Terms of Engagement Flashcards
(16 cards)
Which of the following statements would least likely appear in an audit engagement letter?
A. The fees for our audit services will be at our regular per diem rates plus out-of-pocket expenses.
B. We will provide you with a list of schedules and information needed by our staff during the audit.
C. We will not disclose any information provided under the terms of this engagement letter to third parties.
D. Our audit will be conducted with the objective of expressing an opinion on the financial statements.
C. We will not disclose any information provided under the terms of this engagement letter to third parties.
As part of client acceptance, auditors are required to send a written audit engagement letter, which should be signed by both parties. The letter provides a clear understanding about the terms of the engagement (FACSIMILE).
The AICPA Code of Professional Conduct requires that CPAs maintain confidential client information unless the client grants permission to disclose the information. However, there are instances when the CPA must disclose information without the client’s consent, including:
compliance with a legally enforceable subpoena or summons
an inquiry by the AICPA trial board
a quality control peer review
The engagement letter may include the circumstances under which an auditor is required to disclose client information, but it may not include a statement that suggests information will never be disclosed.
(Choice A) The audit engagement letter should include details about the audit fees.
(Choice B) A statement that the auditor will send the client a schedule of requests is included in an engagement letter so that management can anticipate that request.
(Choice D) The audit’s objective—to express an opinion on the fairness of financial statements—is what differentiates an audit engagement letter from other types of engagement letters; such a statement should be included.
Things to remember:
An audit engagement letter serves as a contract between the auditor and the client; it outlines the terms of the engagement and includes each party’s responsibility, the scope and objective of the audit, and fees. Broad terms of nondisclosure are left out of an audit engagement letter because the CPA may be required by law or by other provisions to disclose information to outside parties.
A former client requests a predecessor auditor to reissue the prior year’s audit report in connection with the issuance of comparative financial statements by the client. What is the predecessor auditor’s responsibility?
A. Review the previous report and make the necessary changes.
B. Consult with the client’s legal counsel to determine available remedies.
C. Read the current report, compare it to the previous report, and obtain a letter of representation from the successor auditor.
D. Audit the current statements.
C. Read the current report, compare it to the previous report, and obtain a letter of representation from the successor auditor.
Comparative financial statements (F/S) are F/S from prior periods that are presented alongside those of the current period. If the F/S of the prior period(s) were audited by a different auditor (ie, predecessor auditor), the client may request that the predecessor reissue the prior period report. Before doing so, the predecessor auditor must ensure the previously issued report is still appropriate.
Before reissuing a report, the predecessor is required to compare the current year F/S with the F/S on which the predecessor reported. The predecessor will also obtain representation letters from the former client’s management and the successor auditor (ie, the auditor of the current year’s F/S) confirming that they are aware of nothing that would require a modification to the prior period’s F/S or audit report (eg, subsequent event).
(Choice A) Reviewing only the previous year’s report will not reveal the need for any changes to that report.
(Choice B) The predecessor might consult with its own legal counsel if it deems such a consultation necessary, but it would not consult with the client’s legal counsel.
(Choice D) By definition, the predecessor auditor has not been engaged to audit the current F/S.
Things to remember:
Before reissuing a prior year audit report, a predecessor auditor should compare the current financial statements with those being reissued and obtain representation letters from management and the successor auditor.
An accountant has been engaged to compile the financial statements of a nonissuer. The financial statements contain many departures from GAAP because of inadequacies in the accounting records. The accountant believes that modification of the compilation report is not adequate to indicate the deficiencies. Under these circumstances, the accountant should
A. Inform management that the engagement can proceed only if distribution of the accountant’s report is restricted to internal use.
B. Withdraw from the engagement and provide no further service concerning these financial statements.
C. Quantify the effects of the departures from GAAP and describe the departures from GAAP in a special report.
D. Obtain written representations from management that the financial statements will not be used to obtain credit from financial institutions.
