Solutions to Problems

2-14
Item Number Type of Assurance Service Type of Auditor

a Compliance or operational Government

b Financial statement External

c Compliance or operational or Internal or external

possibly internal control

d Internal control Internal or external

e Prospective financial Government, external or

information or operational internal

f Operational Internal or external

g Compliance Government

h Compliance or forensic Government, external or

forensic

2-15
a In a one-tier board structure, an audit committee is normally a subcommittee of the
board of directors that has overall responsible for the financial reporting and disclosure
process. Members of the audit committee typically must be independent with some
members having competence in accounting and auditing.
b An audit committee exists to assist the governing body in meeting its responsibilities
with respect to financial reporting, including supervise the audit function. In an increasing
number of countries and jurisdictions an audit committee is a mandatory requirement for
listed companies and financial institutions. For example, the EU 8th Directive on
Statutory Audits requires public-interest entities (PIEs) to establish an audit committee.
c In the EU the audit committee of PIEs: (1) monitor the financial reporting process, (2)
monitor the effectiveness of the companys internal control, internal audit where
applicable, and risk management systems, (3) monitor the statutory audit of the annual
and consolidated account, and (4) review and monitor the independence of the statutory
auditor or audit firm, and in particular the provision of additional services to the audited
entity.
The audit committee is typically directly responsible for the appointment, compensation
and oversight of the work of the audit firm engaged by the company. Audit and non-audit
services provided by its auditor would require pre-approval by the audit committee.

2-16
Sally Jones Actions Resulting in
 Brief References to IESBA Code of
Ethics and International Standards on
Auditing
IESBA Code of Ethics:
1. The IESBA Code of Ethics
requires that the accountant performs his
or her professional responsibilities with
competence. A professional accountant
should also take steps to ensure that
those working under his or her authority
in a professional capacity have
appropriate training and supervision.
2. The IESBA Code of Ethics
requires that practitioners should be both
independent of mind and in appearance
for audits. Independence is related to
the basic principles of integrity and
objectivity as well as professional
scepticism. Contingent fees for audit
engagements create unacceptable self-
interest and advocacy threats.
3. The IESBA Code of Ethics
requires that the accountant performs his
or her professional responsibilities with
due care. Due care means that the
professional accountant and those
working under his or her authority should
observe technical and professional
standards.
International Standards on Auditing:
1. Auditing standards requires that
the engagement partner is satisfied that
the engagement team has the
appropriate capabilities and competence
to perform the audit (ISA 220). The
engagement partner shall also take
responsibility for direction, supervision
and performance of the audit (ISA 220).
The auditor shall plan the audit so that
the engagement will be performed in an
Failure to Comply with IESBA Code
of Ethics and International Standards
on Auditing
1. It was inappropriate for Jones to
hire the two students to conduct the
audit. The examination must be
conducted by persons with proper
education and experience in the field of
auditing. Although a junior assistant
has not completed his formal education,
he may help in the conduct of the
examination as long as there is proper
supervision and review.
2. To satisfy the IESBA Code,
Jones must be without bias with respect
to the client under audit. Jones has an
obligation for fairness to the owners,
management, and creditors who may
rely on the report. Because of the
financial interest in whether the bank
loan is granted to Boucher, Jones is not
independent in either of mind or in
appearance with respect to the
assignment undertaken.
3. The IESBA Code requires Jones
to perform the audit with due care,
which imposes on Jones and everyone
in Jones's organization a responsibility
to observe the auditing standards.
1. Jones accepted the engagement
without considering the availability of
competent staff. In addition, Jones
failed to supervise the assistants. The
work performed was not adequately
planned.
effective manner (ISA 300).
2. The auditor shall obtain an
understanding of internal control relevant
to the audit (ISA 315).
3. The auditor shall obtain sufficient
appropriate evidence to be able to draw
reasonable conclusions on which to base
the audit opinion (ISA 500).
4. The report shall state that the
audit was conducted in accordance with
the ISAs or relevant national standards
(ISA 700).
5. The report shall state that the
audit includes evaluating the
appropriateness of accounting policies
used and the reasonableness of
accounting estimates made by
management, as well as evaluating the
overall presentation of the financial
statements (ISA 700).
6. The report shall contain either an
expression of opinion regarding the
financial statements, taken as a whole,
or an assertion to the effect that an
opinion cannot be expressed. When an
overall opinion cannot be expressed, the
reasons therefore should be stated. In
all cases where an auditor's name is
associated with financial statements, the
report should contain a clear-cut
indication of the character of the
auditors work (ISA 700).
2. Jones did not study internal
control, nor did the assistants. There
appears to have been no audit
examination at all. The work performed
was more an accounting service than it
was an auditing service.
3. Jones acquired little evidence
that would support the fairness of the
financial statements. Jones merely
checked the mathematical accuracy of
the records and summarized the
accounts. Standard audit procedures
and techniques were not performed.
4. Joness report made no
reference to the ISAs. Because Jones
did not conduct a proper examination,
the report should state that no opinion
can be expressed as to the fair
presentation of the financial statements
in accordance with the financial
reporting framework.
5. Joness improper examination
would not enable her to determine
whether accounting policies have been
consistently applied.
6. Although the Jones report
contains an expression of opinion, such
opinion is not based on the results of a
proper audit examination. Jones should
disclaim an opinion because she failed to
conduct an examination in accordance
with ISAs.
Solutions to Problems

