An audit engagement is an agreement between an auditor and a client to audit the client’s financial statements and accounting records.
The phrase is frequently used to refer to the contractual agreement between the two parties rather than the details of auditing procedures that the auditor would carry out. It consists of a few steps: planning, control testing, substantive testing, and finalization.
Planning
Before the auditors can begin performing any audit, they have to first perform some researches to find out more about the audit client, this is what we called client due diligence. It is especially important when the audit client is new as the auditor does not have prior year knowledge about the client which can potentially give rise to higher audit risk.
During this process, background checks will be performed. Some of the key points the client will have to be assessed on are:
- Its industry and business as well as risks associated with them
- Its financial status, as it may affect its payment to the firm
- The level of the audit activities required as this affects the fees to be charged by the firm
At this stage, the firm will also need to decide if it has the capacity to perform the audit. The things to consider are whether the firm:
- Has sufficient resources to carry out the audit. This includes headcount and competence.
- Has charged a fair fee to cover the cost that may be incurred
- Has been given enough time to complete the audit without jeopardizing the quality
Engagement letter
After the assessment has been performed, they need to notify the client that the audit work has been accepted and also give explanations on the scope and objective of the audit.
In some engagements, particularly an agreed-upon procedures (AUP) engagement, the engagement letter may also indicate all of the exact steps to be carried out by an auditor for a client.
To do so, they will first meet with the client to discuss the client’s needs. This step is not to produce any results or findings as those procedures are what an auditor does during the actual audit. Instead, it is to help the auditor decide whether the audit is viable and how to approach it, i.e., how, when, and why to get those findings.
The information required includes the additional information the auditor will need during the audit, the services to be performed, resources the auditors will have at their disposal, people with whom the auditor will need to speak to perform the audit, and the fee duration for the audit.
All the significant terms and conditions of engagement, such as the scope of the audit, objective of the audit, client’s responsibilities on the financial statement, and auditor’s responsibilities on the financial statements, will also be included in the engagement letter. Take note that the audit engagement letter should also clearly indicate the auditor assigned to the audit.
The auditor is the one that prepares the engagement letter. Once it has been reviewed and signed by the auditor, it will be sent to the client.
When the client receives the letter, the client will have to decide if to accept the letter’s terms. If accepted, the authorized personnel will sign the engagement letter and return a copy to the auditor. An audit engagement will start from that point on.
From what we can see above, a good audit engagement letter acknowledges that not all clients are familiar with audit procedures and, as a result, is there to outline and explain such procedures to the client for clarification.
It is also fundamentally the same as a contract because it defines duties and relationships. However, depending on its wording, it may not necessarily legally bind the way a formal contract is. It is, however, required for both parties to establish their expectations for an audit engagement before it commences.
Control testing
After the auditor is done with the planning stage, they will then perform control testing. This is where the auditor gains an in-depth understanding of the client’s business processes and relevant controls.
During this stage of the audit, the auditor is concerned with finding out if the controls in place are sufficiently set up to ensure the smooth running of the business and prevent any material misstatement in the financial statements produced by the management.
They will get in touch with the client by having small interviews and also perform tests of controls. Tests of controls are performed by selecting a list of samples and test them through the steps in control to ensure the client properly does all the steps.
The auditors will document all their observations and note down if any exception is noted. From the findings, they will decide the level of substantive testing required.
Substantive testing
This stage is where the auditors check if the numbers in the financial statements are stated accurately and fairly. The exact procedures performed are tailored to the financial statement line items and the audit risks involved.
For example, to test if the cash and bank balances are correctly stated, the auditors will perform substantive testing by obtaining bank confirmation from the banks and reperform the bank reconciliation prepared by the client to ensure they are properly prepared.
Finalisation
The audit work ends when the auditors are satisfied with the sufficiency and appropriateness of the evidence they have gathered. They will then schedule an exit meeting with the client to discuss their audit findings and results and the implications of those findings.
Usually, a draft report will be prepared and shared with the client. The client will read through the draft report and respond to the recommendations, adjustments proposed, and findings.
Once everything is settled, the auditor will prepare a final audit report, sign it and hand it to the client. This will conclude the entire audit engagement.
