PSY 002: AUDITING THEORY (ADVANCE TOPIC)

LECTURE NOTES AND PRACTICE EXERCISE

Lesson 4: Performing Preliminary Engagement Activities

Lesson Objectives:
- Discuss the activities in the pre-planning phase of audit
- Enumerate client acceptance and continuance consideration
- Discuss the basis of audit engagement that the auditor should establish.

Performing Preliminary Engagement Activities

1. The integrity of the client. Why is the client's integrity important if we are to audit its FS, the client's
integrity is questionable there is a chance that their financial statement is fraudulent too. We could
talk to the predecessor auditor if necessary, use the search engines for news and inquiry with the
third party to obtain necessary information about this.

2. The auditor's compliance with ethical requirements . For example, you are to audit the business of
your wife. Do you think there is a lack of independence and potential bins on your part? Of course!
So, we are likely to decline that engagement unless this risk is addressed.

3. "Can we finish the audit on time? So, we must ask the following questions.
a. Do we have enough people with necessary skills to do the audit? One auditor cannot serve 15
clients at the same time. They are already exhausted with one.
b. Do we have enough resources to complete the audit? Auditing requires time and money to
finish. Of course, no CPA will work in an auditing firm for free. No auditor will go to the client by
walking if it is in another city. How about the internet etc.? Although the client will eventually pay
you. You need a working fund to support your daily needs in auditing. As a general, most of the
audit fees will only be received at the release of auditor's.
c. Do we have enough time to finish the audit? For example, a client is negotiating with you to
perform an audit engagement to be completed next week. This client is San Miguel Corp. Can
you finish it? Of course, NO! You will die first because of lack of sleep.

4. After considering these three, you may now decide whether to decline the engagement or to
continue preparation and agreement of engagement terms. If we are to decline the engagement, we
must communicate with Those Charged with Governance (TCWG) the reason, basis, and key
issues in declining the engagement. If we are to accept their engagement, we must prepare an
engagement letter that contains the audit objective, parties' responsibilities, and audit fees if already
negotiated.

5. Based on the agreement above, we will know if we can complete the audit based on the scope
agreed by the client. If the scope limits us to obtain necessary information to opine, we are likely to
decline the engagement. How can we audit the FS if there will be no or insufficient information to be
provided? Just disclaim your opinion

Engagement Letter
● Contains the objective (to express opinion whether the FS are presented fairly), scope (to audit the
complete sets of FS) and acceptance of the engagement.
● Auditors’ responsibilities which is to conduct the audit in accordance with Philippine Standards on
Auditing (PSAs) to opine whether the FS is presented fairly or not. This includes performing necessary
procedures and obtaining sufficient and appropriate evidence. We also acknowledge the inherent
limitation in the audit that may hinder us in detecting all errors and frauds. Remember, we do not offer
absolute assurance. Risks will never be 100% removed.
● Management responsibilities which states that they acknowledge their full responsibility in preparation of
FS in accordance with PFRS, for internal controls, and to provide the auditor all of the necessary
information in any form (document or inquiry) to do the audit.

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 PSY 002: AUDITING THEORY (ADVANCE TOPIC)
LECTURE NOTES AND PRACTICE EXERCISE
Audit Fees
These are the following billing methods and corresponding example:
● Fix flat fee basis – lump sum billing. For example, the client will pay you P100,000 for the whole audit
● Actual time (Per Diem) – we will bill the client depending on actual time spent. For example, two auditors’
rate is P1,000 per hour. They spent 100 hours to finish the audit, and we will bill P200,000.
● Maximum fees. – continuing the preceding example but the maximum amount allowed to be billed is
150,000. In that case, we can only bill P150,000
● Retainer’s fee – billing client on a periodic basis. For example, we will bill the client P20,000 monthly.

PRACTICE EXERCISE:
Decide whether to decline or accept the engagement based on the following:
The client is involved in a big corporate scandal
The client did not agree with the terms written in the engagement letter
The auditor has the required experience to conduct the audit.
The auditing firm has a limited staff to accept another client

MULTIPLE CHOICE:
1. In determining estimates of fees, an auditor may take into account each of the following, except the
A. Value of the service to the client
B. Degree of responsibility assumed by undertaking the engagement
C. Skills required to perform the service
D. Attainment of specific findings

2. Retainer’s fee is basis is when

A. Billing is done of actual time spent at agreed rate
B. Client is charged on per diem basis with a ceiling amount
C. The client is billed at a fixed amount fee periodically
D. Client is billed on fixed amount

3. In an audit of FS, the financial reporting framework used is generally the GAAP. In the Philippines, which of
the following is/are the accepted framework?
A. Philippine Financial Reporting standards (PFRS)
B. PFRS for SMEs
C. Other acceptable basis of reporting
D. any of the above depending on the type of client.

4. Engagement letters are required for?

A. All engagements C. Assurance engagements only
B. Audit engagements only D. All engagements except preparation of ITR

5. It is the interest of both client and auditor that the auditor sends an engagement letter , preferably before
A. Substantive testing C Completion of audit
B. Commencement of the engagement D. Issuance of audit report

ESSAY:
1. Is an engagement letter necessary for the audit?

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