could happen because of threat of replacement
over disagreements with the application of accounting principles, or pressure to disproportionately
reduce work in response to reduced audit fees or being threatened with litigation. Such threats
attempt to intimidate auditors to deter them from acting objectively.

Notes to Add

868 Auditing & Ethics PW

 SAFEGUARDS TO INDEPENDENCE
Safeguards to Independence
(i) Always be & appear to be Independent
(ii) Have I, O, PS
(iii) Consider threats to his Independence
(iv) Desist from the task or put inplace safeguards
(v) If unable to fully implement safeguards → must not accept work
Chartered Accountants have a responsibility to remain independent by taking into account the
context in which they practice, the threats to independence and the safeguards available to address
the threats.
Safeguards are actions, individually or in combination, that the professional accountant takes that
effectively reduce threats to comply with the fundamental principles to an acceptable level.
To address the issue, the following guiding principles are to be applied:
‰ For the public to have confidence in the quality of audit, it is essential that auditors should always
be and appears to be independent of the entities that they are auditing.
‰ Before taking on any work, an auditor must conscientiously consider whether it involves threats
to his independence.
‰ When such threats exist, the auditor should either desist from the task or eliminate the threat or
at the very least, put in place safeguards which reduce the threats to an acceptable level. All such
safeguards measures need to be recorded in a form that can serve as evidence of compliance with
due process.
‰ If the auditor is unable to fully implement credible and adequate safeguards, then he must not
accept the work.

Notes to Add

Ethics and Terms of Audit Engagements 869

 PROFESSIONAL SKEPTICISM

For

870 Auditing & Ethics PW

 An audit engagement involves engaging an auditor by a client for audit of its financial statements.
Audit engagement terms can include matters such as objective and scope of audit of financial
statements, responsibilities of auditor, responsibilities of management, identification of applicable
financial reporting framework for preparation of financial statements and reference to expected form
and contents of report to be issued by auditor.
Professional skepticism refers to an attitude that includes a questioning mind, being alert to
conditions which may indicate possible misstatement due to error or fraud, and a critical assessment
of audit evidence.
It signifies that auditor has to remain alert forever. The auditor’s attitude should be of questioning
mind- of challenging the things in light of available evidence.
The auditor shall plan and perform an audit with professional skepticism recognising that
circumstances may exist that cause the financial statements to be materially misstated.
Professional skepticism includes being alert to, for example:
‰ Audit evidence that contradicts other audit evidence obtained.
‰ Information that brings into question the reliability of documents and responses to inquiries to be
used as audit evidence.
‰ Conditions that may indicate possible fraud.
‰ Circumstances that suggest the need for audit procedures in addition to those required by the SAs.
Maintaining professional skepticism throughout the audit is necessary if the auditor is to
reduce the risks of:
‰ Overlooking unusual circumstances.
‰ Over generalising when drawing conclusions from audit observations.
‰ Using inappropriate assumptions in determining the nature, timing, and extent of the audit
procedures and evaluating the results thereof.
Professional skepticism is necessary to the critical assessment of audit evidence. It also includes
consideration of the sufficiency and appropriateness of audit evidence obtained in the light of the
circumstances, for example in the case where fraud risk factors exist and a single document, of a
nature that is susceptible to fraud, is the sole supporting evidence for a material financial statement
amount. The auditor may accept records and documents as genuine unless the auditor has reason to
believe the contrary.
Nevertheless, the auditor is required to consider the reliability of information to be used as audit
evidence. In cases of doubt about the reliability of information or indications of possible fraud, the SAs
require that the auditor investigate further and determine what modifications or additions to audit
procedures are necessary to resolve the matter.
The auditor cannot be expected to disregard past experience of the honesty and integrity of the
entity’s management and those charged with governance. Nevertheless, a belief that management
and those charged with governance are honest and have integrity does not relieve the auditor of the
need to maintain professional skepticism.
Ethics and Terms of Audit Engagements 871
Test Your Understanding
3. CA Raman Gupta is offered appointment as auditor of a company. One of his distant uncles held
some shares in the same company. Holding of such shares, by a distant relative, is not prohibited
under provisions of law nor does it affect his independence. Before he could accept appointment,
he received unfortunate news of death of his uncle who had died without any children. He came
to know that he was nominee of these shares having substantial value. It landed him in a tricky
situation. What should be proper course of action for him?
Ans. When threats to independence exist, the auditor should either desist from the task or eliminate
the threat or at the very least, put in place safeguards which reduce the threats to an acceptable
level.
Holding of shares involves financial interest in the company and is in nature of self-interest threat.
He has come to hold shares due to nomination made by his distant relative before accepting the
appointment. Considering above, he should take steps to eliminate the threat by selling shares
immediately before accepting appointment. Holding of shares of the same company for which
he is offered appointment as auditor constitutes threat to his independence.
4. A Chartered accountant receives about 40% of his total audit fees from a single client. Discuss
how it could affect independence of Chartered accountant as auditor of this client. What are
such types of threats referred to as?
Ans. Undue dependence on fees of a client constitutes a threat as there is fear of losing the client.
Such threats are referred to as self-interest threats.
5. CA Murli Madhavan provides accounting and book keeping services to a leading NGO engaged
in environmental protection work. He is also offered audit of the accounts of NGO. Identify and
discuss what kind of threat to independence may be involved in accepting such an engagement.
Ans. In this case, Chartered Accountant is already rendering accounting and book keeping services to
an NGO. If he accepts audit, he would be involved in reviewing own work. Therefore, the same
constitutes “self-review” threat.
6. The auditors of a company have only relied upon management representation letter regarding
treatment of certain tax matters under appeal by the company. The auditors have not carried
out any other audit procedures to justify management’s treatment of the said tax matters under
appeal in the financial statements. What is lacking on part of auditors in such a situation?
Ans. In the given case, auditors have relied only upon management representation letter regarding
treatment of certain tax matters under appeal by the company. No other audit procedures to
verify management’s treatment of such matters under appeal have been performed by auditors.
It shows lack of “professional skepticism” on part of auditors.

Notes to Add

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 AGREEING THE TERMS OF AUDIT ENGAGEMENTS

TCWG
Accept
∗Objective of Auditor Audit Engagement  Only when
Continue 
Basis upon which it is to be performed

Has been Agreed

Through

Establising Conirming
 
Pre-condition Common
 understanding
Present  Auditor
B/w
Mgt./TCWG

SA 210 deals with the auditor’s responsibilities in agreeing the terms of the audit engagement with
management and, where appropriate, those charged with governance. This includes establishing
that certain preconditions for an audit, responsibility for which rests with management and, where
appropriate, those charged with governance, are present.
The objective of the auditor is to accept or continue an audit engagement only when the basis
upon which it is to be performed has been agreed, through:
(a) Establishing whether the preconditions for an audit are present and
(b) Confirming that there is a common understanding between the auditor and management and,
where appropriate, those charged with governance of the terms of the audit engagement.

