Understand the Client’s Business and Industry | Auditing and Attestation | CPA Exam

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Obtain an Understanding with the Client

A clear understanding of the terms of the engagement should exist between the client and the CPA firm. Auditing standards require that auditors obtain an understanding with the client in an engagement letter, including the engagement’s objectives, the responsibilities of the auditor and management, identification of the financial reporting framework used by management, reference to the expected form and content of the audit report, and the engagement’s limitations. For public companies, the audit committee is responsible for hiring the auditor as required by the Sarbanes–Oxley Act. The engagement letter is typically signed by management for private companies. An example of an engagement letter for the audit of a private company is provided in Figure 8-2.

The engagement letter may also include an agreement to provide other services such as tax returns or management consulting allowed under the Code of Professional Conduct and regulatory requirements. It should also state any restrictions to be imposed on the auditor’s work, deadlines for completing the audit, assistance to be provided by the client’s personnel in obtaining records and documents, and schedules to be prepared for the auditor. It often includes an agreement on fees. The engagement letter also serves the purpose of informing the client that the auditor cannot guarantee that all acts of fraud will be discovered.

Engagement letter information is important in planning the audit principally because it affects the timing of the tests and the total amount of time the audit and other services will take. For example, if the deadline for submitting the audit report is soon after the balance sheet date, a significant portion of the audit must be done before the end of the year. If unexpected circumstances arise or if client assistance is not available, arrangements must be made to extend the amount of time for the engagement. Client-imposed restrictions on the audit can affect the procedures performed and possibly even the type of audit opinion issued.

Develop Overall Audit Strategy

After understanding the client’s reasons for the audit, the auditor should develop and document a preliminary audit strategy that sets the scope, timing, and direction of the audit and that guides the development of the audit plan. This strategy considers the nature of the client’s business and industry, including areas where there is greater risk of significant misstatements. The auditor also considers other factors such as the number of client locations and the past effectiveness of client controls in developing a preliminary approach to the audit. The planned strategy helps the auditor determine the resources required for the engagement, including engagement staffing.

Select Staff for Engagement
The auditor must assign the appropriate staff to the engagement to comply with auditing standards and to promote audit efficiency. One of the underlying principles in auditing standards is that:

Auditors are responsible for having appropriate competence and capabilities to perform the audit.

Staff must therefore be assigned with that requirement in mind, and those assigned to the engagement must be knowledgeable about the client’s industry. Larger audit engagements are likely to require one or more partners and staff at several experience levels. Individuals in multiple offices of the firm may be involved, including offices outside the United States, if the client has operations in numerous locations around the world. Specialists in such technical areas as statistical sampling, business valuation, and information technology risk assessment may also be assigned. On smaller audits, only one or two staff members may be needed.

A major consideration of staffing is the need for continuity from year to year. Continuity helps the CPA firm maintain familiarity with the technical requirements and closer interpersonal relations with client personnel. An inexperienced staff assistant is likely to become the most experienced nonpartner on the engagement within a few years.

Consider a computer manufacturing client with extensive inventory of computers and computer parts where risk of material misstatement for inventory has been assessed as high. It is essential for the staff person doing the inventory portion of the audit to be experienced in auditing inventory. The auditor should also have a good understanding of the computer manufacturing industry. The CPA firm may decide to engage a specialist if no one within the firm is qualified to evaluate whether the inventory is obsolete.