UNIVERSAL COLLEGE OF PARAÑAQUE

Dr. A Santos Avenue, Paranaque City

AUDITING THEORY
AT 04 – Preliminary Engagement Activities

SECOND SEMESTER AT-03

AY 2023 - 2024
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AUDITING THEORY

Preliminary Engagement Activities

TOPIC OUTLINE:
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 Client Acceptance & Continuance

 Communication with Predecessor Auditor
 Agreeing the Basis of Engagement
 Acceptance of Change in Engagement

CLIENT ACCEPTANCE & CONTINUANCE

 Careful examination of clients in order for the auditor to

manage engagement risks.
 Engagement risks include loss of reputation (most
important asset) and financial loss.
 Ultimately, auditor’s judgment prevails whether to accept
a client or not.
 Guidelines in accepting clients:
 Auditor’s competence (preliminary knowledge)
 Ethical requirements
 Ability to serve client properly
 Integrity of management

In relation to client’s integrity, the following matters shall

be considered:
 The identity and reputation of owners and officers
 Nature of client’s business
 Indications of client’s involvement in illegal activities
Sources of such information are the following:
 Communication with predecessor auditor
 Previous accounting services provider
 Inquiry of third parties such as banks and legal counsel
 Background searching

COMMUNICATING PREDECESSOR AUDITOR:

What is the importance of communicating the predecessor auditor?

(1) Serve as a basis of client acceptance and continuance
(2) Matter of courtesy to the previous auditor
REQUISITE:
The successor auditor shall seek permission to communicate from
BOTH the predecessor auditor and client.
NOTE: If client will not permit communication, it will raise
questions as to acceptability of engagement.

Questions to be asked

Prof. Ahlbert S. Umali, CPA PAGE 3

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If the client grants permission, the successor auditor inquiries
of predecessor auditor:
1. Integrity of client
2. Disagreements with management about audit procedures or
accounting principles
3. Communication with audit committee about fraud, illegal
acts or internal control
4. Reason for change in auditor.
NOTE: If the predecessor auditor is prohibited by the client to
disclose information, again it raises a question as to the
integrity of the client.

AGREEING THE BASIS OF ENGAGEMENT

Once an engagement is considered acceptable, the auditor now
establishes the basis of engagement through:
1. Preconditions of audit
2. Agreement on audit engagement terms (engagement
letter)

AUDIT PRECONDITIONS
The auditor shall not accept the engagement without the
following audit preconditions
• Use of acceptable FRF available to FS users.
• Agreement with management and TCWG’s responsibility (see
AT 02)
NOTE: If there is a scope limitation imposed prior acceptance of
engagement, the auditor shall NOT ACCEPT the engagement
unless required by law or another regulatory requirement to
do so.

ENGAGEMENT LETTER
A written terms of an engagement in the form of a letter by the
auditor to the client.
Importance of engagement letter:
• Avoid misunderstanding with respect to the engagement.
• Document and confirms auditor’s acceptance of appointment.
NOTE: It is in the interest of both the client and auditor that
the auditor sends the engagement letter before the
commencement of audit.

CONTENTS OF ENGAGEMENT LETTER

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PRIMARY CONTENTS:
(FROM A)
(a) Identification of FRF for the preparation of FS.
(b) Reports and form and content of reports
(c) Objective and scope of audit
(d) Management responsibility
(e) Auditor’s responsibility

OTHER CONTENTS:
(WE EPAL)
(a) Obligation to provide working papers
(b) Involvement of other auditor and experts
(c) Elaboration of scope of audit
(d) Planning and performance of audit
(e) Audit fees
(f) Audit and internal control limitation

AUDIT COMPONENTS
When the auditor of a parent entity is also the auditor of a
component (subsidiary, joint venture, associate or branch), the
following factors are considered whether to send a separate
engagement letter to the component:
 Who appoints the component auditor
 Whether a separate auditor’s report is required to be
issued
 Legal requirements
 Degree of ownership
 Degree of independence

RECURRING AUDITS
On recurring audits, the engagement terms may be confirmed
without a new letter. However, the following situations may
require the auditor to send a new letter to client:
 Misunderstanding of the objective and scope
 Any revised or special terms
 Change in client’s senior management
 Significant change in ownership, nature or size
 Change in legal or regulatory requirements
 Change in FRF

ACCEPTANCE OF CHANGE IN ENGAGEMENT:

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AUDITING THEORY
In prior to completing the audit, the auditor is requested to
change the audit into a lower-level assurance engagement or
other
engagement, the auditor’s MAIN CONSIDERATION is whether there is
REASONABLE JUSTIFICATION to change the engagement.