Notes to Add

Ethics and Terms of Audit Engagements 873

 PRECONDITIONS FOR AN AUDIT

As per SA 210 “Agreeing to the terms of Pre-Conditions

Audit Engagement” for an Audit

Use by the Management Agreement of Mgt. / TCWG

of an acceptable F.R.F To the premise on which

In preparation of F.S An audit is conducted

To determine whether Pre-Conditions are present  Auditor shall

Determine whether F.R.F is Obtain an agreement of Mgt.

applicable

That it Acknowledges + Understands its responsibilities

For the preparation of F.S For I.C. To Provide the auditor with

In accordance As Mgt. Considers Additional Info.  Unrestricted access

Access to all That auditor may to persons within
with App. F.R.F. necessary
request from Mgt. entity from whang
For purpose of audit Auditor obtain A.E.

Info.

Records

Docs.

Other Matters

As per SA 210 “Agreeing the Terms of Audit Engagements”, preconditions for an audit may be
defined as the use by management of an acceptable financial reporting framework in the preparation
of the financial statements and the agreement of management and, where appropriate, those charged
with governance to the premise on which an audit is conducted.

874 Auditing & Ethics PW

Preconditions for an audit

Use by management of and the agreement of

in the preparation of management to the
an acceptable inancial
the inancial statements premise on which an
reporting framework
audit is conducted

In order to establish whether the preconditions for an audit are present, the auditor shall:
(a) Determine whether the financial reporting framework is acceptable and
(b) Obtain the agreement of management that it acknowledges and understands its responsibility:
(i) For the preparation of the financial statements in accordance with the applicable financial
reporting framework including where relevant their fair representation;
(ii) For such internal control as management considers necessary to enable the preparation
of financial statements that are free from material misstatement, whether due to fraud or
error; and
(iii) To provide the auditor with:
¾ Access to all information of which management is aware that is relevant to the preparation
of the financial statements such as records, documentation and other matters;
¾ Additional information that the auditor may request from management for the purpose
of the audit; and
¾ Unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence.

Notes to Add

Ethics and Terms of Audit Engagements 875

 AGREEMENT ON AUDIT ENGAGEMENT TERMS

to include
(I) Objective & Scope  of Auditor
(ii) Responsibilities of Auditor
(iii) Responsibilities of Mgt.
(iv) Identiication of app. F.R.F.  for preparation of F.S
(v) Reference of any Expected  Form/Content  of any Report
to be issued by the Auditor
+
Statement  that Report may differ from Expected  Form/Content
If  Law  Regulation  Prescribes  Suficient Details
↓
The Auditor NEED not Record them in writing
↓
Except

Such Management

Law Regulation Acknowledges Understands

Applies Its
Responsibilities

Except in the cases where it is required under law to get accounts audited (for example in case of
companies), audit is a matter of contract between auditor and client. It is, therefore, important, both
for the auditor and client, that each party should be clear about the nature of the engagement. It must
be reduced to writing and should exactly specify the scope of the work.
876 Auditing & Ethics PW
 The auditor shall agree the terms of the audit engagement with management or those charged
with governance, as appropriate. The agreed terms of the audit engagement shall be recorded in an
audit engagement letter or other suitable form of written agreement.
The audit engagement letter is sent by the auditor to his client. It is in the interest of both the
auditor and the client to issue an engagement letter so that the possibility of misunderstanding is
reduced to a great extent. Such a letter includes:-
(a) The objective and scope of the audit of the financial statements
(b) The responsibilities of the auditor
(c) The responsibilities of management
(d) Identification of the applicable financial reporting framework for the preparation of the financial
statements and
(e) Reference to the expected form and content of any reports to be issued by the auditor and a
statement that there may be circumstances in which a report may differ from its expected form
and content.
If law or regulation prescribes in sufficient detail the terms of the audit engagement, the auditor
need not record them in a written agreement, except for the fact that such law or regulation applies
and that management acknowledges and understands its responsibilities.

Notes to Add

Ethics and Terms of Audit Engagements 877

 EXAMPLE OF AN ENGAGEMENT LETTER
PJ Shrimali & Co. 24, MG Road,
Chartered Accountants Mumbai
10th August XXXX
To the Board of Directors of Pristine Products Limited
The objective and scope of the audit
You have requested that we audit the financial statements of Pristine Products Limited, which comprise
the Balance Sheet as at March 31st, 20XX, the Statement of Profit & Loss, Cash Flow Statement for the
year then ended, and notes to the financial statements, including a summary of significant accounting
policies and other explanatory information.
We are pleased to confirm our acceptance and our understanding of this audit engagement by
means of this letter.
The objectives of our audit are to obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement, whether due to fraud or error, and to issue
an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is
not a guarantee that an audit conducted in accordance with Standards on Auditing (SAs) will always
detect a material misstatement when it exists. Misstatements can arise from fraud or error and are
considered material if, individually or in the aggregate, they could reasonably be expected to influence
the economic decisions of users taken on the basis of these financial statements.
The responsibilities of the auditor
We will conduct our audit in accordance with Standards on Auditing (SAs) issued by the Institute
of Chartered Accountants of India (ICAI). Those Standards require that we comply with ethical
requirements. As part of an audit in accordance with SAs, we exercise professional judgment and
maintain professional skepticism throughout the audit. We also:
‰ Identify and assess the risks of material misstatement of the financial statements, whether due to
fraud or error, design and perform audit procedures responsive to those risks, and obtain audit
evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not
detecting a material misstatement resulting from fraud is higher than for one resulting from error,
as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override
of internal control.
‰ Obtain an understanding of internal control relevant to the audit 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 company’s internal control. However, we will communicate to you in writing
concerning any significant deficiencies in internal control relevant to the audit of the financial
statements that we have identified during the audit.
‰ Evaluate the appropriateness of accounting policies used and the reasonableness of accounting
estimates and related disclosures made by management.
‰ Conclude on the appropriateness of management’s use of the going concern basis of accounting and,
based on the audit evidence obtained, whether a material uncertainty exists related to events or
conditions that may cast significant doubt on the company’s ability to continue as a going concern.
If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s
report to the related disclosures in the financial statements or, if such disclosures are inadequate,

878 Auditing & Ethics PW

 to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date
of our auditor’s report. However, future events or conditions may cause the company to cease to
continue as a going concern.
‰ Evaluate the overall presentation, structure and content of the financial statements, including
the disclosures, and whether the financial statements represent the underlying transactions and
events in a manner that achieves fair presentation.
Because of the inherent limitations of an audit, together with the inherent limitations of internal
control, there is an unavoidable risk that some material misstatements may not be detected, even
though the audit is properly planned and performed in accordance with SAs.
The responsibilities of management
Our audit will be conducted on the basis that management and, where appropriate, those charged
with governance acknowledge and understand that they have responsibility:
(a) For the preparation of financial statements that give a true and fair view in accordance with the
financial reporting Standards. This includes:
 The responsibility for the preparation of financial statements on a going concern basis.

