ENGAGEMENT LETTER

LET SEE AND GET INFORMATION FROM IT

1. Auditing – Study Notes Chapter 8 Engagement Letter

CHAPTER EIGHT
ENGAGEMENT LETTER


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IICCAAPP''SS SSTTUUDDYY TTEEXXTT
RREEFFEERREENNCCEE****

LLOO 11
✯✯
PPUURRPPOOSSEESS OOFF AAUUDDIITT EENNGGAAGGEEMMEENNTT LLEETTTTEERR
22..22..22
LLOO 22
✯✯✯✯
FFOORRMM AANNDD CCOONNTTEENNTTSS OOFF EENNGGAAGGEEMMEENNTT LLEETTTTEERR
LLOO 33
✯✯✯✯✯✯
AACCCCEEPPTTAANNCCEE OOFF CCHHAANNGGEE IINN TTHHEE TTEERRMMSS OOFF AAUUDDIITT
EENNGGAAGGEEMMEENNTT
LLOO 44
✯✯✯✯
EENNGGAAGGEEMMEENNTT LLEETTTTEERR OONN RREECCUURRRRIINNGG AAUUDDIITTSS

*Explanation of Symbol:
Symbol ✯✯ shows important of the concept from exam point of view.
 If a concept is tagged with three stars i.e. ✯✯✯✯✯✯, it is very very important concept. Such concepts should be focused
most during preparation, should be revised atleast 10 times in the last month before exam, and should be revised
first on last day before exam.
 If a concept is tagged with two stars i.e. ✯✯✯✯, it is very important concept. Such concepts should be focused highly
during preparation, should be revised atleast 6 times in the last month before exam, and should be revised after three-star concepts on last day before exam.
 If a concept is tagged with single star i.e. ✯✯, it is important concept. Such concepts should be focused moderately
during preparation, should be revised atleast 3 times in the last month before exam, and should be revised after
two-star concepts on last day before exam.
((NNoottee tthhaatt nnoonnee ooff tthhee ccoonncceepptt iiss uunniimmppoorrttaanntt,, tthheerreeffoorree nnoonnee sshhoouulldd bbee sskkiippppeedd))

***Explanation of Reference:
First digit in Study Text’s Reference represents chapter number, second and third digits represents
section and sub-section number. Contents in brackets (if any) represent part of the sub- section
which is covered by the learning objective.

Coverage from Question Bank:
After completion of this chapter, you will be able to attempt following questions in ICAP's Question
Bank:


Question # in ICAP’s
Question Bank
Type of Question

Question # in ICAP’s
Question Bank
Type of Question
Q. # 16a (Engagement letter) Concept Review Question

Q. # 27 (Changing terms) Concept Review Question
Q. # 17b (Shahid Corporation) Concept Review Question Q. # 28 (EL) Concept Review Question
1 By: Muhammad Asif, ACA

2. Auditing – Study Notes Chapter 8 Engagement Letter

LLOO 11:: PPUURRPPOOSSEESS//OOBBJJEECCTTIIVVEESS OOFF AAUUDDIITT EENNGGAAGGEEMMEENNTT LLEETTTTEERR :: ✯✯
Audit Engagement Letter:
Engagement letter is a written agreement between auditor and client (through appropriate
representative e.g. CFO, CEO) on terms and conditions of audit engagement.

Purposes of Engagement Letter:
 It confirms appointment by clie nt and acceptance by auditor and constitutes a contract
between them.
 It removes misunderstanding between auditor and client on scope of audit and their
respective responsibilities.

CONCEPT REVIEW QUESTION
List the objects of the engagement letter. Indicate who writes the letter to whom it is written and
the time when it is written.
(CA Inter–Spring 1991)


LLOO 22:: FFOORRMM AANNDD CCOONNTTEENNTTSS OOFF EENNGGAAGGEEMMEENNTT LLEETTTTEERR :: ✯✯✯✯
Audit Engagement Letter shall include:
a) The objective and scope of the audit;
b) Identification of the applicable financial reporting framework ;
c) The responsibilities of the auditor;
d) The responsibilities of management (also called Premise);
e) Expected form and content of report to be issued by the auditor and
f) A statement that there may be circumstances in which a report may be different from its
expected form and content.