Circumstances that a client may request a change in engagement

may include:
• A change in circumstances affecting the need for the
service.
• A misunderstanding as to the nature of an audit originally
requested.
• A scope limitation imposed on the audit engagement

AUDITOR’S RESPONSE FOR CHANGE IN ENGAGEMENT

REASONABLE JUSTIFICATION UNREASONABLE

1. Stop performing the JUSTIFICATION
old engagement, 1. Continue performing
2. Stop referring to the original or old
the old engagement, engagement.
except for agreed- 2. When prohibited to
upon procedures continue, withdraw
3. Start performing from the
the new engagement. engagement.
3. Determine reporting
responsibilities.

EXERCISES
1. Which of the following is not normally done in preliminary
engagement phase of an audit?
I. Procedures on client acceptance and retention
II. Establishing the preconditions of an audit
III. Obtain understanding on the legal framework of the client.
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III

2. Why does an auditor perform preliminary engagement

activities?

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I. To ensure that there is no misunderstanding with the client
as to the terms of the engagement.
II. To ensure that sufficient and appropriate audit evidence will
be obtained to support the opinion of the auditor on the
client’s financial statements.
A. I only C. Both I and II
B. II only D. Neither I nor II

3. Engagement risk is the risk that the auditor, by being

associated with a certain client, will result to:
I. Loss of reputation II. Financial loss
A. I only C. Both I and II
B. II only D. Neither I nor II

4. In making a decision to accept or continue with a client, the

auditor should consider:
A. B. C. D.
Its competence Yes Yes Yes Yes
Its own independence Yes No Yes No
Its ability to service the Yes Yes Yes No
client properly
The integrity of the Yes Yes No Yes
client’s management

5. If a CPA has been approached by an airline company to conduct

audit and he/she has never audited such industry, the auditor
A. must not accept such engagement.
B. may accept the engagement after 1 year had elapsed.
C. may accept the engagement after attaining a reasonable
preliminary knowledge about the airline industry and the
business practices.
D. may accept the engagement depending on the reasonableness
of the audit fee and availability of resources.

6. ASU, CPA has been approached by MANUYO DOS INC. to audit

their financial statements. You were notified that the
services of JSU, CPA, their previous auditor, has been
terminated.
I. Under these circumstances, the burden of initiating the
communication rests with JSU, CPA, the predecessor auditor.
II. ASU, CPA should communicate JSU without advising MANUYO DOS
so that there is an element of surprise in obtaining
information bearing the integrity of the client.
III. If ASU, CPA advised the client of his intention to
communicate JSU, CPA and MANUYO DOS refused to proceed with
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the intended communication, such will raise a serious
question as to whether to accept the
engagement.
Which of the above statements is correct?
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III

7. Which of the following should an auditor obtain from the

predecessor auditor prior to accepting an audit engagement
A. Analysis of balance sheet accounts
B. Analysis of income statement accounts
C. All matters of continuing accounting significance
D. Facts that might bear on the integrity of management

8. Before accepting an audit engagement a successor audit should

make specific inquiries of the predecessor audit regarding
A. The predecessor’s assessment of inherit risk and judgments
about materiality.
B. The predecessor’s evaluation of matters of continuing
accounting significance.
C. The degree of cooperation the predecessor received
concerning the inquiry of the client’s lawyer.
D. Disagreements the predecessor had with the client
concerning auditing procedures and accounting principles.

9. Which of the following factors most likely would cause an

auditor not to accept a new audit engagement?
A. An inadequate understanding of the entity’s internal
control structure
B. The close proximity to the end of the entity’s fiscal year
C. Concluding that the entity’s management probably lacks
integrity
D. An inability to perform preliminary analytical procedures
before assessing control risk

10. Preconditions of an audit are important in preliminary

engagement activities which include:
I. Determining the acceptable Financial Reporting Framework
II. Agreement of management’s responsibilities
A. I only C. Both I and II
B. II only D. Neither I nor II

11. S1: The auditor shall not accept an audit engagement, if

management or TCWG imposes a limitation on the scope of work
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that will result to disclaimer of opinion unless required by
a law or regulation to do so.

S2: The acceptable financial reporting framework depends on

the type of business the client is involved in.
A. True, false C. False, false
B. False, true D. True, true

12. S1: Engagement letters are required for audit engagements

only.

S2: Engagement letters may either be oral or written.