 The responsibility for selection and consistent application of appropriate accounting policies,
including implementation of applicable accounting standards along with proper explanation
relating to any material departures from those accounting standards.
 The responsibility for making judgements and estimates that are reasonable and prudent so
as to give a true and fair view of the state of affairs of the entity at the end of the financial year
and of the profit or loss of the entity for that period.
(b) For such internal control as management determines is necessary to enable the preparation of
financial statements that are free from material misstatement, whether due to fraud or error and
(c) To provide us with:
(i) Access, at all times, to all information, including the books, accounts, vouchers and other
records and documentation, of the company, whether kept at the head office of the company
or elsewhere, of which management is aware that is relevant to the preparation of the
financial statements such as records, documentation and other matters,
(ii) Additional information that we may request from management for the purpose of the audit
and
(iii) Unrestricted access to persons within the entity from whom we determine it necessary
to obtain audit evidence. This includes our entitlement to require from the officers of the
company such information and explanations as we may think necessary for the performance
of our duties as auditor. As part of our audit process, we will request from management
and, where appropriate, those charged with governance, written confirmation concerning
representations made to us in connection with the audit.
Fees
Our fees bill for ` XXXXXX (plus applicable taxes) and out of pocket expenses will be raised after
completion of audit work.
Reporting
We will report to the members of Pristine Products Limited as a body, whether in our opinion, the
financial statements give the information required by the Companies Act, 2013 in the manner so
Ethics and Terms of Audit Engagements 879
required and give a true and fair view in conformity with the accounting principles generally accepted
in India, of the state of affairs of the company as at March 31, 20XX, and its profit/loss, and its cash
flows for the year ended on that date. The form and content of our report may need to be amended in
the light of our audit findings.
Please sign and return the attached copy of this letter to indicate your acknowledgement of, and
agreement with, the arrangements for our audit of the financial statements including our respective
responsibilities.
For PJ Shrimali & Co. Chartered Accountants Firm’s Registration Number
(Signature)
(Name of the Member)
(Designation)

Notes to Add

880 Auditing & Ethics PW

 WHAT HAPPENS IF PRECONDITIONS FOR AN AUDIT ARE NOT PRESENT?

If the preconditions for an audit are not present, the auditor shall discuss the matter with management.
Unless required by law or regulation to do so, the auditor shall not accept the proposed audit
engagement:
(a) If the auditor has determined that the financial reporting framework to be applied in the
preparation of the financial statements is unacceptable or
(b) If the agreement of management is not obtained on matters relating to understanding of
responsibility of management on preparation of financial statements, internal controls for
preparation of financial statements, providing access to all information to auditor and unrestricted
access to persons within the entity.

Notes to Add

Ethics and Terms of Audit Engagements 881

 LIMITATION ON SCOPE PRIOR TO AUDIT ENGAGEMENT ACCEPTANCE
If Mgt./TCWG → Impose Limitations → On the scope → Such that
↓
Limitation would Result in → Auditor Disclaiming an opinion
↓
The Auditor shall not accept such a limited engagement

If management or those charged with governance impose a limitation on the scope of the auditor’s
work in the terms of a proposed audit engagement such that the auditor believes the limitation will
result in the auditor disclaiming an opinion on the financial statements, the auditor shall not accept
such a limited engagement as an audit engagement, unless required by law or regulation to do so.
Acceptance of a change in the terms of the audit engagement
Request from Entity to change the Terms of Audit Engagement-When Reasonable Justification
Exists?

REQUEST may Result from

A misunderstanding A restriction on Scope of

A  in circumstances
 As to nature of Engagement

Audit Caused by

Related Services Mgt.

Circumstances
Auditor  Carefully Consider

Justiication for Request  particularly  Implication of

A restriction on

The scope of Audit engagement
∗A  in circumstances

affects entity’s Requirement Considered

Reasonable Basis
Misunderstanding

Nature of service originally requested

882 Auditing & Ethics PW

 info

Notes to Add

Ethics and Terms of Audit Engagements 883

 ACCEPTANCE OF A CHANGE IN THE TERMS OF THE AUDIT ENGAGEMENT
The auditor shall not agree to a change in the terms of the audit engagement where there is no
reasonable justification for doing so.
Review
Before Agreeing to   Audit Engagement Service
 Related
Need to assess
Legal Contractual
Implication
∗Auditor concludes  Reasonable Justiication
 Review
 Audit engagement Service
+ Related
Audit work  up to the date of   Relevant
+
Work  to be performed
Appro. To revised engagement
Report  to be issued
∗Report  would not include  Reference

Original Engagement Any procedure  that


May have been performed

Original engagement

EXCEPTION

Engagement  to under take  Agreed procedure

Reference is Normal part
∗  Terms of Audit engagement

Auditor Mgt.
Agree
+
Record
 Engagement Letter
New Terms
Other written agreement

Recourse available to auditor in situation of non-agreement to a change in terms of engagement

and lack of permission from management to continue original audit engagement

884 Auditing & Ethics PW

 REQUEST FROM ENTITY TO CHANGE THE TERMS OF AUDIT ENGAGEMENT-WHEN
REASONABLE JUSTIFICATION EXISTS?
A request from the entity for the auditor to change the terms of the audit engagement may result from
a change in circumstances affecting the need for the service, a misunderstanding as to the nature of an
audit as originally requested or a restriction on the scope of the audit engagement, whether imposed
by management or caused by other circumstances. The auditor considers the justification given for
the request, particularly the implications of a restriction on the scope of the audit engagement.
A change in circumstances that affects the entity’s requirements or a misunderstanding concerning
the nature of the service originally requested may be considered a reasonable basis for requesting a
change in the audit engagement.
In contrast, a change may not be considered reasonable if it appears that the change relates to
information that is incorrect, incomplete or otherwise unsatisfactory.
An example might be where the auditor is unable to obtain sufficient appropriate audit evidence
regarding receivables and the entity asks for the audit engagement to be changed to a review
engagement to avoid a qualified opinion or a disclaimer of opinion.

