Lecture0224

Engagement Acceptance & Continuance

Ethics
• Moral principles that govern a person's behaviour or the conducting
of an activity.
• Accountants & Auditors are required to observe Code of Ethics for
Professional Accountants
Professional Code of Ethics as per International Federation of
Accountants
Fundamental Principles
• Integrity-straightforward, honest & sincere
• Objectivity-fair, free from prejudice, bias, or being impartial
• Independence-free from conflict of interest
• Confidentiality- keep inform. Confidential
• Technical Proficiency -perform to technical & professional standards
• Professional Competency- high level & skilful
• Ethical Behavior-good conduct to maintain good reputation
Rules of Independence
1. Prohibited Financial Interest
-no shares in the auditee company
-no lending to and from client
-no commission from client
-no accepting goods/services
-no accepting hospitality/gifts
2. Incompatible duties
-no partner or employee of the auditor is to be an
employee of the client
- no partner or employee of the auditor to be a
director
Rules of Independence cont.
3.Companies Acts restricts auditors from
-being officers of audit clients
-have debts with audit clients
-have interests in the client
4. Auditors are relaxed from the above when
auditing for Non Reporting Entities-
because it’s not mandatory
5. No Other Conflicts of interest between
auditor & client
Values upheld by Professionals
• Honesty
• Integrity
• Exercise of due care
• Objectivity
• Confidentiality
• Competency
• Public interest ahead of self interest-others first & self last
Consequences of Unethical Behavior
• Damaged Reputation
• Lost Customers
• Lost Employees
• Legal Problems - fraudulent accounting activities, tax evasion,
disqualification, fines
Material Misstatement
• Material misstatement in financial statements are those that could
reasonably influence the decisions of users of financial statements.
• Material misstatements can be caused by errors or fraud.
• Errors are unintentional mistakes that occur in the preparation of the
financial statements. They can be caused by a variety of factors,
including misunderstandings, mistakes in calculation, or oversight.
• Fraud is a deliberate attempt to deceive financial statement users by
intentionally misrepresenting or omitting information in the financial
statements. Fraud can be perpetrated by management, employees.
Example of Material Misstatement
• A company reports annual revenue of K 5 million. However, due to
an accounting error, their revenue is overstated by K 500,000. This
represents a 10% overstatement of revenues, a significant proportion. In
this case, the K 500,000 misstatement would be considered a material
misstatement.
• Here’s why: If investors, creditors, or other stakeholders were making
decisions based on the reported revenue, this error could significantly
affect those decisions. For instance, an investor might decide to buy shares
in the company based on its strong revenue growth. However, if
the revenue is overstated, the company might not be as financially strong
or as profitable as it appears, which could lead to financial loss for
the investor when this misstatement is eventually corrected and the
company’s stock price potentially falls.
Example of Material Misstatement by Fraud
• The Enron scandal 2001
• It was America’s seventh-largest company that was involved in corporate
corruption and fraudulent accounting practices, eventually leading to bankruptcy.
Shareholders lost $74 billion and employees lost their jobs and billions in pension
benefits. Executives of the firm committed many layers of financial fraud. One
example was that they logged estimated profits as actual profits. The company
would build an asset — for example, a power plant — and immediately claim
projected profits on its books even though the asset had yet to earned a dime.
• The auditors did not pick this up.
• When the scandal broke in 2001, Arthur Andersen — the accounting firm Enron
had hired to audit the company’s financial statements — was investigated by the
Department of Justice. Arthur Andersen quickly collapsed, and even though most
of the firm’s 85,000 partners and staff weren’t directly responsible for what
happened, they lost their jobs, their wealth tied to the company and their good
reputations.
Risk Assessment
Overview of Risk Assessment
Major Steps in Engagement
Acceptance/Continuance Process
Perform engagement acceptance or continuance
procedures – Similar to Risk Assessment
Pre-conditions exist
• Once a decision has been reached to accept or continue with the
client engagement, the next step is to:

• Establish whether the preconditions for an audit are present; and

• Confirm a common understanding between the auditor and management (and where
appropriate, those charged with governance) of the terms of the audit engagement.
Continued

• Where management does not acknowledge its responsibilities or

agree to provide written representations, auditor will not be able to
obtain sufficient appropriate audit evidence.
• Financial reporting framework is not acceptable, the auditor may
decline the engagement unless required by law or regulation.
Agreeing Terms of Engagement
• Management and the auditor agree on the terms of engagement
through an engagement letter
• The engagement letter is prepared by the auditor and signs and gives
to management to accept and sign
Engagement Letter Addresses the following
Updating the Engagement Letter

• Any revised or special terms of the engagement;

• A recent change in senior management;
• A significant change in ownership;
• A significant change in the nature or size of the entity’s business;
• A change in legal or regulatory requirements;
• A change in the financial reporting framework adopted in the preparation
of the financial statements;
• A change in other reporting requirements; and
• Some indication that management misunderstands the objective and scope
of the audit.
A Change in Terms of Audit Engagement
• Management may request changes to terms due to change in circumstances or a
misunderstanding of nature of original service requested.

• If it is motivated by issues raised during the audit. This could include:

o audit information that does not support management representations
o an inability to obtain certain audit information (which would effectively limit the
scope of the audit)
o or evidence that is otherwise unsatisfactory.

• An example might be auditor is unable to obtain sufficient appropriate audit

evidence regarding inventory balances, and entity asks for audit engagement to
be changed to a review engagement to avoid a qualified opinion or a disclaimer
of opinion.
What the auditor should do
• The auditor is required to:

o Withdraw from the audit engagement where possible under applicable law or
regulation; and
o 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.
Ends
• Refer to Case Study