PRACTICE MANAGEMENT

1 TOWER & CO

Key answer tips

Practice management is a regularly examined topic and quality control is an important topic in
this area. The question should be fairly straightforward if you’ve studied the relevant chapters.
Make sure you explain your points in order to score well. Brief lists of points are likely to only
be worth ½ mark.

(a) Quality control policies and procedures

Why quality control policies and procedures are necessary:
(1) ISQC 1 Quality Control for Firms that Perform Audits and Reviews of Historical
Financial Statements, and Other Assurance and Related Services Engagements,
requires firms to establish a system of quality control designed to provide it with
reasonable assurance that the firm and its personnel comply with professional
standards and regulatory and legal requirements, and that the reports issued by
the firm or engagement partners are appropriate in the circumstances.
(2) ISA 220 Quality Control for Audits of Financial Statements states that the
engagement team should implement quality control procedures that are
applicable to the individual audit engagement. The standard places emphasis on
the engagement partner’s responsibility to ensure that all matters in relation to
the engagement are properly dealt with. The key reason for this is as follows:
Whenever an audit assignment is performed by a firm there are several risks which they
are exposed to such as performing work negligently such that the client or indeed a
third party suffers loss as a result. This could have an adverse effect on the audit firm –
their reputation could suffer, and therefore both the income from that client and
potential clients may be lost.
Other risks that could materialise if there were insufficient/inadequate quality control
procedures are that the audit opinion may be unmodified when in fact it should be
modified or vice versa i.e. it could be unnecessarily modified.
Such risks are clearly ones that should be avoided by any firm and therefore proper
management of quality control within our firm is vital.
Areas that should be covered by quality control policies include:
Leadership
The partners in charge of the audit firm should ensure that adequate quality control
policies and procedures are in place within the firm. They should ensure these policies
are communicated to staff and monitor whether they are being complied with.
Ethics
It should be ensured that all staff adhere to the ACCA’s principles of independence,
integrity, confidentiality and professional behaviour. The firm should ensure staff are
aware of the need to declare any relationships, shareholdings or job offers with a client.
Human resources
All personnel should be either fully qualified or trained for the work which they are
performing, and a system should be in place to ensure that knowledge is maintained up
to date.
 Proper/effective recruitment and retention policies and procedures to ensure that the
right personnel are selected for the right job and that such staff are retained within the
firm.
Acceptance and retention of clients
The firm should ensure that they are able to perform the audit i.e. that they have
sufficient capacity and skills, that they would be able to remain independent, and that
the client’s directors and management are trustworthy and have integrity. There should
be a system in place which ensures that prior to accepting any new client, and when
reviewing all existing clients circumstances all such relevant factors are considered.
Engagement performance
Assignment of personnel to the audit – Clearly it is important that appropriate staff are
assigned to each audit i.e. that they have relevant skills and experience to perform the
work.
Delegation of work to staff undertaking the audit – All work that is delegated must be
performed to satisfactory standards and meet quality control criteria. Adequate
direction, supervision and review should exist throughout all stages of the audit.
Consultation – There should be consultation within the firm with other audit managers
or partners on subjective audit issues; in addition, where necessary, consultation with
external bodies/individuals on specialist issues should also be conducted. If the auditor
is uncertain about any issue he must ensure that he can give his opinion based on
sufficient and appropriate evidence.
Monitoring
It is an important part of any quality control system to ensure that such policies stay
relevant and are sufficient; an effective and appropriate system should be in place.
Procedures that would be required to ensure that quality control policies are met:
Hot review – an independent partner should review the files of high risk, listed and
public interest clients before the auditor’s report is signed. Particular attention should
be paid to areas of judgment and subjective matters.
Cold review – On an ongoing basis, a sample of completed audit files should be
reviewed to ensure the work has been performed in accordance with ISAs and the
firm’s own policies and procedures. This review should be performed by someone with
suitable seniority.
Review of work – during each engagement, each team member’s work should be
reviewed by someone more senior to ensure it has been done properly.
(b) Hot review
A hot review is also known as a pre-issuance review or engagement quality control
review.
It is performed by a senior member of staff, unconnected with the audit in question, in
order to ensure independence. Essentially the review enables a fresh perspective of the
audit.
The review is conducted before the auditor’s report is signed, and is usually performed
soon after the work is completed to ensure that the auditor’s report to be issued is
appropriate.
The focus of attention will be the subjective and judgemental areas of the audit such as
materiality, significant risks of material misstatement, significant areas of management
judgement and areas requiring consultation.
 The reviewer will indicate that he has performed the review by dating and initialling the
piece of work. The review should ensure that the work has been performed in line with
the audit plan and that the conclusions are consistent with the results obtained.
Cold review
A cold review is also known as a post-issuance review or monitoring review.
It is performed by someone senior within the firm unconnected to the audit who is
sufficiently experienced to be able to identify issues with audit documentation.
The review is performed after the auditor’s report has been signed.
This review is designed to identify systemic deficiencies in the firm’s audit
methodologies so that training and other remedial actions can be taken.
(c) All audit reasons and justifications need to be documented in the audit working papers
because they need to enable an auditor with no previous experience of the audit to
establish what work has been completed and how the conclusions were reached.
This is especially important if the auditors had to give evidence in a court of law
regarding the audit.
It should also be clear from the documentation in the file that the auditors’ conclusions
are reasonable therefore the explanations should be sufficiently detailed.
(d) Standardised audit working papers ensure:
 work is performed consistently across audits which is an important aspect of ISQC
1.
 evidence required to meet the audit objectives is always obtained. If a working
paper is not completed it would indicate the sufficient appropriate evidence has
not been obtained for that area of the audit.
 evidence required by ISAs is obtained as every audit file will contain the
mandatory requirements of the ISAs.
However, they should not be so rigid that they inhibit the auditors’ skills and flair, as
these are the factors that make the difference between a good and a bad auditor.
Auditors should always exercise professional scepticism and look out for anything
unusual when performing their work. If any such issues are identified they should be
should not be ignored just because it is not part of the standard programme.
Auditors must be flexible in their approach, and use their initiative.