If, prior to completing the audit engagement, the auditor is requested to change the audit engagement
to an engagement that conveys a lower level of assurance, the auditor shall determine whether there
is reasonable justification for doing so.
Before agreeing to change an audit engagement to a review or a related service, an auditor who was
engaged to perform an audit in accordance with SAs may also need to assess any legal or contractual
implications of the change.
If the auditor concludes that there is reasonable justification to change the audit engagement to
a review or a related service, the audit work performed to the date of change may be relevant to the
changed engagement. However, the work required to be performed and the report to be issued would
be those appropriate to the revised engagement. In order to avoid confusing the reader, the report on
the related service would not include reference to:
Ethics and Terms of Audit Engagements 885
 (a) The original audit engagement or
(b) Any procedures that may have been performed in the original audit engagement, except where
the audit engagement is changed to an engagement to undertake agreed- upon procedures and
thus reference to the procedures performed is a normal part of the report.
If the terms of the audit engagement are changed, the auditor and management shall agree on and
record the new terms of the engagement in an engagement letter or other suitable form of written
agreement.

Notes to Add

886 Auditing & Ethics PW

 RECOURSE AVAILABLE TO AUDITOR IN SITUATION OFNON-AGREEMENT TO
A CHANGE IN TERMS OF ENGAGEMENTAND LACK OF PERMISSION FROM
MANAGEMENT TO CONTINUE ORIGINAL AUDIT ENGAGEMENT
If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted
by management to continue the original audit engagement, the auditor shall:
(a) Withdraw from the audit engagement where possible under applicable law or regulation and
(b) Determine whether there is any obligation, either contractual or otherwise, to report the
circumstances to other parties, such as those charged with governance, owners or regulators.

Notes to Add

Ethics and Terms of Audit Engagements 887

 TERMS OF ENGAGEMENT IN RECURRING AUDITS

An Audit  performed  over years
Recurring Audit  Auditor shall assess

Circumstances Whether there is a need to

Law That require the Terms REMIND

of Audit Engagement

To be REVISED The Entity

of the existing Terms of Audit Engagements

Auditor May decide → Not to send → A new → for each period → Audit Engagement Letter
→ written Agreement
Following Factors makes it appropriate to → Revise → Remind:
(i) Any indication that Entity → Misunderstands → Objective → Scope
(ii) Any → Revised → Special → Terms of Audit Engagement
(iii) A recent Δ in senior Mgt.
(iv) A significant Δ in ownership
(v) A Significant Δ in → Nature → Size → of Entity Business
(vi) A Δ in → Legal → Regulatory → Requirement
(vii) A Δ in F.R.F.
(viii) A Δ in other Reporting Requirement
Recurring audit is an audit which is performed by an auditor over years. On recurring audits, the
auditor shall assess whether circumstances require the terms of the audit engagement to be revised
and whether there is a need to remind the entity of the existing terms of the audit engagement.
The auditor may decide not to send a new audit engagement letter or other written agreement
each period. However, the following factors may make it appropriate to revise the terms of the audit
engagement or to remind the entity of existing terms:
(i)
Any indication that the entity misunderstands the objective and scope of the audit.
(ii)
Any revised or special terms of the audit engagement.
(iii)
A recent change of senior management.
(iv)
A significant change in ownership.
(v)
A significant change in nature or size of the entity’s business.
(vi)
A change in legal or regulatory requirements.
(vii)
A change in the financial reporting framework adopted in the preparation of the financial
statements.
(viii) A change in other reporting requirements.
888 Auditing & Ethics PW
Test Your Understanding
7. Chirag, as part of articled training, is part of an engagement team conducting audit of a company.
He has read somewhere that engagement letter issued by auditor to client also includes expected
form and content of the auditor’s report. He was at a loss to understand how could an auditor
include form and content of the report beforehand. Try to help Chirag by making things clear to him.
Ans. Engagement letter includes reference to expected form and content of audit report. It merely
states that auditor would provide opinion in this form. However, engagement letter also includes
statement that the form and content of report may need to be amended in the light of audit
findings. Therefore, if in light of audit findings, auditor needs to give a modified opinion, he shall
do so.
The management of an entity feels that it is not necessary for it to give in writing explicitly to
the auditor that it understands its responsibilities for preparation of financial statements in
accordance with applicable financial reporting framework. Discuss, whether, it is necessary for
the management to do so. In case management refuses, why should an auditor not accept the
proposed engagement?
8. It is necessary for management to give in writing explicitly to the auditor that it understands its
responsibilities for preparation of financial statements in accordance with applicable financial
reporting framework. It is a necessary precondition for an audit in accordance with SA 210.

If the preconditions for an audit are not present, the auditor shall discuss the matter with
management. Unless required by law or regulation to do so, the auditor shall not accept the
proposed audit engagement: -
(a) If the auditor has determined that the financial reporting framework to be applied in the
preparation of the financial statements is unacceptable or
(b) If the agreement of management is not obtained on matters relating to understanding of
responsibility of management on preparation of financial statements, internal controls
for preparation of financial statements, providing access to all information to auditor
and unrestricted access to persons within the entity.

Unless required by law or regulation to do so, such a refusal on the part of auditor is necessary
as management is not willing to accept its responsibility for preparation of financial statements
in accordance with applicable financial reporting framework. An audit is conducted on this basic
premise according to SA 210. When basic premise on which audit is conducted is not fulfilled,
refusal by auditor is necessary.

Notes to Add

Ethics and Terms of Audit Engagements 889

 AUDIT QUALITY

High Audit Quality  Essential  Maintain Conidence


Independent assurance

Provided by Auditor
Deals with Q.C.
SQC 1 and SA 220
 
 All engagements  Audit engagements
Only
Audit Reviews Assurance Related
Services  Particular Audit
 Entire Firm

The purpose of an independent audit is to provide confidence to users of audited financial

statements. Therefore, high audit quality is essential to maintain confidence in the independent
assurance provided by the auditors. It is the responsibility of auditor to maintain high audit quality.
SQC 1 and SA 220 both deal with quality control. Whereas SQC 1 deals with all engagements
including audits, reviews and other assurance and related service engagements, SA 220 applies to
audit engagements only.
Further, SQC 1 applies to entire firm. However, SA 220 applies to a particular audit engagement.
SQC 1 –“QUALITY CONTROL FOR FIRMS THAT PERFORM AUDITS AND REVIEWS OF HISTORICAL
FINANCIAL INFORMATION, AND OTHER ASSURANCE AND RELATED SERVICES ENGAGEMENTS”

SQC 1– “Quality Control For Firms That Perform Audits And Reviews Of Historical Financial
Information, And Other Assurance And Related Services Engagements”
SQC 1 requires that the firm should establish a system of quality control designed to provide it
with reasonable assurance that the firm and its personnel comply with professional standards and
890 Auditing & Ethics PW
regulatory and legal requirements and that reports issued by the firm or engagement partners are
appropriate in the circumstances. Firm’s system of quality control should consist of policies designed
to achieve these objectives.
Please see the next topic irst
Elements of system of Quality Control

Leadership Ethical Acceptance & Human Engagement Monitoring

Responisibilities Requirements Continuance of Resources performance
for quality within client’s
the irm relationships &
speciic
Engagements
Documented
Q.C.  P & P To Firm’s Personnel
Communicated

Notes to Add

Ethics and Terms of Audit Engagements 891

 ELEMENTS OF SYSTEM OF QUALITY CONTROL
The firm’s system of quality control should include policies and procedures addressing each of the
following elements: -
(a) Leadership responsibilities for quality within the firm
(b) Ethical requirements
(c) Acceptance & continuance of client relationships & specific engagements
(d) Human resources
(e) Engagement performance
(f) Monitoring
Quality control policies and procedures should be documented and communicated to the firm’s
personnel. By communicating, the firm recognizes the importance of obtaining feedback on its quality
control system from its personnel. Therefore, the firm encourages its personnel to communicate their
views or concerns on quality control matters.
Elements of a System of Quality Control: The firm’s system of quality control should include policies
& procedures addressing each of the following elements:

Leadership responsibilities for quality within the firm.

