◄UNIT 2:LEGAL AND PROFESSIONAL REQUIREMENTUNIT 4: AUDITOR’S REQUIREMENTS►

UNIT 3: AUDITOR’S APPOINTMENT

  • UNIT 3: AUDITOR’S APPOINTMENT

    Key unit competence: To be able to describe the procedures for 

    auditor’s appointment.

    Introductory activity

    MODERN BUSINESS enterprise has been operating for ten years in 
    manufacturing business industry. For the last ten years in operation, the 
    business was characterized with high costs and thus affecting its profitability. 

    The business owner thought of seeking advice from the expert.

    NTRODUCTION 

    TO ACCOUNTING

    UNIT AUDITOR’S APPOINTMENT 3

    Key unit competence: To be able to describe the procedures for 

    auditor’s appointment.

     Introductory activity

    MODERN BUSINESS enterprise has been operating for ten years in 
    manufacturing business industry. For the last ten years in operation, the 
    business was characterized with high costs and thus affecting its profitability. 

    The business owner thought of seeking advice from the expert.

    After the consultation , the owner found it necessary to execute the following:
    • Change the business’s nature and become a limited liability 
    Company;
    • To issue more shares;
    • To ensure that the produces are accessible to customers in their 
    respective places;
    • To increase the sales turnover;
    • To reduce the number of sales staffs and be replaced by the sales 

    agents, that will be provided the commissions on sales made.

    After the structuring of the business, a new company named XY ltd and 
    started its operations on 1st Jan 2016. This was followed with the appointed 

    of board members. 

    Due to the fact that it was its first year of operation as a company, the 
    shareholders were interested to know the performance of the company and 
    thought of hiring an expert to review the financial statements of XY ltd for 

    the period ended 31 December 2016 and give his/her independent opinion.

    Questions 
    1. What is a professional name of a person who examines financial 
    statements and other financial documents on behalf of shareholders?
    2. What are procedures of appointing him/her?

    3. What should that person consider before accepting the assignment?

    3.1. Auditor’s appointment procedures

    Learning activity 3.1

    On the appointment of the auditor, in the general annual meeting of the 
    board of directors, shareholders and the management were discussing 
    the basis under which the auditor of their famous company known as 
    TWUNGANIRANE Ltd, would be recruited. They wanted to set ethical 
    duties, rights and liabilities of their new auditor.

    1. What should be the fundamental ethical principles of auditors?

    2. What do you think are the rights of an auditor?

    3. What are the auditor’s liabilities?

    3.1.1. Appointment of an auditor

    It is a legal requirement of the Companies Act for all Limited Companies to 
    appoint an auditor who will oversee the company’s affairs for a given financial 

    period.

    a) Conditions and ways of appointing an auditor

    • First auditor is appointed after the company’s registration by the Board 
    of Directors in 30 days and when fair to do, he/she is appointed by the 

    registrar of companies.

    • In case the above auditor is to resign, he/she must give a notice of 28 
    days in writing to the Board of Directors and for removal he/she is given 

    28 days.

    • At the annual general meeting, the shareholders will have to appoint an 

    auditor-28 days must be given to the out-going auditor in this respect.

    • Automatic Appointment 

    – If there is no resolution intended to remove the previous auditor, 

    then he/she is automatically reappointed.

    – If the previous auditor does not give a notice of the resigning in 

    writing (of 28 days) then he/she is deemed to be automatically re-appointed.

    – If the auditor has not committed any act which disqualifies him/her 

    automatically from being re-appointed.

    – If after the annual general meeting, the shareholders disagree on 
    who is to be the next auditor. (If no new auditor is appointed nor do 
    they delegate this duty to the Board of Directors, then 7 days after 
    the annual general meeting the Registrar of Companies will have to 
    appoint a new auditor) assuming that the previous auditor has been 

    removed.

    – In addition, automatic re-appointment will be obvious accepted.