2 LANCASTER
Key answer tips
This question brings together practice management and ethics in a practical scenario. If a firm
is unlikely to win the audit then it may not be worth the time spent putting together the
proposal so the firm will first consider whether it wants the engagement. The tender
document is a sales pitch to the prospective client. The tender allows the firm to communicate
why they should be chosen as auditor.

(a) Matters to be considered before tendering

Fees
Increased fees would be especially advantageous as the audit firm has recently lost two
clients. However the fee would need to be sufficient for the level of work involved. The
firm should be careful not to quote too low a fee in order to win the work (lowballing).
Although the audit fee represents increased total fee income from Lancaster, this
together with the potential amount for the consultancy support would mean that the
total income for the firm would become $770,000 ($700,000 – 50,000 + 120,000).
Therefore fees from Lancaster would represent 15.6% of the total fee income
(120,000/770,000 × 100). The audit fees on their own represent 2.6% (20,000/770,000 ×
100) so clearly this is well within the recommended limit of 15% (UK syllabus: 10%)
which would have to be considered if the company was listed. However, because of the
potential additional income, the audit firm would have to be aware of any
independence issues, and take appropriate action as necessary.
The ability of the company to pay the audit fees should also be considered. Credit
checks should be performed to assess their credit status, particularly given the poor
financial performance and ongoing legal cases.
Possibility of additional work
There is the possibility of additional work (i.e. management consultancy) as well as the
audit which would significantly increase the firm’s overall fee income.
Risks
Lancaster is currently experiencing difficulties in respect of sales.
Lancaster has had staff morale problems that could make the audit more difficult as
staff may be unwilling to co-operate with the auditors or may present an unbalanced
view of circumstances due to the low morale and use the auditors as a ‘moaning block’.
The auditor clearly has to obtain evidence to support his opinion, but such
circumstances can make his task more onerous.
Lancaster has not invested in non-current assets recently and this has only compounded
their current financial problems and does not assist in improving the outlook for the
future and the company’s long-term viability, especially taking into account the other
factors such as retirement of the MD, staff issues and litigations.
There is a litigation case currently outstanding from an employee regarding Health and
Safety. The audit firm would have to ensure that this is correctly treated. Furthermore,
the Finance Director is suing Lancaster for unfair dismissal; both of these litigation cases
should put the audit firm on notice that the situation within Lancaster is one which is far
from ideal for taking over an audit.
Discussions should be held with management and their lawyers regarding the litigation
case, as the outcome of the cases could have a significant impact on the profit for the
year.
Reasons for changing audit firm
 The audit firm should ascertain what has happened to the previous auditors i.e. did they
resign, or were they removed from office. Reasons for either of these situations should
be ascertained. The previous auditors should be contacted for relevant information.
Money laundering checks
A company search should be undertaken to confirm who is involved in the running of
Lancaster, and a copy of the filed financial statements should be obtained. Credit
references should also be obtained.
Competence
Background information regarding the industry as a whole and for Lancaster specifically
should also be obtained to ascertain whether or not expert assistance would be
required, and whether the audit firm has the relevant skills and experience to perform
the audit.
(b) Fee determinants
 What work will be required to be performed for the audit – this depends on how
complex their financial affairs are and whether or not the audit firm can rely on
the controls in existence. Clearly the latter will not be known until the audit work
is commenced. However, they may be able to get a feel for this from the initial
information obtained. The tender should state this and make allowance for this in
the price.
 Consider what the fee is for similar companies audited in respect of size,
complexity, degree of risk.
 Consider what the set up costs would be for the audit and then subsequent
annual costs. The first audit will obviously take more time due to the systems
documentation required.
 The level and number of staff that will need to be involved in the audit.
 Expenses to be recovered for travelling, accommodation if applicable and meals.
 The fee charged must be able to be clearly explained and analysed.
 Consider whether or not the fee can be easily renegotiated at a later date.
 Ensure that the client is clear as to what is included in the audit fee and what will
have to be paid for in addition if required.
(c) Tender document contents
 The nature, purpose and legal requirements of an audit.
 An assessment of the client’s requirements for the audit and the management
consultancy support.
 Details of how the audit firm will satisfy the client’s requirements in respect of
the audit and the management consultancy support.
 Any assumptions made by the audit firm in preparing the tender e.g. work to be
done by the client.
 The audit methodology/approach to be used for the audit, together with how the
management consultancy work would be approached.
 Details of the firm and its personnel who are likely to be used on the audit and for
the management consultancy work.
 The other services that the audit firm can offer in addition to management
consultancy.
 Background of the firm.
 Details of number of offices, staff and partners of the firm.
 Quality control procedures of the firm to provide confidence to the prospective
client that the work will be of a high standard.