1. 40 APRIL 2014
BUSINESS
A
sking the right questions when considering either
acceptance of new clients or continuance of existing
clients, is a key first step for establishing a quality
relationship between the auditor and client.
Audit firms are encouraged to approach client acceptance
and continuance with selectivity, taking on and retaining
only those audit clients that are consistent with their ethical
obligations.
Due diligence on prospective clients is a necessary step for
reducing risk, and an audit firm that fails to take a selective
approach to client acceptance may face financial losses,
reputational damage and even litigation.
The Financial Markets Authority (FMA) recently released
its first report on its audit quality reviews for the year ended 30
June 2013. The report identifies acceptance and continuance
procedures as one of the weaknesses that impacted on the
overall quality of some issuer audits performed. It observes
that acceptance and continuance procedures were not always
documented on the audit file, or failed to take into account
all issues identified during the prior year’s audit, such as
management fraud.
Client acceptance and continuance procedures should focus
on independence considerations, possible conflicts of interest
and whether the firm is competent to perform the engagement,
and has the capabilities, including time and resources to do
so. However, this weakness is not just isolated to the audits
of issuers; it is an area that practice review finds there is scope
for improvement in non-issuer audits too.
What do the standards say?
In the current business environment, it not only makes good
business sense to consider client due diligence, but certain
client acceptance and continuance procedures are required
by the auditing and assurance standards.
ISA (NZ) 210 Agreeing the terms of the audit engagement
establishes the preconditions for accepting an audit, which are:
• an acceptable financial reporting framework has been used
in the preparation of the financial statements
• those charged with governance agree that they acknowledge
and understand their responsibilities.
If the preconditions for an audit are not present, the auditor
must discuss the matter with those charged with governance.
Unless required by law or regulation to do so, the auditor
must not accept the engagement.
ISA (NZ) 220 Quality control for an audit of financial
statements deals with those aspects of engagement acceptance
that are within the control of the auditor. The engagement
partner must be satisfied that appropriate procedures regarding
the acceptance and continuance of client relationships and
audit engagements have been followed, and must determine
that conclusions reached in this regard are appropriate.
PES 3 Quality control for firms that perform audits and
reviews of financial statements, and other assurance engagements
requires the firm to obtain information considered necessary
in the circumstances before accepting an engagement with
a new client, and when deciding whether to continue an
existing engagement.
Information such as the following assists the engagement
partner in determining whether the conclusions reached
regarding the acceptance and continuance of audit engagements
are appropriate:
• the integrity of the principal owners, key management and
those charged with governance of the entity
• whether the engagement team is competent to perform
the audit engagement and has the necessary capabilities,
including time and resources
• whether the firm and the engagement team can comply
with relevant ethical requirements
• significant matters that have arisen during the current
or previous audit engagement and their implications for
continuing the relationship.
Ethical requirements
Audit firms should expect the same commitment to quality and
integrity on the part of their clients as they do of themselves.
As a result, many have developed and implemented improved
processes for approving new clients as well as reviewing
relationships with existing clients.
An important part of the client acceptance process, which is
required by NZICA’s Code of Ethics (Revised 2013), is for the
prospective auditor to communicate with the existing auditor
in writing. A professional clearance letter enquires whether
there are any professional or other reasons why the engagement
should not be accepted. For example, one such reason may be
a disagreement with some particular accounting treatment the
client wishes to adopt. However, before the existing auditor
can pass on any information to the prospective auditor, they
By Zowie Murray CA
Client acceptance and continuance
Knowing when to say no.
2. 41APRIL 2014
BUSINESS
must have the client’s authority to discuss its affairs. If the
client refuses permission then all the existing auditor can do
is advise the prospective auditor that there are matters they
would like to discuss but the client has refused permission for
this, and this should speak volumes.
The practice of low-balling, in which audit fees are deliberately
understated in order to win new clients, is believed to weaken
auditor independence. For this reason, this pricing behaviour is
discouraged by regulators and NZICA. Furthermore, low-balling
may also tempt the auditor to reduce the amount of audit work
performed and therefore compromise audit quality, including
where staff are under unreasonable pressure to do the same
work in less time. If unrealistic fees continue to be charged
over the medium or long term, this may result in decreased
investment in developing the audit profession, which in turn
could result in a reduced supply of competent auditors. In
summary, quality costs, but the absence of quality costs more
in the long run.
Adequate resources
Prior to acceptance or continuance of an audit engagement,
the engagement partner must determine that the audit team
has the necessary technical expertise and sufficient resources
such as time and access to experts. The increasing complexity
and regulation of audit requires a significant investment of
practice resources to maintain audit competence. Internal
and external reviews are an important mechanism to help
practitioners decide whether they are competent and adequately
equipped to perform audits.
This issue was demonstrated in the 2009 report by former
Companies Registrar Neville Harris on the failed finance
companies. He cited issues that arose as to whether auditors
had sufficient capability and experience to conduct the initial
due diligence for the client, and to audit such complex and
elaborate company and business structures. He further observed
that the audits of many of these finance companies lacked
the rigour and analytical depth one would expect for entities
managing substantial public investments.
The International Accounting Education Standards Board
(IAESB) recently released for comment an Exposure Draft of
International Education Standard (IES) 8 (Revised), Professional
Competence for Engagement Partners Responsible for Audits
of Financial Statements (comments are due 17 April). It
recognises that as the career of a practitioner progresses,
practical experience also becomes increasingly important in
maintaining and further developing the necessary depth and
breadth of professional competence.
Key message
Typically the process of handling audit client acceptance
and continuance varies with the size of the firm, and such
directives should be included in a firm's quality control manual.
The process should provide the audit firm with information
to judge whether the entity meets or exceeds the necessary
standards of integrity and whether the firm has the capacity
to perform a quality audit. if these standards are not clearly
met, the engagement should not be accepted. If a client no
longer meets the firm's standards, or when the firm cannot
commit sufficient resources to deliver a quality audit to the
client, the auditor should not accept the engagement. As with
any auditing procedure, the process should be documented
and all correspondence retained as audit evidence.
The cost of client due diligence is a small fraction of the
value of the engagement, and if the outcome is acceptance
this cost should be passed onto the client as part of the audit
fee. If the prospective client is not accepted, then clearly this
is time and money well spent. The key message is that audit
firms can turn work down, a firm does not have to accept
an audit engagement, it can say “no” to clients that do not
fit the risk profile of the firm and capital will go where it is
deserved. This will contribute towards developing a healthy
and profitable business.
Zowie Murray CA is a Technical Advisor in NZICA’s
Technical Services Team.
At a glance – red flag examples
1. Frequent changes of auditors – can mean an
organisation is opinion shopping.
2. Poor financial history – prior failed business or
bankruptcy could indicate a person who takes
unjustifiable risks.
3. Work/business history – is there unstable address,
employment or professional history?
4. Overly litigious as a plaintiff or defendant – signals
a party who is not afraid to sue, presents a risk
of non-payment or who may not honour their
agreements.
5. High turnover in upper management – can indicate
a lack of internal stability.
6. Short operating history – where were the management
team before they were at the current organisation?
7. Foreign operations/plants – complex business
structures may be concealing something.
8. Reluctance to provide references – if they are
reluctant to disclose information now, how will
they be once they are a client?
9. Pressure to start work quickly – can be a sign that
they do not want you looking into their background.
10.Regulatory actions – can indicate poor internal
controls or a management team ignoring internal
controls.
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