B. Withdraw from the engagement and provide no further service concerning these financial statements.
By performing a compilation, accountants assist a client in presenting financial statements (F/S) and issue a report. A compilation engagement requires the accountants to read the resulting F/S to verify that there are no obviousmaterial misstatements or misapplications of the reporting framework, but it provides no assurance.
If accountants believe the F/S are materially misstated (ie, contain GAAP departures), they should notify management and request corrections. If management is unwilling to revise the F/S, the accountants should modify the report to inform users. However, if modifying the report is not adequate to communicate the deficiencies (eg, because misstatements are too pervasive), the accountants should withdraw from the engagement and provide no further services related to those F/S.
(Choices A and D) Accountants should not issue a compilation report on F/S if errors are so severe they cannot be communicated in the report because such a report would be misleading. This is true even if the report is restricted to internal use or the F/S are not used to obtain credit.
(Choice C) A compilation results in a standard compilation report or a modified compilation report, not a special report. If the GAAP departures cannot be communicated in a modified compilation report, there will be no report and no compilation.
Things to remember:
If material misstatements cannot be adequately communicated in a compilation report, an accountant cannot perform a compilation. The accountant should withdraw from any such engagement and provide no further services concerning those financial statements.
Before reissuing the prior year’s auditor’s report on the financial statements of a former client, the predecessor auditor should obtain a letter of representation from the
Former client’s management Successor auditor
A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Yes Yes
Comparative financial statements (F/S) are F/S from prior periods presented alongside those of the current period. If the F/S of the prior period(s) were audited by a different auditor (ie, predecessor auditor), the client may request that the predecessor reissue the prior period report. Before doing so, the predecessor auditor must ensure the previously issued report is still appropriate.
Before reissuing a report, the predecessor is required to compare the current year F/S (eg, opening balances) to the F/S on which the predecessor reported (eg, closing balances). The predecessor will also obtain representation letters from the former client’s management and the successor auditor (ie, auditor of the current F/S) confirming they are aware of nothing requiring modification of the prior period F/S or audit report (eg, subsequent event).
Things to remember:
Before reissuing a prior year audit report, a predecessor auditor should compare the current financial statements to those being reissued and obtain representation letters from both management and the successor auditor.
Which of the following factors most likely would cause an accountant not to accept an engagement to compile the financial statements of a nonissuer?
A. A lack of segregation of duties in the entity’s accounting and payroll departments.
B. Indications that reports of asset misappropriation are not investigated by management.
C. The entity’s intention to omit from the financial statements substantially all of the disclosures required by GAAP.
D. Management’s acknowledgement that the financial statements will be included in a written personal financial plan.
B. Indications that reports of asset misappropriation are not investigated by management.
CPAs performing compilation engagements apply their accounting and financial expertise to assist management in presenting the entity’s financial statements (F/S), with no assurance provided. Regardless of the type of engagement (eg, audit, review, compilation), CPAs generally do not want to associate with clients whose F/S are likely misstated due to fraud.
When the circumstances suggest that misappropriation of assets (ie, fraud) has not been investigated by management, the CPA will most likely decline the engagement because the F/S are likely misstated. The personnel committing the fraud are likely misstating accounting records to cover up theft or misuse of company assets.
(Choice A) Audits, not compilations, require CPAs to evaluate internal controls, including segregation of duties.
(Choice C) The CPA can compile F/S for a client who omits substantially all disclosures if the omissions are not intended to mislead users of the F/S.
(Choice D) CPAs can compile F/S for general use (ie, not restricted to specified parties) or restricted use (eg, personal financial plan). CPAs should include language in such a report indicating that the F/S are intended solely for the use of the restricted party, and management should acknowledge this restriction.
Things to remember:
Regardless of the type of engagement (eg, audit, review, compilation), CPAs generally do not want to associate with clients whose financial statements are likely misstated due to fraud. Misstatements due to fraud are possible when known instances of misappropriation of assets are not investigated by management, in which case the CPA will most likely decline the engagement.