Ethical requirements.

Acceptance and continuance of client relationships and

specific engagements.

Human resources

Engagement performance

Monitoring

Notes to Add

892 Auditing & Ethics PW

 LEADERSHIP RESPONSIBILITIES
Leadership FOR
responsibilities forQUALITY WITHIN
quality wit hin the THE
irm FIRM
SQC – 1  Requires Firms  to establish P & P

Designed to promote

Internal culture

Based on recognition  Quality is essential

CEO
P & P require  Firm’s Ultimate responsibility
Managing 
Partner Firm’s Sys. Of Q.C.
 Persons assigned  for firm’s Q.C. Sys.
 Suff.
Should have Experience + Ability + Authority
Appro.

SQC 1 requires firms to establish policies and procedures designed to promote an internal culture
based on the recognition that quality is essential in performing engagements. Such policies and
procedures should require the firm’s chief executive officer or the firm’s managing partners to
assume ultimate responsibility for the firm’s system of quality control. The example set by firm’s
leadership encourages an inner culture that recognizes high quality audit work. Further, persons
assigned operational responsibilities for the firm’s quality control system by the firm’s chief executive
officer or managing partners should have sufficient and appropriate experience, ability and the
necessary authority to assume that responsibility.

Notes to Add

Ethics and Terms of Audit Engagements 893

 ETHICAL REQUIREMENTS
Ethical requirements
Ethical Requirements

Integrity Objectivity Professional Conidentiality Professional

Competence Behaviour
+ Due Care

As per code of Ethics for professional Accountants

Observance of independence  Basic Req.  All engagements
 Firm should establish P & P  designed to provide it with R.A.

Firm Its personal Experts Network Firm’s

Personnel

Contracted
Maintain Independence
+

Communicate Identify + Evaluate


Independence
requirement Circumstances Relationships
 Create
To its personnel 
Threat to independence
+
Take Appro. action

Eliminate Reduce

Acceptable
Level

 
Applying Appro. To
Or
safeguards withdraw

 The irm should create a mechanism

Engagement Firm’s Breach of Written

partners personnel independence conirmation of
compliance

894 Auditing & Ethics PW

   Circumstances  
Provide Notify Promptly P&P
relevant info  Relationships notiied 
 That create threat At least
Client annually
engagement

Acceptance and Continuance of Client Relationships and Speciic

The firm should establish policies and procedures designed to provide it with reasonable assurance
Engagements
that the firm and its personnel comply with relevant ethical requirements contained in the Code of
New client
ethics issued by ICAI.
Firm  Before accepting Acquire vital info.
The Code establishes the fundamental principles of professional ethics which include integrity,
Continue on existing
objectivity, professional competence and due engagement
care, confidentiality and professional behaviour.
Observance of “Independence” in all engagements is the basic requirement. The firm should
establish policies and procedures designed to provide it with reasonable assurance that the firm,
its personnel and (including experts contracted by the firm and network firm personnel) maintain
independence where required by the Code. Such policies and procedures should enable the firm to: -
(a) Communicate its independence requirements to its personnel.
(b) Identify and evaluate circumstances and relationships that create threats to independence, and
to take appropriate action to eliminate those threats or reduce them to an acceptable level by
applying safeguards, or, if considered appropriate, to withdraw from the engagement.
There should exist a mechanism in the firm by which engagement partners provide the firm
with relevant information about client engagements and personnel of firm promptly notify firm of
circumstances and relationships that create a threat to independence. All breaches of independence
should be promptly notified to firm for appropriate action. Its objective is to ensure that independence
requirements are satisfied.
At least annually, the firm should obtain written confirmation of compliance with its policies and
procedures on independence from all firm personnel required to be independent in terms of the
requirements of the Code.

Notes to Add

Ethics and Terms of Audit Engagements 895

 ACCEPTANCE AND CONTINUANCE OF CLIENT RELATIONSHIPS AND SPECIFIC
ENGAGEMENTS

Issues identified
 Where + Document issue resolution
Firm decides to

Accept Continue  client relationship

+
Speciic engagement

 Matter  Regarding  integrity of client

(1) Identity + Reputation client’s Principal Owners
KMP
Related Parties
TCWG
Client operation
(2) Nature
Business Practices

Principal owners
(3) Info.  Attitude  client’s KMP
TCWG
(4) Client → Aggressively concerned → maintaining Low firm’s Fees
(5) Indication → Inappro. Limitation → scope of work
Money laundering
(6) Indication → client involved
Criminal activities

Proposed appointment  of irm

(7) Reason
Non – reappointment  previous irm

Firm
 Any  conlict of interest
 client
Properly Resolved  Before accepting

896 Auditing & Ethics PW

  Firm obtains Info.  would have caused to decline

If info. had been obtained earlier

P & P should include consideration of

Req. of Firm Possibility of

Prof. + Legal  withdrawing
Resp. To report

Engagement Engagement
Person (s) Regulatory +
 Authorities Client
Who made appointment Relationship

A firm before accepting an engagement should acquire vital information about the client. Such an
information should help firm to decide about: -
‰ Integrity of Client
‰ Competence (including capabilities, time & resources) to perform engagement

‰ Compliance with ethical requirements

The firm should obtain such information as it considers necessary in the circumstances
before accepting an engagement with a new client, when deciding whether to continue an existing
engagement, and when considering acceptance of a new engagement with an existing client. Where
issues have been identified, and the firm decides to accept or continue the client relationship or a
specific engagement, it should document how the issues were resolved.
With regard to the integrity of a client, matters that the firm considers include, for example:
‰ The identity and business reputation of the client’s principal owners, key

‰ Management, related parties and those charged with its governance.

‰ The nature of the client’s operations, including its business practices.

‰ Information concerning the attitude of the client’s principal owners, key management and those
charged with its governance towards such matters as aggressive interpretation of accounting
standards and the internal control environment.
‰ Whether the client is aggressively concerned with maintaining the firm’s fees as

‰ low as possible.