    If he/she is not qualified for re-appointment e.g. due to misconduct or delays the 
    annual general meeting. If the auditor has given a notice (28 days) in writing of 
    his/her intention/unwillingness to be re-appointed. If a notice for a solution has 
    been given by any one shareholder, intending to appoint someone else then the 

    auditor cannot be automatically re-appointed.

    b) Casual Vacancies 

    A casual vacancy may arise in the auditor’s office due to any one of the following 

    situations:

    • The auditor’s death –Directors will have to fill such a vacancy;

    • The auditor is incapacitated, e.g. loss of limbs -Directors can fill such 

    a vacancy;

    • A doctor has to give a formal certificate to this effect;

    • The auditor’s resignation 

    This can only be filled by shareholders through an Extra Ordinary General Meeting. 
    Explanation why the auditor is resigning is required, if due to disagreement, he/

    she can be reinstated by the shareholders and directors may be removed.

    c) Procedures for appointing an auditor

    Advertising 

    To enhance comply with the company’s Act and other requirements in place, 
    recruiting company should advertise for a vacancy of its offer of external 
    auditor. The advertisement should be done through official different medium of 

    communication such as company website, radios, news papers…etc.

    Use of logos 

    A firm /auditor must have a practicing/auditing certificate to qualify him/her 
    as registered auditor. The firm/ auditor’s documentations should be designed 

    logos representing him/her.

    Tendering 

    Client companies can change auditors. In this regard, a firm/auditor may be 
    approached to submit a tender for an audit. When approached to tender, an 
    audit firm must consider whether they want to do the work and they must have 
    regard for the ethical considerations, such as independence and professional 
    competence. In addition, they need to consider fees and some other practical 

    issues. 

    Fees 

    A member may quote whatever fee is deemed to be appropriate. The fact that 
    one may quote a lower fee than another auditor is not in itself unethical. However, 
    it does raise the risk of a threat to the principles of professional competence 
    and due care in that the fee quoted may be so low as to make it appear to be 

    difficult to perform the audit to the expected standards.

    Therefore, it is wise to set out the basis of the calculation of the fee. The following 
    factors should be considered when setting out a fee: 
    • What does the job involve? 
    • Is it audit and/or tax or is there some other complicated work involved? 
    • Which staff will need to be involved, numbers and quality? How long 
    will they be required? Is the nature of the business complex?

    • What charge out rates are to be applied?

    The practice of undercutting fees has been called lowballing and can be seen 
    in action generally where large audits are concerned. We have seen that having 
    a lower fee may seem to have a negative impact on an auditor’s perceived 

    independence but there are other factors to be considered: 

    • Auditors operate in a market like any other business where supply and 
    demand very often dictate the price;
    • Fees may be lower due to reasons such as better internal audit functions; 
    • Simplified group structures within client companies;
    • Auditing firms have increased productivity, whether through the use of 
    more sophisticated IT or experience gained through understanding the 

    client’s business. 

    Other considerations

    It is important that the auditor also considers a number of other issues: 
    • Can the audit assignment be fitted in to the audit firms current work 
    plan? 
    • Is their suitable audit staff available?
    • Will any specialist skills be required? 
    • What are the future plans for the company? 
    • Is there any training required for current staff and what will be the cost 
    of that training? 
    • What work does the client actually want? Audit and/or tax?
    • Is this the first time the company has been audited. 
    • Whether the client is seeking to change its auditors and if so what is 

    the reason behind it?

    Submitting an audit proposal 

    There is no set format. In fact, the client may dictate the format. Whatever the 
    form of the tender submission, the following matters should be included in the 
    proposal: 
    • The audit fee and the basis for its calculation ;
    • An assessment of the needs of the client ;
    • How the firm/auditor intends to meet the needs of the client ;
    • Any assumptions made to support the proposal; 
    • The audit approach to be adopted by the firm ;
    • A brief outline of the firm;
    • Details and background of the key audit staff on the proposed 

    engagement.

