Answer of Cases/ Short Questions relating to Accepting Engagements

Question/ Case 1 Answer:

Rights:

 To receive notice of the resolution to appoint another auditor.

 To have written representations circulated to all members, or read out at the meeting.

 To attend the meeting.

 To be heard at the meeting.

Question/ Case 2 Answer:

ABC & Co., Chartered Accountants

123 Free School Street
Kathalbagan
Dhaka

V Angry Esq
Gonzo Animations Ltd.
Mirpur Road
Kalabagan
Dhaka

5 April 2012

Dear Mr. Angry,

Engagement letters

We are required by International Standards on Auditing to send you a formal engagement letter
before conducting the audit. All firms of auditors should abide by this procedure.

The letter is there as much to protect the client, as it is the auditor, and we would suggest that
legal advice is taken prior to you accepting the terms.

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Purpose of engagement letter

The purpose of the letter is to:

 Define clearly the extent of our responsibilities, and your responsibilities.

 Minimize the possibility of any misunderstanding between ourselves and Gonzo

Animations Ltd.

 Provide written confirmation of our acceptance of appointment, the scope of the audit
and the form of the report.

We believe that it is important for both parties to clearly understand their roles within the
external audit function.

Contents of engagement letter

The contents of the letter are set out below, together, where necessary, with the justification of
the inclusion of the section.

 Our respective relevant statutory and professional responsibilities (to avoid

misunderstanding).

 An explanation of the scope of the audit (so that we inform you of what we will do).
This covers a number of issues:

 The audit will be carried out in accordance with the International Standards on
Auditing issued/ adopted by the Financial Reporting Council.

 We need to obtain an understanding of the accounting system in order to assess

its adequacy as a basis for the preparation of the financial statements.

 We need to obtain relevant and reliable evidence sufficient to enable us to draw

reasonable conclusions therefrom.

 The nature and extent of our procedures will vary according to the assessment
of the accounting system and, where we wish to place reliance upon it, the
system of internal control.

 We will endeavor to plan the audit so that we have a reasonable expectation of

detecting material misstatements in the financial statements or accounting
records resulting from fraud, error or non-compliance with law or regulations but
that the examination ought not to be relied upon to disclose all frauds, errors or
instances of non-compliance which may exist (as some may be immaterial).

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  Due to the test nature and other inherent limitations of an audit, together with
the inherent limitations of any system of internal control, there is an unavoidable
risk that even some material misstatement may remain undiscovered.

 An explanation that management representations may be required in writing

during the audit (this will only be in the case of audit areas where we have to
rely on your representations).

 The fact that we may send a letter of comment, adding value to the audit, by
outlining ways in which we discussed the business may be improved.

 Other matters such as:

 Our billing arrangements

 Any arrangements in the future concerning the involvement of:

 Other auditors and experts.

 Internal auditors.

 Previous auditors.

 Management’s responsibility to detect and prevent fraud.

 Your complaints procedures.

 A proposed timetable for the engagement (which will vary each year).

I hope this clarifies the need for the letter. Except for the timetable, we will only send out such
letters in future where absolutely necessary.

Yours sincerely

Mr. A Accountant

Question/ Case 3 Answer:

Directors responsible for:

 Forecasts including the assumptions on which they are based.

 Cooperating with the reporting accountant by making available records, documents and
personnel.

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Reporting accountant

 Forecast is properly prepared on the basis of the assumptions made.

 Provide negative assurance that nothing has come to reporting accountant’s attention to
cause them to believe that the assumptions do not provide a reasonable basis for the
forecast.

Question/ Case 4 Answer:

Requirement (a)

Matters/procedures prior to acceptance of audit

i. Check adequacy of resources to enable:

 Work to be completed to a high standard on a timely basis/ use of competent

staff.

 Provision of tax/ accountancy services without compromising independence (i.e.

safeguards can be put in place) e.g.:

 Use of separate personnel to perform accountancy and tax.

 Review by an independent partner/ senior staff member with appropriate

expertise if tax computation prepared by audit team.