Which of the following statements would least likely appear in an auditor’s engagement letter?
A. Fees for our services are based on our regular per diem rates, plus travel and other out-of-pocket expenses.
B. During the course of our audit we may observe opportunities for economy in, or improved controls over, your operations.
C. Our engagement is subject to the risk that material errors or irregularities, including fraud and defalcations, if they exist, will not be detected.
D. After performing our preliminary analytical procedures we will discuss with you the other procedures we consider necessary to complete the engagement.
D. After performing our preliminary analytical procedures we will discuss with you the other procedures we consider necessary to complete the engagement.
The engagement letter documents the understanding between the auditor and the client regarding the nature and timing of the services to be performed, expected fees and the basis for billing, the responsibilities of the auditor, the client’s responsibilities in preparing for the audit, and the need for other services to be performed. It would not include a statement committing the auditor to discuss the auditing procedures considered necessary. Selection and performance of auditing procedures are a matter of auditor judgment and not subject to disclosure to the client.
An auditor is required to establish an understanding with a client regarding the services to be performed for each engagement. This understanding generally includes
A. The auditor’s responsibility for determining the preliminary judgments about materiality and audit risk factors.
B. Management’s responsibility for identifying mitigating factors when the auditor has doubt about the entity’s ability to continue as a going concern.
C. The auditor’s responsibility for ensuring that the audit committee is aware of any significant deficiencies or material weaknesses in internal control that come to the auditor’s attention.
D. Management’s responsibility for providing the auditor with an assessment of the risk of material misstatement due to fraud.
C. The auditor’s responsibility for ensuring that the audit committee is aware of any significant deficiencies or material weaknesses in internal control that come to the auditor’s attention.
An engagement letter is used to establish an understanding between the auditor and the client. The letter generally includes broad auditor responsibilities outlined in the auditing standards. These responsibilities help the auditor form an opinion about the fair presentation of the financial statements including:
Conducting the audit in accordance with GAAS
Obtaining reasonable assurance that the financial statements are free from material misstatement
Communicating internal control deficiencies (eg, material weaknesses) to the client (eg, audit committee)
(Choice A) The engagement letter states the auditor has the responsibility to conduct the audit in accordance with GAAS. However, the individual components (eg, judgments about materiality) of the audit process and procedures are not included.
(Choice B) When an auditor has doubts about the entity’s ability to continue as a going concern, management may respond with mitigating factors that the auditor is responsible to evaluate. However, management’s responsibility for identifying mitigating factors is not usually specified in an engagement letter.
(Choice D) Management’s responsibility for designing, implementing, and maintaining internal controls to prevent material misstatements due to fraud or error is usually included in an engagement letter. Other specific responsibilities regarding fraud (eg, to provide a risk assessment on fraud) are not usually included in the letter.
Things to remember:
An auditor’s responsibilities in an engagement letter include conducting the audit in accordance with GAAS, obtaining reasonable assurance, and communicating control deficiencies to the client. Management’s responsibilities include preparing the financial statements, internal controls, and providing the auditor with relevant information.
Which of the following matters should an accountant include when establishing an understanding with a client regarding the services to be performed for a compilation engagement?
A. The effect that independence impairments, if present, will have on the expected form of the accountant’s report.
B. The dates on which the accountant will be present to observe the taking of the physical inventory.
C. The assistance that the accountant will receive from internal auditors in performing account analyses.
D. The accountant’s responsibility for the preparation and fair presentation of the financial statements.
A. The effect that independence impairments, if present, will have on the expected form of the accountant’s report.
CPAs performing compilation services use their financial reporting expertise to assist management in the presentation of their financial statements. Compilations provide no assurance that the financial statements are fairly stated and in accordance with the applicable framework (eg, GAAP).
Independence is expected but not required for a compilation engagement; if the CPA lacks independence, that must be disclosed in the final paragraph of the compilation report. CPAs must consider if they are independent when establishing terms of engagement (eg, engagement letter) with a client so that the client is aware ahead of time if the disclosure is required.