‰ Indications of an inappropriate limitation in the scope of work.

‰ Indications that the client might be involved in money laundering or other criminal activities.

‰ The reasons for the proposed appointment of the firm and non-reappointment of the previous
firm.
If there is any conflict of interest between the firm and client, it should be properly resolved before
accepting the engagement. Where the firm obtains information that would have caused it to decline
an engagement if that information had been obtainable earlier, policies and procedures on the
continuance of the engagement and the client relationship should include consideration of:
Ethics and Terms of Audit Engagements 897
(a) The professional and legal responsibilities that apply to the circumstances, including whether
there is a requirement for the firm to report to the person or persons who made the appointment
or, in some cases, to regulatory authorities; and
(b) The possibility of withdrawing from the engagement or from both the engagement and the client
relationship.

Notes to Add

898 Auditing & Ethics PW

 HUMAN RESOURCES

The firm should establish policies and procedures designed to provide it with reasonable assurance
that it has sufficient personnel with the capabilities, competence, and commitment to ethical
principles necessary to perform its engagements in accordance with professional standards and
regulatory and legal requirements and to enable the firm or engagement partners to issue reports
that are appropriate in the circumstances. Such policies and procedures should address relevant HR
issues including recruitment, compensation, training, career development, performance evaluation
etc. There should be emphasis on the continuing professional development of firm’s personnel.
Engagement Performance
Engagement Performance
(1) Consistency in quality  through brieing of team
(1) Consistency in quality → through briefing of team

Objectives Process for Engagement Reviewing Appro.

Complying Performance Documentation

Supervision Training

Dificult
(2) Consultation Matters
 Contentious
Within
Discussion  Individual (s) Firm
Outside
(3) Sig. Judgement  Reviewed by  Q.C. Review
 Firm should establish P & P

To complete the assembly of Final Engagement File

On Timely Basis  Generally  60 Days

After the date of Auditor Report

 Engagement Doc  Retained  Suff. Time pd.


No shorter than 7 years

Ethics and Terms of Audit Engagements 899

 ENGAGEMENT PERFORMANCE
Consistency in quality of engagement performance is achieved through briefing of engagement teams
of their objectives, processes for complying with engagement standards, processes of engagement
supervision and training, methods of reviewing performance of work, appropriate documentation
of work performed.
Consultation should take place in difficult or contentious matters pertaining to an engagement.
Consultation includes discussion, at the appropriate professional level, with individuals within or
outside the firm who have specialized expertise, to resolve a difficult or contentious matter.
A firm needing to consult externally, for example, a firm without appropriate internal resources,
may take advantage of advisory services provided by other firms or professional and regulatory
bodies.
Significant judgments made in an engagement should be reviewed by an engagement quality
control reviewer for taking an objective view before the report is issued. The extent of the review
depends on the complexity of the engagement and the risk that the report might not be appropriate
in the circumstances. The review does not reduce the responsibilities of the engagement partner.
Engagement quality control review is mandatory for all audits of financial statements of listed
entities. In respect of other engagements, firm should devise criteria to determine cases requiring
performance of engagement quality control review.
There might be difference of opinion within engagement team, with those consulted and
between engagement partner and engagement quality control reviewer. The report should only be
issued after resolution of such differences. In case, recommendations of engagement quality control
reviewer are not accepted by engagement partner and matter is not resolved to reviewer’s satisfaction,
the matter should be resolved by following established procedures of firm like by consulting with
another practitioner or firm, or a professional or regulatory body.
Besides, the firm should establish policies and procedures for engagement teams to complete
the assembly of final engagement files on a timely basis after the engagement reports have been
finalized. The assembly of engagement files should be completed in not more than 60 days after date
of auditor’s report in case of audit engagements and in other cases within the limits appropriate
to engagements.
Policies and procedures should be designed to maintain the confidentiality, safe custody, integrity,
accessibility and retrievability of engagement documentation.
Unless otherwise specified by law or regulation, engagement documentation is the property of the
firm. The firm may, at its discretion, make portions of, or extracts from, engagement documentation
available to clients, provided such disclosure does not undermine the validity of the work performed,
or, in the case of assurance engagements, the independence of the firm or its personnel.
Engagement documentation has to be retained for a period of time sufficient to permit those
performing monitoring procedures to evaluate the firm’s compliance with its system of quality control,
or for a longer period if required by law or regulation.
In the specific case of audit engagements, the retention period ordinarily is no shorter than seven
years from the date of the auditor’s report, or, if later, the date of the group auditor’s report.

900 Auditing & Ethics PW

 MONITORING
Monitoring
Firm should ensure that P & P  Related to Sys. Of Q.C.

Relevant Adequate Operating effectively Complied with


In practice

The firm should ensure that policies and procedures relating to the system of quality control are
relevant, adequate, operating effectively and complied with in practice. Such policies and procedures
should include an ongoing consideration and evaluation of the firm’s system of quality control,
including a periodic inspection of a selection of completed engagements.

Notes to Add

Ethics and Terms of Audit Engagements 901

 SA 220-“QUALITY CONTROL FOR AN AUDIT OF FINANCIAL STATEMENTS”
statements”
∗Based on Q.C. Sys. Of a irm [Previous topic]

Q.C. policies pertaining to Audit engagements are decided by engagement
teams
∗Engagement partner  Responsible for Q.C.  as per SA 220
∗As per SA 220  Objective of Auditor  implement Q.C. policies

Provide him with R.A.

Audit complies with Issue Appro.


Prof. Legal Regulatory Audit Report
Standards Requirement

Notes to Add

902 Auditing & Ethics PW

 LEADERSHIP RESPONSIBILITIES FOR QUALITY ON AUDITS
SA 220  modelled  on lines of SQC.1

Leadership Ethical Acceptance & Human Engagement Monitoring

Responsibilities Requirements Continuance of Resources performance
for quality within client’s
the irm relationships &
speciic
Engagements

BasedLeadership
upon qualityresponsibilities
control system offor quality
firm, qualityon auditspolicies pertaining to audit engagements
control
are decided by engagement teams. Engagement partner of a team is responsible for quality control
procedures of a particular audit engagement in accordance with SA 220.
Therefore, SA 220 is premised on the basis that the firm is subject to SQC 1. Within the context of the
firm’s system of quality control, engagement teams have a responsibility to implement quality control
procedures that are applicable to the audit engagement and provide the firm with relevant information
to enable the functioning of that part of the firm’s system of quality control relating to independence.
As per SA 220, the objective of the auditor is to implement quality control procedures at the
engagement level that provide the auditor with reasonable assurance that: -
(a) The audit complies with professional standards and regulatory and legal requirements and
(b) The auditor’s report issued is appropriate in the circumstances.
SA 220 is modelled on lines of SQC 1. It describes responsibilities of engagement partner in relation
to following matters:
(a) Leadership responsibilities for quality on audits
(b) Relevant ethical requirements
(c) Acceptance and continuance of client relationships and audit engagements
(d) Assignment of engagement teams
(e) Engagement performance
(f) Monitoring
Leadership Responsibilities for quality within the irm on Audit
• As per SA 220 “Quality control for an Audit of F.S”

Engagement partner shall take responsibility

for overall quality of each audit engagement  to which he is assigned.

