Before formalizing an external audit engagement, auditors are required to follow a structured process to ensure compliance with professional standards and ethical
responsibilities. According to ISA 210: Agreeing the Terms of Audit Engagements, there are a number of steps that must be completed before the engagement letter is signed.
Before signing an engagement letter with a client, an external auditor must first assess the client’s integrity, ethical standards, and reputation. This involves considering factors like the client’s history of fraud, unethical behavior, and overall reputation within the industry. Additionally, the auditor must determine their own independence and professional judgment to ensure they can objectively perform the audit. Finally, clarify the scope of the audit,
the responsibilities of both parties, and the fee arrangements within the engagement letter itself. These considerations help ensure that the audit can be conducted effectively, ethically, and in compliance with professional standards.
- Client Integrity and Reputation: Auditors need to assess the client’s track record and ethical standards, as this can impact the auditor’s ability to be impartial and provide an accurate audit opinion.
- Assessing the Nature of Client Operations: The auditor must gather sufficient knowledge of the entity’s operations, to determine whether it is complex or operates in a high-risk industry. The structure of the entity and its group (if applicable) and jurisdiction of the client should be assessed.
- Independence and Objectivity: The auditor must assess whether it is independent of the client, both in fact and appearance and any existing or potential conflicts of interest must be identified and resolved.
- Scope and Objectives of the Audit: The scope of the audit, including the financial statements to be audited, the period covered, and any specific objectives or areas of focus must be clearly defined.
- Competence and Resources: The auditor must evaluate whether it has the technical expertise, industry knowledge, and sufficient staff to perform the audit. Consideration should be given to the complexity of the client’s operations and any specialized skills required.
- Legal and Regulatory Environment: Understand the legal framework applicable to the client’s industry and jurisdiction.
- Previous Auditor Communication (if applicable): If the client had a previous auditor, the incoming auditor should: Communicate with the predecessor auditor (with client permission); Inquire about reasons for the change and any issues encountered; Review prior audit documentation if available.
- Risk Assessment: Perform a preliminary risk assessment to identify any red flags, such as (1) History of financial irregularities (2) Ongoing litigation or regulatory investigations (3) Aggressive accounting practices.
- Ethical Considerations: Ensure compliance by the engagement team and audit firm with all relevant ethical requirements.
- Other preconditions: The auditor must determine whether the following preconditions are present:
- Management’s use of an Acceptable Financial Reporting Framework: The financial statements must be prepared in accordance with a framework that is acceptable in the circumstances.
- Agreement on Management’s Responsibilities: Management must acknowledge and understand its responsibility for: Preparing the financial statements; Implementing internal controls; Providing access to all relevant information and personnel.
- Agree on Terms of the Engagement: Agree with the potential client on the terms and conditions of the engagement. This usually includes the scope of the audit, responsibilities of The following Key Working Papers should be reviewed by the Engagement Partner before signing the engagement letter
- Client Acceptance or Continuance
- Independence and Conflict of Interest Checks
- Compliance with Ethical Requirements
- Engagement Risk Assessment
- Resource and Competency Assessment
- Communication with Predecessor Auditor (if applicable)
- Draft Engagement Letter