3-16
a Prior to acceptance of the engagement, Tan & Faisal should have communicated with
the predecessor auditor regarding:
Information that might bear on the integrity of management.
Disagreements with management about accounting policies, auditing procedures
or other similarly significant matters.
Communications to those charged with governance regarding fraud and non-
compliance with laws or regulations by the entity.
Communications to management and those charged with governance regarding
significant deficiencies in internal control.
The predecessor auditors understanding about the reasons for the change of
auditors.

b The additional procedures Tan & Faisal should perform before accepting the
engagement include the following:
Obtain and review available financial information (annual reports, interim financial
statements, income tax returns, etc.).
Inquire of third parties about any information concerning the integrity of the
prospective client and its management. (Such inquiries should be directed to the
prospective clients bankers and lawyers, credit agencies and other members of
the business community who may have such knowledge.)
Consider whether the prospective client has any circumstances that will require
special attention or that may represent unusual business or audit risks, such as
litigation or going-concern issues.
Determine if the firm is independent of the client and able to provide the desired
service.
Determine if the firm has the necessary technical skills and knowledge of the
industry to complete the engagement.
Determine if acceptance of the client would violate any applicable regulatory or
ethical requirements such as those in the IESBA Code of Ethics for Professional
Accountants.

c The form and content of engagement letters may vary, but they would generally
contain information regarding:
The objective of the audit.
The estimated completion date.
Managements responsibility for the financial statements.
The scope of the audit.
Other communication of the results of the engagement.
The fact that because of the test nature and other inherent limitations of an audit,
together with the inherent limitations of any system of internal control, there is an
 unavoidable risk that even some material misstatement may remain
undiscovered.
Access to whatever records, documentation, and other information may be
requested in connection with the audit.
Arrangements with respect to client assistance in the performance of the audit
engagement.
Expectation of receiving from management written confirmation concerning
representations made in connection with the audit.
Notification of any changes in the original arrangements that might be
necessitated by unknown or unforeseen factors.
The basis on which fees are computed and any billing arrangements.
The type of opinion expected.
A request for the client to confirm the terms of the engagement by acknowledging
receipt of the engagement letter.

3-17 The preliminary engagement and planning activities that Pandamany needs to
complete are:
Reading the current years interim financial statements.
Discussing the scope of the examination with management of the client.
Establishing the timing of the audit work.
Arranging with the client for adequate working space.
Coordinating the assistance of client personnel in data preparation.
Establishing and coordinating staffing requirements, including time budget.
Holding a planning conference with assistants assigned to the engagement and
discussing possible fraud-related issues.
Determining the extent of involvement, if any, of consultants, experts, and
internal auditors.
Considering the effects of applicable accounting and auditing pronouncements,
particularly recent ones.
Drafting an appropriate engagement letter.
Preparing documentation setting forth the preliminary audit plan.
Establish overall materiality and performance materiality.
Making a preliminary assessment about control risk.
Updating the prior year's written audit plan and possibly developing new
procedures as warranted by changes in the business.

3-18
a In addition to the items shown in the EarthWear engagement letter (Exhibit 3-1), the
letter generally may include the following items:
Arrangements involving the use of experts or internal auditors.
Explanation of the auditors responsibilities to communicate audit matters of
governance interest with those charged with governance.
Additional services to be provided relating to regulatory requirements.
 Arrangements regarding other services (e.g. assurance, tax or consulting
services).

b The benefits of preparing an engagement letter include the avoidance of possible

problems between the independent auditor and the client concerning (1) the scope of the
work; (2) the service to be rendered; and (3) the audit fee. In addition, the in-charge
auditor conducting the examination can avoid misunderstanding the nature and scope of
the engagement if the engagement letter is included in the permanent section of the
audit working papers. The letter should eliminate misunderstandings and confusion
about the type of financial statements to be examined, the estimated report date, and the
type of opinion expected. In addition to avoiding possible misunderstandings, any legal
problems relating to the auditor's failure to perform certain procedures can be reviewed
with reference to the contractual commitment assumed. For example, if scope
limitations prevent the auditor from performing normal audit procedures, the auditor
cannot be legally responsible if a fraud is not detected when clearly it would have been
detected if such procedures were performed. The engagement letter is also useful as a
reference document when preparing for future engagements.