• Engagement partner’s Actions + Messages to Engagement Team Members

Should emphasize

Importance of Quality Is essential in

Audit Quality of performing audit engagement

Ethics and Terms of Audit Engagements 903

 Importance of Audit Quality of

Performing work Comply with Issuing Team’s ability to

that complies irms Q.C. appropriate raise concerns
with policies Audit Report without fear

Professional Legal Regulatory

standards
Requirements

Leadership responsibility of an engagement partner is to take responsibility for the overall quality
on each audit engagement. The actions of the engagement partner and appropriate messages to the
other members of the engagement team, in taking responsibility for the overall quality on each audit
engagement, emphasise
(a) The importance to audit quality of: -
(i) Performing work that complies with professional standards and regulatory and legal requirements;
(ii) Complying with the firm’s quality control policies and procedures as applicable;
(iii) Issuing auditor’s reports that are appropriate in the circumstances; and
(iv) The engagement team’s ability to raise concerns without fear of reprisals.
(b) The fact that quality is essential in performing audit engagements.

Notes to Add

904 Auditing & Ethics PW

 RELEVANT ETHICAL REQUIREMENTS
The responsibilities of an engagement partner in relation to ethical requirements in an audit
engagement are as under: -
‰ Identifying a threat to independence regarding the audit engagement that safeguards may not be
able to eliminate or reduce to an acceptable level.
‰ Reporting by engagement partner to the relevant persons within the firm to determine appropriate
action, which may include eliminating the activity or interest that creates the threat, or withdrawing
from the audit engagement, where withdrawal is legally permitted.
Acceptance and Continuance of Client Relationships and audit Engagements

SQC-1  Requires the irm  to obtain info  Before Accepting Audit

Engagement

Integrity of
Competence of Signiicant matters of
Principal owners, Firms’ Engagement
Engagement Team + current / previous Audit
KMP & TCWG of Partner
Time & Resources Engagement
entity

Comply with ethical

requirements

Notes to Add

Ethics and Terms of Audit Engagements 905

 ACCEPTANCE AND CONTINUANCE OF CLIENT RELATIONSHIPS AND AUDIT
ENGAGEMENTS
The responsibility of an engagement partner in this regard in an audit engagement is on lines of SQC 1
which requires the firm should obtain such information as it considers necessary in the circumstances
before accepting an engagement with a new client, when deciding whether to continue an existing
engagement, and when considering acceptance of a new engagement with an existing client.
Information like integrity of principal owners, competence of engagement team and consideration
of necessary capabilities including time and resources, compliance with relevant ethical requirements
and significant matters arisen during current or previous audit engagement and their implications
assist the engagement partner in determining whether the conclusions reached regarding the
acceptance and continuance of client relationships and audit engagements are appropriate.

Notes to Add

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 ASSIGNMENT OF ENGAGEMENT TEAMS

It should be ensured by engagement partner that the engagement team and any auditor’s experts who
are not part of the engagement team, collectively have the appropriate competence and capabilities
to perform the engagement in accordance with professional standards and regulatory and legal
requirements.

Notes to Add

Ethics and Terms of Audit Engagements 907

 ENGAGEMENT PERFORMANCE

Engagement partner has the responsibility for direction, supervision and performance of audit
engagement in accordance with professional standards and regulatory and legal requirements.
He is responsible for auditor’s report being appropriate in circumstances. Further, review of audit
documentation before issue of audit report is his responsibility. It has to be ensured that sufficient
appropriate audit evidence has been obtained to support the conclusions reached and for issuance of
auditor’s report.
Engagement partner is also responsible for ensuring undertaking appropriate consultation on
difficult or contentious matters by engagement team not only within the team but also with others at
appropriate level within or outside the firm.
For audits of financial statements of listed entities, and those other audit engagements, if
any, for which the firm has determined that an engagement quality control review is required, the
engagement partner shall:
(a) Determine that an engagement quality control reviewer has been appointed.
(b) Discuss significant matters arising during the audit engagement, including those identified
during the engagement quality control review, with the engagement quality control reviewer.

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 (c) Not date the auditor’s report until the completion of the engagement quality control review.
If differences of opinion arise within the engagement team, with those consulted or, where
applicable, between the engagement partner and the engagement quality control reviewer, the
engagement team shall follow the firm’s policies and procedures for dealing with and resolving
differences of opinion.

Notes to Add

Ethics and Terms of Audit Engagements 909

 MONITORING

An effective system of quality control includes a monitoring process designed to provide the firm
with reasonable assurance that its policies and procedures relating to the system of quality control
are relevant, adequate, and operating effectively. The engagement partner shall consider the results
of the firm’s monitoring process as evidenced in the latest information circulated by the firm and, if
applicable, other network firms and whether deficiencies noted in that information may affect the
audit engagement.
The engagement partner should document following matters pertaining to an audit engagement: -
(a) Issues identified with respect to compliance with relevant ethical requirements and how
they were resolved.
(b) Conclusions on compliance with independence requirements that apply to the audit
engagement, and any relevant discussions with the firm that support these conclusions.
(c) Conclusions reached regarding the acceptance and continuance of client relationships and
audit engagements.
(d) The nature and scope of, and conclusions resulting from, consultations undertaken during
the course of the audit engagement.
Test Your Understanding
9. CA PK Nair is offered appointment as auditor of a company engaged in providing tourism services.
While making due diligence of the proposed client, he comes to know that there have been raids
on premises of the company and residences of its directors by National Investigation Agency (NIA)
on suspicion of links with terror outfits. It has been followed up with searches by Enforcement
Directorate hunting for illicit money trail. There is a strong suspicion of tourism services provided
by company being façade of terror funds. Should proposed offer be accepted by him?

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Ans. Integrity of principal owners has to be considered before accepting an audit engagement in
accordance with SA 220. In this regard, SA 220 states requirements on lines of SQC 1. SQC 1
clearly states that in cases where there are indications that the client might be involved in money
laundering or other criminal activities, appointment should not be accepted.
In the instant case, there have been raids of NIA on suspected links with terror outfits which is a
criminal activity. Further, raids by Enforcement Directorate also point towards money laundering.
Therefore, proposed offer should not be accepted.
10. CA Arpita has joined a mid-sized CA firm recently. She finds that partners remain too busy and
the firm is proposing to accept audit work in areas in which it has no experience or capabilities.
The firm is proposing to accept audit of some entities engaged in emerging “fin-tech” sector.
Such audits may be requiring extensive use of technology and data analytics. However, the said
firm has no such capabilities and trained personnel. Discuss, whether, firm should accept such
audits with reason.
Ans. SQC 1 requires that before accepting an engagement, competence (including capabilities, time
and resources) to perform engagement have to be considered.
In the given case, the proposed engagements involve use of technology and data analytics.
The firm has no prior experience of audits in emerging “fin- tech” sector. The firm does not
have trained personnel to carry out these audits. Hence, offer for these audits should not be
accepted.