An audit engagement letter may also include following:
a) Elaboration of the scope of the audit.
b) Inherent limitations of an audit
c) Inherent limitations of internal control.
d) Arrangements regarding the planning and performance of the audit, including composition
of the audit team and timing.
e) Fee or Basis of fee.
f) Agreement of management to inform the auditor of subsequent events affecting financial
statements (after date of auditor’s report till issuance of financial statements).
g) The expectation that management will provide written representation letter.
h) Reference to any other communication as a result of the audit engagement (e.g. Letter of
Weakness).
i) Arrangements concerning involvement of predecessor auditor, component auditor, expert,
internal auditor, quality control reviewer.


CONCEPT REVIEW QUESTION
List the important matters that are required to be included in an audit engagement letter.
(06 marks)
(CA Inter, Autumn 2012)
2 By: Muhammad Asif, ACA

3. Auditing – Study Notes Chapter 8 Engagement Letter

List the principal items to be agreed in an engagement letter between an assurance firm and a
person commissioning an assurance engagement. (02 marks)
(ICAEW - 2006 March)


LLOO 33:: AACCCCEEPPTTAANNCCEE OOFF CCHHAANNGGEE IINN TTHHEE TTEERRMMSS OOFF AAUUDDIITT EENNGGAAGGEEMMEENNTT :: ✯✯✯✯✯✯
Circumstances leading to change in terms of audit engagement:
Client may request auditor to change terms of the audit engagement as a result of:
 a change in circumstances affecting the need for the service,
 a misunderstanding as to the nature of service originally requested, or
 a restriction on the scope of the audit engagement.

Factors to be considered by auditor before accepting change:
If, prior to completing the audit engagement, auditor is requested to change the terms of
engagement, auditor shall consider:
1. whether there is a reasonable justification to do so, and
2. legal or contractual implications of the change.

A change in circumstances that affects the need for the service or a misunderstanding as to nature
of the service originally requested may be a reasonable justification. In contrast, a change may not
be reasonable if it relates to information that is incorrect, incomplete or otherwise unsatisfactory.

Acceptance of Change by Auditor:
If auditor accepts the change:
1. Revised terms of engagement shall be agreed.
2. Procedures to be performed and Report to be issued shall be according to revised engagement.
3. Report shall NOT refer to:
 Original audit engagement or
 Any procedures performed in original audit engagement
If auditor does not accept the change:
Auditor shall continue to perform the audit engagement as per original terms of engagement.
If management does not permit auditor to continue original engagement, it will be scope limitation
whose effect is pervasive. Auditor shall withdraw from engagement (if withdrawal is possible and
practicable). If withdrawal is not possible and practicable, auditor shall express disclaimer of
opinion on financial statements.


CONCEPT REVIEW QUESTION
An auditor may agree to a change in the terms of engagement provided there is a reasonable
justification for doing so.
Required:
(a) List the circumstances in which the management may request the auditor to change the terms of
an audit engagement.
(b) What factors should be considered by the auditor before accepting a change in the terms of the
engagement?
3 By: Muhammad Asif, ACA

4. Auditing – Study Notes Chapter 8 Engagement Letter
(c) List the steps that the auditor should consider, if he is unable to agree to a change in the terms of
engagement. (09 marks)
(CA Inter, Spring 2012)



LLOO 44:: EENNGGAAGGEEMMEENNTT LLEETTTTEERR OONN RREECCUURRRRIINNGG AAUUDDIITTSS :: ✯✯✯✯
On recurring audit, auditor shall assess whether there is need to send fresh engagement letter to
remind management of the existing terms of the engagement or due to changes in circumstances.
Following factors may indicate that above is appropriate:
1) Any indication that client misunderstands the objective and scope of the audit.
2) A recent change in senior management or ownership of entity.
3) A change in l egal or regulatory requirements.
4) A significant change in nature or size of entity’s business.
5) A change in applicable financial reporting framework of entity.
6) A change in other reporting requirements
7) Any revised or special terms of the audit engagement.