    Evaluating the tender 

    Different clients will have different ways of evaluating a tender. Some of the 
    more general points are listed below. It is important to bear these in mind when 

    preparing a proposal: 

    • Fee: This can be the most vital point. Some clients go straight to this 

    figure and do not even bother with the rest of the document. 

    • Professionalism: Auditors are expected to be professional. 
    Remember, the audit team and the tender documents are often the first 

    factors on which a prospective client forms an impression. 

    • Proposed audit approach: Clients are always looking for the least 
    amount of disruption to their already busy schedules, so the shortest 

    number of days on-site may be the key to winning a tender.

    • Personal service: Fostering relationships is vital. Client should always 

    feel he/she is getting value for money. 

    Acceptance of the firm/auditor 

    You have submitted a tender. You have been successful and the client has 
    offered you the tender. Before you accept and commence the audit, you should 
    carry out a number of procedures in order to comply with the provisions in 

    ISQC1.

    3.1.2 Acceptance procedures

    a) Conditions before accepting the assignment 

    • Make sure there are no ethical issues that would prevent you from 

    accepting this assignment. 

    • Make sure that you are professionally qualified to carry out the work 
    requested and that your firm has the resources available in terms of 

    staff, expertise and time. 

    • Check out references for the directors of the client firm especially if 

    they are unknown to the audit firm. 

    • Consult previous auditors as a matter of professional courtesy and 
    establish from them whether there is anything that you ought to know 

    about this vacancy. 

    b) Conditions after accepting the assignment 

    • Make sure the resignation of the previous auditors has been properly 
    carried out and that the new appointment is valid. A resolution by 

    shareholders of the company is required. 

    • Submit a letter of engagement to the directors of the client company 
    and ensure it is accepted and signed before any audit work is carried 

    out.

    ISQC1 states that a firm should establish policies and procedures for the 
    acceptance and continuance of client relationships and specific engagements, 
    designed to provide it with reasonable assurance that it will only undertake or 

    continue relationships and engagements where it: 

    • Has considered the integrity of the client and does not have any 

    information that would lead it to conclude that the client lacks integrity, 

    • Is competent to perform the engagement and has the capabilities, time 

    and resources to do so and 

    • Can comply with the ethical requirements.

    The firm should obtain such information as it considers necessary in the 
    circumstances before accepting an engagement with a new client, when 
    deciding whether to continue an existing engagement and when considering 
    acceptance of a new engagement with an existing client. Where issues have
    been identified and the firm decides to accept or continue the relationship or a 
    specific engagement, it should document how the issues were resolved. 

    In short, a firm must: 

    • Obtain relevant information; 
    • Identify relevant issues ;

    • Resolve issues that are identified, and document that resolution. 

    c) Integrity of client 

    Matters to be considered: 

    • Identity and business reputation of owners, key management and those 

    charged with governance;

    • Nature of the client’s operations and its business practices;

    • Attitude of the owners, key management and those charged with 
    governance towards matters such as aggressive interpretation of 

    accounting standards and the internal control environment;

    • Client’s attitude to fees;

    • Indications of inappropriate limitation in the scope of work;

    • Indications that client may be involved in money laundering or other 

    criminal activities. 

    • Reasons given for non-reappointment of previous auditors. 

    Information can be gathered through communications with previous auditors 
    or other professionals who may have provided services and through other 
    third parties such as bankers, legal counsel and industry peers. There is also a 

    multitude of relevant databases where one can do some background research. 

    d) Competence of the audit firm 

    Matters to be considered: 

    • Does the firm have sufficient knowledge of the relevant industry and the 

    relevant regulatory environment? 

    • Are there sufficient personnel within the firm having the necessary 
    capabilities and competence and are experts/specialists available 

    when needed? 

    • Are competent individuals available to perform engagement quality 

    control reviews? 

    • Will the firm be able to complete the engagement within the reporting 

    deadline? 

    Where a potential conflict of interest is identified, the firm should consider 

    whether it is appropriate to accept the engagement. 

    • Need to consider any significant matters that may have arisen during 

    the current or previous engagements of whatever description. 