CASE STUDY
Das & Co, a firm of auditors, is offered appointment as auditor of a company, a prospective new
client. CA Sukanya, one of partners, is dealing with new client. While meeting with officers of the
company, she comes to know that Sushant, CFO of the company, was her class mate. In fact, both of
them had started CA together. However, Sushant had left CA mid-way due to repeated failures and
tried his luck to pursue MBA (finance) from one of leading institutions.
During initial discussions, it transpires that company is going to launch new services in the
field of “weather-forecasting”. Such services would be available on web site of company and micro
weather information would be available on payment of charges. The company requests audit firm
to be visibly associated with their marketing blitz.
Assume that firm choses to accept the offer and writes to previous auditor, Walker & Co., to
advise whether there exist any professional reasons for them not to accept the proposed offer.
However, Walker & Co. do not reply to the request of Das & Co.
During preliminary discussions, it also became known that the said company has acquired all
shares of another company. Under relevant provisions of law, financial statements of both companies
needed to be consolidated and audited. Despite this knowledge, Das & Co. failed to advise their
client regarding audit of consolidated financial statements.
The company also offers auditors contract for providing IT services pertaining to information
system of company.

Ethics and Terms of Audit Engagements 911

 QUESTIONS

Based on above, answer following questions:

1. Considering discussion about Sukanya and Sushant, which of the following statements seems
most appropriate?
(a) The above discussion is irrelevant in context of proposed offer.
(b) The proposed offer should be accepted by firm. The engagement team may be headed by CA
Sukanya for better coordination and results.
(c) The proposed offer should be accepted by firm. The engagement team may be headed by a
different partner of the firm.
(d) The matter is too trivial to be reported by CA Sukanya to other partners of firm.
Ans. (c)
2. Keeping in view request of the company to be visibly associated with company’s new services,
identify which type of threat is being faced by audit firm.
(a) Self-interest threat (b) Familiarity threat
(c) Self-review threat (d) Advocacy threat
Ans. (d)
3. The previous auditors, Walker & Co., have not replied to communication of Das & Co. Which
fundamental principle of professional ethics is not followed by them?
(a) Objectivity
(b) Professional behaviour
(c) Professional competence and due care
(d) Integrity
Ans. (b)
4. Das & Co. have failed to advise the company regarding audit of consolidated financial statements.
Which fundamental principle of professional ethics is violated by Das & Co.?
(a) Professional behaviour
(b) Integrity
(c) Objectivity
(d) Professional competence and due care
Ans. (d)
5. Which of the following statements is most appropriate regarding providing offer of work of IT
services by auditors to the company?
(a) Such offer may create a self-review threat
(b) Such offer may create an advocacy threat
(c) Such offer does not constitute any threat
(d) Such offer may create self-review and advocacy threats
Ans. (a)
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Multiple Choice Questions (MCQ)
1. Identify the most appropriate statement: -
(a) SA 220 applies at the level of firm.
(b) SQC 1 is premised on the basis that firm is subject to SA 220.
(c) SA 220 is premised on the basis that firm is subject to SQC 1.
(d) SA 220 applies to all engagements.
Ans. (c)
2. Professional skepticism includes-
(a) Overlooking unusual circumstances
(b) Using inappropriate assumptions in determining extent of audit procedures
(c) Over generalising when drawing conclusions from audit observations
(d) Being vigilant to conditions that might indicate possibilities of fraud
Ans. (d)
3. Which of the following is not a fundamental principle governing professional ethics?
(a) Professional competence and due care
(b) Integrity
(c) Objectivity
(d) Safeguards to independence
Ans. (d)
4. Which of the following is not necessary to establish preconditions for an audit?
(a) Acceptability of financial reporting framework.
(b) Acknowledgment of cooperation from management in designing audit procedures.
(c) Acknowledgment from management of providing access to persons within company.
(d) Acknowledgment of management in understanding its responsibility for preparation of
financial statements.
Ans. (b)
5. Identify the most appropriate statement in context of SQC 1.
(a) Assembly of engagement files should be completed in not more than 60 days after date of
auditor’s report in case of audit engagements.
(b) Engagement files should be completed before date of auditor’s report in case of audit
engagements.
(c) Engagement files should be completed in not more than 60 days after completion of an
engagement.
(d) Engagement files should be completed on date on which audit report is signed in case of
audit engagements.
Ans. (a)

Ethics and Terms of Audit Engagements 913

Correct /Incorrect
State with reasons (in short) whether the following statements are correct or incorrect:
6. The audit engagement letter is sent by the client to auditor.
Ans. (Incorrect)
As per SA 210 “Agreeing the Terms of Audit Engagements”, the Audit engagement letter is sent by
the auditor to his client.
7. The Audit Engagement documentations should ordinarily be retained by the auditor for minimum
of six years from the date of the auditor’s report or the date of the group auditor’s report, whichever
is later.
Ans. (Incorrect)
SQC 1 requires firms to establish policies and procedures for the retention of engagement
documentation. The retention period for audit engagements ordinarily is no shorter than seven
years from the date of the auditor’s report, or, if later, the date of the group auditor’s report.
8. Briefly outline how principles-based approach differs from rules-based approach to ethics.
Ans. Refer to topic on principles-based approach vs. rules- based approach to ethics.
Theory Questions
9. How application of professional skepticism throughout audit is helpful in reducing audit risk?
Ans. Refer to topic on “Professional Skepticism”.
10. A Chartered accountant is conducting audit of a client for last two years. Before proceeding to
start audit for next year, he notices that there is substantial change in management. Besides, client
has ventured into areas of business activity which were not present at time of accepting initial
audit engagement. Discuss responsibility of auditor in this regard in context of SA 210.
Ans. Refer to heading “terms of engagement in recurring audits”.
11. How does SQC 1 ensure that independence in engagements is not breached by an audit firm?
Ans. Refer to heading of Ethical requirements under “Elements of System of quality control” in SQC 1.
12. An engagement partner takes overall responsibility for maintaining audit quality in an audit
engagement in accordance with SA 220. What are his objectives in taking and emphasizing such
responsibility?
Ans. Refer to heading of “Leadership responsibilities for quality on audits” under SA 220.
qqq

914 Auditing & Ethics PW