Explaining the Auditor Engagement Process | Ethical Clearance & Engagement Letters
Before the actual audit commences the first step is for a proper and well-documented engagement process to be undertaken between the audit firm and their new client. This process is regimented as there are several important boxes that must be ticked including whether the audit firm, and all of its personnel, are sufficiently independent to assist with the audit and further that the audit firm and client both agree to their responsibilities. In this process topics such as fees and payment timeframes (payment milestones) are also agreed too with most audit firms collecting some amount of their professional fees up front as a deposit for new engagements. In circumstances where the company or organisation being audited is deemed to have solvency issues the entire fee will be collected in advance to prevent the audit firm being left out of pocket.
When we have new clients searching for “Explaining the auditor engagement process”, they generally want to understand why there is a somewhat drawn out process between the initial quote and being able to commence work. This process includes ethical letters to the former auditor; formal engagement letters being signed and consent to act letters if required.
This process is governed by the Auditing and Assurance Standards Board and includes ethical obligations on the part of both the engaging audit firm and the exiting auditor. These standards are designed to enhance audit quality, ensure independence and create a seamless process for the industry as a whole.
Why the Auditor Engagement Process Matters
The engagement process is legally required but more than it being a required compliance outcome it is further designed to:
- Ensure auditor independence is protected
- Help identify any conflicts of interest or ethical issues in the proposed engagement
- Confirm the terms on which the audit is being conducted and the expectations that the audit firm has on the client
- Reduce misunderstandings and disputes
As mentioned, regardless as to a client’s opinion of the process, it is legally required to be followed every time. An auditor cannot choose not to send an ethical clearance letter or other document despite any dispute that exists between the previous audit firm and the client. This is because the engagement process is part of the auditors responsibilities which firms cannot contract away from or avoid.
Overview of the Auditor Engagement Process
The core steps that must be followed in every audit engagement include:
- Review of the proposed client’s organisation, its board and key management personnel and running internal independence and conflict checks.
- Provision of an engagement letter to a client outlined the scope of the audit and the cost involved.
- Writing to the previous auditor and received ethical clearance to undertake the audit.
- Providing a consent to act letter if required to the client.
Ethical Clearance Letter Explained
What Is an Ethical Clearance Letter?
An ethical letter is a standardised letter governed under APES 110 that is sent from one audit firm to another letting the outgoing auditor know that the prospective firm has been approached by the client to be appointed as their new auditor. It requests the former auditor to outline any professional or ethical issues with the engagement. In circumstances where the former auditor has been alerted to fraud, mismanagement or is currently in a dispute with the client there may be grounds for the prospective auditor to either decline the engagement or to put any engagement on hold while the dispute with the former auditor is resolved.
Why Is an Ethical Clearance Letter Required?
Auditors have very strict ethical requirements under the auditing standards that include:
- Protecting the public interest beyond their own interest or their clients
- Act with objectivity and apply professional scepticism at all times
- Avoid conflicts of interest and ensure independence
This ethical clearance allows the ingoing auditor to receive information from the outgoing firm around items such as:
- Any disputes which exist or existed between the auditor and the client
- Any independence concerns
- Any suspicion or evidence of fraud or other non-compliance
Consent to Act Letter Explained
What Is a Consent to Act Letter?
Although not always required a consent to act letter is prepared by an auditor when requested by a client confirming that they have been engaged by the company. This occurs after conflict of interest and independence checks are completed.
As a rule, these are often needed in situations such as:
- To provide to ASIC in relation to appointments for certain license holders
- To provide to lending institutions when the audit is required under a debt covenant
- To provide to the board or shareholders to vote upon at an AGM
For more information about how consent to act letters and how they work checkout the blog below:
What Is an Engagement Letter?
Audit engagement letters are very similar to ones you may have experienced with lawyers or accountants in the past. It is a formal written agreement between the audit firm and the client agreeing to the terms of the assurance activities and the associated fees and timeframe.
A well written engagement letter should include:
- A clear scope for the assurance activity, for example whether a review or full audit
- How the audit will be conducted (eg. In person, a desk audit or some combination)
- Which areas the auditor will be responsible for versus management
- The applicable legislative instrument that the audit firm will be auditing under
- The estimated fees and payment terms
- The objective of the engagement, for example, the provision of an audit report
Why Engagement Letters Are Important
A written agreement is always important to reduce misunderstandings and ensure both parties are agreeing to the same process, outcome and cost. It helps to allocate responsibilities between the parties and reduce the likelihood of issues in the completion of the engagement. It is also an important piece of evidence which both parties may rely upon if a dispute ever does occur. From a governance perspective it is designed to promote transparency and accountability between the parties.
Need Help with an Audit Engagement?
The auditor engagement process is far more than an administrative formality. It is a critical framework designed to uphold audit quality, independence, and trust. By understanding the purpose of ethical clearance letters, consent to act letters, and engagement letters, clients can better appreciate why auditors require these steps before commencing work.