(Choices B and C) Specific details about the engagement (eg, dates for procedures, assistance needed) are generally not included in compilation engagement letters but may be included in other communications to the client.
(Choice D) CPAs are responsible for preparing the financial statements but not for their fair presentation. Management is responsible for the fair presentation.
Things to remember:
Compilations are engagements in which the CPA assists management in the presentation of their financial statements. CPAs performing compilation services are expected but not required to be independent. Lack of independence must be disclosed in the compilation report and discussed when establishing terms of engagement with the client.
Before accepting an audit engagement, a CPA should evaluate whether conditions exist that raise questions as to the integrity of management. Which of the following conditions most likely would raise such questions?
A. There are significant differences between the entity’s forecasted financial statements and the financial statements to be audited.
B. The CPA will not be permitted to have access to sensitive information regarding the salaries of senior management.
C. There have been substantial inventory write-offs just before the year end in each of the past four years.
D. The CPA becomes aware of the existence of related party transactions while reading the draft financial statements.
B. The CPA will not be permitted to have access to sensitive information regarding the salaries of senior management.
Before accepting an audit engagement, auditors must evaluate the integrity of the potential client’s management. Accepting a client that lacks integrity could undermine the accuracy of the financial statements (F/S) and may hinder an auditor’s ability to gather evidence. A client-imposed scope limitation (eg, restricting access to salaries) will raise questions about management’s integrity and lack of transparency.
(Choice A) A significant difference between the forecasted F/S and actual F/S would not necessarily call into question the integrity of management. An entity’s forecast is used for budgeting purposes and is not usually recorded in the F/S.
(Choice C) Most entities perform inventory counts near the end of the period. It is common to write off inventory due to obsolete or damaged goods discovered during the count. Having substantial write-offs in each of the last four years could result in additional inventory testing but would not necessarily question management’s integrity.
(Choice D) Entities may have related party transactions as long as they are properly disclosed and accounted for.
Things to remember:
Before accepting an audit engagement, auditors must evaluate the integrity of the potential client’s management. A client-imposed scope limitation (eg, restricting access to salaries) will raise questions about management’s integrity and lack of transparency.
Which of the following is correct regarding the communication between successor and predecessor auditors?
A. The successor and predecessor auditors should communicate with each other in writing regarding potential problems.
B. The successor auditor should contact the predecessor auditor prior to proposing an audit engagement.
C. The client should be present during the communications between the predecessor auditor and the successor auditor.
D. The successor auditor should request permission from the prospective client to make an inquiry of the predecessor auditor.
D. The successor auditor should request permission from the prospective client to make an inquiry of the predecessor auditor.
Which of the following individuals would be considered a predecessor auditor?
A. A client’s accounting employee who audits the company’s branches, subsidiaries, or other outlying locations from the company’s home office.
B. A client’s accounting employee responsible for the preparation of the company’s financial statements.
C. An independent CPA who was engaged to perform, but did not complete, an audit of financial statements.
D. An independent CPA who is considering accepting an engagement to audit financial statements.
C. An independent CPA who was engaged to perform, but did not complete, an audit of financial statements.
A successor auditor discovers a possible misstatement in a client’s financial statements reported on by a predecessor auditor. Which of the following actions should the successor auditor take next?
A. Advise the client to inform its audit committee of the possible misstatement.
B. Have the client’s internal auditor perform an examination to determine if a misstatement exists.
C. Ask the client to arrange a meeting of the predecessor auditor, management, and the successor auditor to discuss the matter.
D. Require the client to restate its financial statements before proceeding with the audit.
C. Ask the client to arrange a meeting of the predecessor auditor, management, and the successor auditor to discuss the matter.