    • SQC1 goes on to state that where the firm obtains information that 
    would have caused it to decline an engagement if that information had 
    been available earlier, policies and procedures (on the continuance 
    of the engagement and the client relationship) should include 
    consideration of: The professional and legal responsibilities that apply 
    to the circumstances, including whether there is a requirement for the 
    firm to report to the person or persons who made the appointment or, 

    in some cases,to regulatory authorities, and 

    • The possibility of withdrawing from the engagement or from both the 

    engagement and the client relationship. 

    Some suggested procedures would include discussing with appropriate client 
    management the appropriate action that the firm might make based on the relevant 
    facts and circumstances. In addition, the firm should document the significant 

    issues, consultations, conclusions and the basis for those conclusions. 

    3.1.3. Agreeing the terms of engagement 

    a) Terms of engagement 

    Once an engagement has been accepted, it is important to agree the terms. 
    It is essential that both parties fully understand what the agreed services are. 
    Any misunderstanding could lead to a breakdown in the relationship and could 

    result in legal action. 

    ISA 210-terms of audit engagements establishes and provides guidance on: 
    • Agreeing the terms of an engagement with the client and;
    • The auditor’s response to a request by a client to change those terms 

    to one that provides a lower level of assurance. 

    It states that the auditor and the client should agree on the terms of the 
    engagement. The agreed terms would need to be recorded in an audit 
    engagement letter or other suitable form of contract. The terms should be 

    recorded in writing. 

    The objective and scope of an audit and the auditor’s obligations may be 
    established by law, but the auditor may still find that an audit engagement 
    letter will be informative for their clients. The main points to be clarified in the 

    engagement letter would include: 

    • Confirmation of the auditor’s acceptance of the appointment;
    • The auditor is responsible for reporting on the accounts to the 

    shareholders;

    • The directors of the company have a statutory duty to maintain the 
    books of the company and are responsible for the preparation of the 
    financial statements;

    • The directors are responsible for the prevention and detection of fraud;

    • The fact that because of the test nature and other inherent limitations of 
    an audit, there is the unavoidable risk that some material misstatements 
    may remain undiscovered;

    • The scope of the audit including reference to appropriate legislation 
    and standards;

    • There should be unrestricted access to whatever books and records 

    the auditor needs in the performance of his duties. 

    Other points to be included: 

    • Arrangements regarding the planning and performance of the audit; 

    • The expectation of receiving from management written confirmation 
    regarding; 

    • Representations made in connection with the audit;

    • Request for the client to confirm in writing the terms of the letter;

    • The fee to be charged and the credit terms;

    • The form of any reports or other communication of results of the 
    engagement;

    • On recurring audits, the auditor should consider whether circumstances 
    require the terms of the engagement to be revised and whether there 
    is a need to remind the client of the existing terms of the engagement;

    • An auditor who, before the completion of the engagement, is requested 
    to change the engagement to one, which provides a lower level of 
    assurance, should consider the appropriateness of doing so. Where 

    the terms are changed, both parties should agree on the new terms;

    Note, the auditor should not agree to a change of engagement where there is 

    no reasonable justification for doing so. 

    b) Books and documents 

    ISQC1 states that the firm should establish policies and procedures for the 
    retention of engagement documentation for a period sufficient to meet the 

    needs of the firm or as required by law or regulation. 

    Unless otherwise specified by law or regulation, engagement documentation is 
    the property of the audit firm. The firm may, at its discretion, make portions of, 
    or extracts from, engagement documentation available to clients, provided such 
    disclosure does not undermine the validity of the work performed, or, in the case 

    of assurance engagements, the independence of the firm or its personnel. 

    Audit working papers belong to the auditor and cannot be taken over by another 
    set of auditors taking over the audit assignment. In practice, the previous auditors 
    provide the new auditors with enough carry over information such as the lead 

    schedules behind the makeup of the financial statements. 