 Review of the audit by an audit partner who is not involved in the audit
engagement.

ii. Establish/ document existence of informed management – to ensure auditor does not
take management role.

iii. Consider relationships/ familiarity threat – to ensure independence/ objectivity not

impaired.

iv. Consider potential conflicts of interest (e.g. competing clients) – to ensure act in the
best interest of clients.

v. Consider integrity of client – to reduce risk of misstatements due to fraud/

misrepresentation.

vi. Client identification procedures – to reduce exposure to money laundering/ comply with
money laundering requirements.

vii. Send letter of engagement – to ensure client understands nature and scope of the work
to be undertaken/ narrow expectations gap.
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Requirement (b)

Factors Why taken into account

 New client  Lack of familiarity – may not identify events and transactions which
have an impact on the financial statements/ higher detection risk.
 Start-up  Going concern risk.

 Doubts/ material uncertainty will require disclosure in the financial

statements.

 Lack of going concern status will require financial statements to be

prepared on a break-up basis.
 Lack of prior  Lack of comfort/ corroboration from use of analytical review
year figures procedures.

 Require more extensive use of tests of details (substantive tests).

 Bank covenant  Risk that profits may be overstated in order to preserve the debt
equity ratio.
 Trading with IT  Need to ensure complete disclosure of related party transactions.
Systems Ltd.
 Customized  May not be reliable, resulting in errors.
accounting
software
 Lack of  Misstatements may not be prevented or detected and corrected on
segregation of a timely basis/ higher control risk.
duties
 Determine the audit approach which is likely to be substantive
based.

Question/ Case 5 Answer:

Requirement (a) Arguments for Harmony’s subsidiary having an audit

An audit requires all similar-sized companies to be treated the same, regardless of ownership. It
provides assurance that the company has complied with the Companies Act and accounting
standards. Many would consider that an external audit is a fair price to pay for limited liability.

There are more stakeholders in a company than simply its shareholders who can use the
assurance generated by the audit work. The tax authorities can place more reliance on the
financial statements and an audit affords some measure of protection to creditors that the
company is not trading whilst insolvent. It also means potential investors can place similar
reliance on the financial statements whether or not the company is listed.

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Arguments against Harmony’s subsidiary having an audit

Harmony’s shareholders are actively involved in the management of the subsidiary and
therefore an audit will be of little value to them. The auditor’s report will be addressed to
shareholders and therefore contribute little to their knowledge and understanding of the
business. Furthermore, an audit can cause unnecessary red tape and expense.

Requirement (b)

The audit of Harmony will include the results of the subsidiary, which are material as the
subsidiary is the same size as Harmony. The audit firm must consider whether it has adequate
resources to audit the overseas subsidiary itself and whether it has the required level of
competence. Harmony should appoint a local audit firm and undergo an audit of its subsidiary
voluntarily. This local firm would use the firm’s Bangladesh audit packs and the Bangladesh firm
would review the work of the local auditor in detail.

The dispute with the previous auditors may also cast doubt over the integrity of management
and whether accepting the appointment will put the firm at risk of management intimidation. In
an attempt to resolve this issue, permission should be sought to speak with the outgoing
auditors and enquire of them whether there are any other issues of which the incoming auditor
should be aware.

The engagement partner assigned must ensure that members of the audit team have
appropriately consulted on difficult or contentious issues. It is also recommended that an
independent second partner review of the audit file is undertaken in the first year, before the
audit report is signed.

Requirement (c) Threats to objectivity

In some cases, for example when management representations are discussed, it may be
desirable for the auditor to attend board meetings. However, an auditor must not under any
circumstances make management decisions. Attending board meetings is allowed if the auditor
is acting in an advisory capacity only or is reporting the results of audit work.

Safeguards

To safeguard against this threat, the auditor should ensure that there is ‘informed management’
at the company. The auditor should inform the directors that they alone are responsible for
decision-making and he should get their written confirmation of agreement to this. In the
interests however of being ‘seen to be independent’ it may be best to decline the offer of
attendance at monthly board meetings.

Threat to objectivity

The provision of internal audit service causes a self-review threat to the external auditor as the
external audit staff members may overlook errors made by their internal audit colleagues or
may place too much reliance on their work.

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Safeguards

The external audit firm can only act as internal auditor if the external auditor does not place
significant reliance on the work or relies on it only after rigorous and objective assessment of
the work completed by the internal auditors. Additional safeguards include separate
engagement partners, separate engagement letters and different teams for the two respective
roles.

Finally, the directors must confirm in writing that they are responsible for the overall system of
internal control including the work of internal audit, and that they are responsible for acting on
the recommendations of internal audit.

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