One of the primary reasons a successor auditor is required to attempt communication with the predecessor auditor is to
A. Understand the client’s accounting system.
B. Obtain an understanding for the prior period audit opinion.
C. Obtain an understanding of the predecessor’s audit procedures.
D. Obtain information about related party transactions.
D. Obtain information about related party transactions.
Before accepting a new engagement, an auditor should ask the client to authorize the predecessor auditor to respond to inquiries and allow the successor to review the predecessor’s documentation. These inquiries help the auditor decide whether to accept the engagement.
The successor auditor will generally inquire about disagreements with management; issues communicated with management or those charged with governance; reasons for the change in auditors; and anything that may bear on management’s integrity. The successor auditor will also likely ask about related party transactions or significant unusual transactions. Because such transactions present a higher risk of material misstatement due to fraud, the auditor will want to know if there is any reason to believe there are undisclosed related party transactions.
(Choice A) Although the successor auditor may discuss the client’s accounting system with the predecessor, the primary source of understanding that system will be inquiries with the client, not the predecessor.
(Choices B and C) Although obtaining an understanding of the predecessor’s procedures may help the successor understand the reasoning for the prior audit opinion, it is not among the primary reasons the inquiries are initiated. The successor will independently determine what audit procedures are adequate for the current year’s audit.
Things to remember:
Before accepting an initial audit engagement, an auditor should ask the client to authorize the predecessor auditor to answer the successor’s inquiries (eg, about related party transactions). The primary purpose of these inquiries is to help the auditor assess management’s integrity and decide whether to accept the engagement.
A practitioner may perform an agreed-upon procedures engagement on prospective financial statements if which of the following is met?
A. Use of the agreed-upon procedures report is restricted.
B. The practitioner sets the criteria to be used in the determination of findings.
C. The client agrees that the practitioner will decide appropriate procedures to be performed.
D. The prospective financial statements include a summary of significant assumptions.
D. The prospective financial statements include a summary of significant assumptions.
When conducting an agreed-upon procedures engagement on prospective financial statements, a practitioner’s objectives are to:
Apply agreed-upon procedures provided by the engaging party
Issue a written report that describes the procedures and related findings
To perform this type of engagement, CPAs must ensure that management has included a summary of significant assumptions in the prospective financial statements. These are assumptions on which the forward-looking information is based; knowing the assumptions helps users of such information understand how it was derived.
(Choice A) Restrictions on the use of an agreed-upon procedures report are not mandatory. The practitioner has the option of including an alert, in a separate paragraph, that restricts the use of the practitioner’s agreed-upon procedures report.
(Choices B and C) Written representation is required from the engaging parties and states the engaging parties are responsible for setting the criteria used in determining the findings. Criteria can include amounts on which the assumptions are based (eg, prior year’s cash inflow balances). Likewise, the client will decide which procedures will be performed, such as how to verify the amounts (eg, use bank statements to verify cash inflows).
Things to remember:
To perform an agreed-upon procedures engagement on prospective financial information, CPAs must ensure that management includes a summary of significant assumptions in the financial statements. The party that hires the practitioner will be responsible for setting the criteria and for the sufficiency of the procedures performed. Restrictions on report usage are optional.
Among the four categories of records that are established for determining when a member must comply with record requests, which of the following are deliverables set forth in the engagement letter?
A. Client-provided records.
B. Member-prepared records.
C. Member’s work product.
D. Working papers.
C. Member’s work product.
(Choice A) Incorrect. Client-provided records are records given by the client to the member.
(Choice B) Incorrect. Member-prepared records are those the member was not specifically engaged to prepare and are not in the client’s books and records.
(Choice C) Correct! Member’s work product is indeed defined as “deliverables set forth in the engagement letter.”
(Choice D) Incorrect. Working papers are all items other than client-provided records, member-prepared records and working papers prepared solely for the purposes of the engagement.
A registration statement filed with the SEC contains the reports of two independent auditors on their audits of financial statements for different periods. The predecessor auditor who audited the prior-period financial statements generally should obtain a letter of representation from the
A. Successor independent auditor.
B. Client’s audit committee.
C. Principal underwriter.
D. Securities and Exchange Commission.
A. Successor independent auditor.