A. True, false C. False, false
B. False, true D. True, true

13. Which of the following are valid reason(s) why an auditor

sends to his/her client an engagement letter?
I. To avoid misunderstanding with respect to engagement
II. To confirm the auditor’s acceptance of the appointment
III. To ensure CPA’s compliance to PSA
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III

14. Which of the following would be least likely to be included

in the auditor’s engagement letter?
A. Forms of any reports
B. Objectives and scope of the audit
C. Type of opinion to be issued
D. Extent of his responsibilities to his client

15. Which of the following is (are) generally included in an

audit engagement letter?
I. Management’s responsibility for the preparation and
presentation of FS.
II. Factors considered in setting preliminary materiality
III. Identification and timeline of general audit procedures
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III

16. S1:The Chief financial officer normally signs the engagement

letter for an audit of a public company.

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S2: It is in the interest of both the client and auditor that
an audit engagement letter is to be send, preferably before
the issuance of the audit report.
Which of the following statements is correct?
A. Only the first statement
B. Both statements
C. Only the second statement
D. None of the statements

17. When the auditor of a parent company is also the auditor of

one of its components, the following factors are considered
in determining whether a separate engagement letter is to be
sent, except:
A. Legal requirement
B. Degree of ownership
C. Who appointed the component auditor?
D. Size of the audit firm

18. In which of the following situations would the auditor be

unlikely to send a new engagement letter to a continuing
client?
A. A change in terms of the engagement
B. A recent change of client management
C. A significant change in the nature or size of the client’s
business
D. A recent change in the partner and/ or staff in the audit
engagement

19. Which of the following is considered a reasonable basis for

requesting a change in the engagement?
I. A change in the circumstance II. Misunderstanding
as to nature
A. I only C. Both I and II
B. II only D. Neither I nor II

20. If a change in the type of engagement from higher to lower-

level assurance is not justified, the auditor should
A. Continue with the revised engagement but make explicit
reference about the original engagement.
B. Continue with the revised engagement and not make
reference about the original engagement.
C. Refuse to agree to management’s request on the change of
engagement and continue with the original engagement
D. Withdraw from the engagement.

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QUIZZER (DO-IT-YOURSELF DRILL)

1. Which of the following is not normally performed during pre-

planning or pre-engagement phase?
I. Inquiring from predecessor auditor
II. Establishing materiality
III. Agreeing the terms of
the engagement.
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III

2. Before accepting an engagement to audit a new client, a CPA

is required to obtain
A. A preliminary understanding of the prospective client’s
industry and business.
B. The prospective client’s signature to the engagement
letter.
C. An understanding of the prospective client’s control
environment
D. A representation letter from the prospective client

3. The predecessor auditor is required to respond to the request

of the successor auditor for information, but the response
can be limited to stating that no information will be
provided when:
A. The predecessor auditor has poor relations with the
successor auditor
B. The client is dissatisfied with the predecessor’s work
C. There are actual or potential legal problems between the
client and the predecessor
D. The predecessor believes that the client lacks integrity.

4. In making client acceptance decisions, which of the following

shall be considered?
I. client business risk III.CPA firm’s business
risk
II. audit risk
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III

5. S1: One of management’s responsibilities is to provide the

auditor a limited access to some information which are all
relevant to the audit engagement.
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S2: One preconditions of audit is to determine the relevant
and suitable benchmark to be used in evaluating evidence to
be gathered in the audit.
A. True, false C. False, false
B. False, true D. True, true

6. Which of the following is not one of the principal contents

of an engagement letter?
A. Limitations of the engagement
B. Objectives of the financial statements
C. Unrestricted access to records and documents
D. Management’s responsibility for the financial statements

7. Before performing any audit procedures. The auditor and the

client should agree on the
I. Type of opinion to be expressed
II. Specific procedures to be performed
III. Terms of engagement

A. I AND II ONLY
B. II AND III ONLY
C. III ONLY
D. II ONLY
E. ANSWER IS NOT GIVEN

8. When a professional accountant is the auditor of a parent

company and happens also to be the auditor of one of the
parent company’s components, which of the following factors
is considered in determining whether a separate engagement
letter is to be sent?
I. Whether a separate audit report is to be issued.
II. Principal location of the component and its distance from
the location of parent company
III. Ethical requirements
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III

9. In a continuing engagement, the continuing auditor would most

likely send a new engagement letter when
I. There is a change in the audit partner assigned to the
engagement
II. There is a change in financial reporting framework
III. There is a recent change in the client’s board of
directors
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A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III

10. An accountant who had begun an audit of the financial

statements of an entity was asked to change the engagement to
a review. Given reasonable justification for the change, the
accountant’s review report should refer to the

A. B. C. D.
Original engagement that was agreed to YES YES NO NO
Procedures that may have been performed in
the original engagement YES NO YES NO

--END OF HANDOUTS--

Prof. Ahlbert S. Umali, CPA PAGE 13