CONCEPT REVIEW QUESTION
Is it necessary for an audit firm to issue an engagement letter every year in case of a recurring
audit? What are the factors to be considered in this regard? (04 marks)
(CA Inter -Spring 2003)

List the circumstances in which it may become necessary to revise the terms of audit engagement
for a recurring audit. (07 marks)
(CA Inter - Autumn 2011)

List the factors, for a recurring external audit, that may make it appropriate for an audit firm to
revise the terms of an audit engagement or remind the audited entity of existing terms. (03 marks)
(ICAEW - 2015 June)



4 By: Muhammad Asif, ACA

5. Auditing – Case Studies Chapter 8 Engagement Letter

CHAPTER EIGHT (CASE STUDIES)
ENGAGEMENT LETTER


AAPPXX 11:: CCAASSEE SSTTUUDDYY RREELLAATTIINNGG TTOO EENNGGAAGGEEMMEENNTT LLEETTTTEERR::
Structure of the Case:
In exam, you may be given a situation in which , you will be required to assess whether:
 it is necessary to issue a fresh letter on recurring audit, considering facts of the case.
 to accept changes in terms of audit engagement during audit.

Suggested Approach to Answer:
Remember to differentiate between change in terms of engagement on “recurring audit” and
“during the audit”.

Model Case Study From Examination Questions:


Case Study 1:
Guilin & Partners is a CGA firm that has audited ZFL for the past 5 years. During the past year, ZFL has grown to include
exports to Asia. The president and the controller both retired last year. The new management met with Guilin this year to
discuss this year’s audit and hope to reduce the audit fees. ZFL’s new management suggested that since the company had
received an unqualified audit opinion every year from Guilin, less audit work would be needed this year. They suggested
that there was no need for an engagement letter this year since Guilin’s staff were very familiar with the company. The
managing partner at Guilin, Tim, explained to the controller that there were new accounting principles being applied this
year because differential reporting rules no longer applied to the company. Tim also explained the audit process in more
detail to the controller and president, who then agreed that the audit fees requested by Guilin were reasonable.

Required
Explain why you would or would not require an engagement letter this year. Support your answer with three points.
(08 marks)
(CGA – Canada, External Auditing 1, September 2011)

Suggested Solution:
A fresh engagement letter should be sent to ZFL (even if it is our recurring audit) this year because:
1. Size of business has grown (now goods are also exported to Asia) which will bring new accounting and audit
implications to engagement.
2. There has been a significant change in senior management (president and controller have retired).
3. New management has some misunderstanding about objective and scope of audit (as it is expecting auditor to
reduce fee and work less).
4. Auditor’s understanding of terms of engagement is not sufficient, Client should also have sufficient
understanding of terms and conditions of engagement.
5. There has been major changes in requirements of Applicable Financial reporting framework.

Examiners’ Comments:
Question was answered satisfactorily by most students; however, some students simply discussed engagement letters in
general, without any reference to the situation given in the question. To succeed on the examination, it is necessary to identify
the concept, and then explain how it relates to the facts given in the question. If students simply state a general answer
without referring to the question facts, this only shows that they can recite a definition or memorize points, whereas a
professional accountant must be able to apply the knowledge in the course material to everyday facts.


1 By Muhammad Asif, ACA

6. Auditing – Case Studies Chapter 8 Engagement Letter

Case Study 2:
Your audit firm has been appointed to conduct a full scope audit of the financial statements covering a period of three
months of Clever Limited. Clever Limited needs the audit report for obtaining a bank loan. While verifying certain account
heads you identify certain problems for which you are not provided satisfactory replies by the client. At the same time
Clever Limited approaches you and asks you to change the scope of assignment from a full scope audit to a review
assignment. They give you the reason that they have misunderstood the scope of assignment earlier. What course of
action you would adopt in this situation?
(06 marks)
(CA Inter, Spring 2003)

Solution:
Whenever auditor is asked by client to revise terms of engagement during audit, auditor shall consider following factors
before accepting change:
1. Whether there is a reasonable justification for the change.
2. Legal or Contractual implications of the change.

As certain problems have been identified for which no satisfactory replies have been given by the client, it seems that this
change in engagement is due to incorrect or incomplete information and client wants to avoid qualified opinion by
changing terms of engagement. Hence, there is no reasonable justification to the change. So, we will not agree to change
the terms of engagement.

In this situation, auditor should continue to perform the audit engagement as per original terms of engagement. If
management of Clever Limited does not permit auditor to perform original engagement, it will be similar to scope
limitation and auditor shall:
 Withdraw from engagement if possible and practicable.
 Express disclaimer of opinion if withdrawal is not possible and practicable..








2 By Muhammad Asif, ACA