    The auditor owes a duty of confidentiality to the client, so documents about the 

    client should not be given to third parties unless: 

    • The client agrees to the disclosure ;

    • The disclosure is required by law or court order;

    • Disclosure is otherwise in accordance with the rules of professional 

    conduct. 

    The previous auditors should ensure that all the books and documents belonging 
    to the client are returned promptly. In some cases, the previous auditors are 
    allowed to keep the books where they are exercising a lien. This is a supplier’s 
    right to retain possession of a customer’s property until the customer pays up 

    what is owed. 

    Strict conditions that can be enforced: 

    • The books and documents must actually belong to the client;

    • The auditor must have got them by proper means;

    • The actual work must have been done and a fee note raised and given 

    to the client; 

    • The fee must relate to the held documents. Financial statements and tax 
    compliance work belong to the client, even if the auditor/ accountant 

    has prepared them. 

    Change in auditors
    Companies do actually change their auditors. It is important that auditors 
    understand why a company may seek to change their auditor in a bid to prevent 
    this from happening to them. 

    The following sets out the reasons why this can happen: 

    Audit fee 

    • Many companies perceive that an audit has very little value. In turn this 

    makes the audit fee a very sensitive issue;

    • The fee may be perceived to be too high. Remember, a lot of audit work 
    may be done off site and the hours charged at the firms office will belong 
    to the managers and partners, so the client might not understand why 

    the fee is so high;

    • It may not be seen as good value for money. For example, a client may 
    have important tax work carried out for him. The fee charged may be 
    way lower than that of the audit, probably due to the time involved, yet 
    the client might see the value of this work far greater than that of the 
    audit;

    • The current fee might not appear to be very competitive. Other similar 
    firms may be getting audit services for less;

    • The client may put the audit out to tender to see whether the price is 
    actually negotiable, even though he may have no intention of changing 
    his auditor;

    • The audit fee may breach the recommended level of overall practice 
    fees as laid down by ethics and auditor may have no other alternative 

    but to resign. 

    Audit firm may not seek re-election 
    • The auditor may choose not to stand for ethical reasons, such as he/
    she doubts the integrity of management.

    • Conflicts of interest may have arisen such as competition between 
    clients or maybe he/she has been offered some lucrative work by the 
    client and he/she may have to resign the auditor.

    • The auditor may have a disagreement with the client such as in the 
    formulation of accounting policies.

    • The auditor may simply not want to reduce his/her audit fee. 

    Problems related to the size of the company 
    • The company may be growing at such a rate that the audit firm no 
    longer has the necessary resources, staff, time, and expertise, to allow 
    it to retain the audit. 

    • It is important to apply the principle of professional competence and 
    due care. 

    • Alternatively, the company may be constricting and it now finds that it 
    can avail of the 

    • Audit exemption specified under relevant jurisdiction regulations. 

    • There is very little that the auditor can do in each of these cases. 

    • With small companies, the audit is almost a personal service. If 
    the relationship breaks down, there may be nowhere to go except 
    discontinue the relationship. Within a big firm with big audit clients, you 

    could simply change the engagement partner. 

    • As part of the safeguards against the threats to independence, audit 
    rotation was put forward. This is where the audit moves to another firm 
    although in the previous point, rotating to another engagement partner 

    within the same firm will mean the same thing.

    Application activity 3.1

    1. Go to the library and search in audit books, look on matters the 

    auditor considers related to the integrity of the client.

    Skills lab activity 3

    Through the search in audit books from the library, make a summary to 
    be presented in the class on the procedures for recruiting/appointing an 

    auditor.

    End unit 3 assessment

    1. Highlight the procedures for appointing of an auditor?

    2. Indicate the main terms of engagement as per ISA 210? 

    3. Provide the conditions for setting the remuneration of the auditor?

    4. What are conditions for accepting the audit assignments?

    5. What are conditions of engagement client must respect

    6. Write down the main elements of engagement letter?

    ◄UNIT 2:LEGAL AND PROFESSIONAL REQUIREMENTUNIT 4: AUDITOR’S REQUIREMENTS►