Which of the following is a precondition for an audit?

Preconditions for an Audit ensuring the presence and course of action

The directors of a company are in the process of appointing the first statutory auditor of the company. They have requested your firm to submit a proposal for the statutory audit assignment. A partner of your firm has asked you to draft the proposal after assessing whether the preconditions for the audit exist.

Required:

(a) Briefly discuss the term ‘preconditions for an audit’.

(b) What are the steps that you would perform in order to ensure that preconditions for the audit exist?

(c) Discuss whether your firm may or may not accept the assignment if one of the preconditions for the audit is not present.

Preconditions for an audit

• An acceptable financial reporting framework has been used by the management in the preparation of the financial statements; and
• the management and, where appropriate, those charged with governance agreed on the premise on which the audit is to be conducted.

Ensuring the presence of ‘‘Preconditions for an audit’’

In order to establish whether the preconditions for an audit are present, we will:
determine whether the financial reporting framework to be applied in the preparation of financial statements is acceptable;
obtain the agreement of management that it acknowledges and understands its responsibility:

• for the preparation of the financial statements in accordance with the applicable financial reporting framework.
• for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
• to provide us with access to all information of which management is aware, that may be relevant to the preparation of the financial statements;
• additional information that the auditor may request from management for the purpose of the audit; and
• unrestricted access to persons within the entity from whom the auditor determine it necessary to obtain audit evidence.

Course of Action if Precondition for an audit not present:

If a precondition for an audit is not present, the matter would be discussed with the management. Unless required by law or regulation to do so, we will not accept the proposed audit engagement, if the pre-conditions are not met.However, if the financial reporting framework is prescribed by law or regulation and it would have been unacceptable but for the fact that it is prescribed by law or regulation, the audit engagement will be accepted only if the following conditions are met:

(i)  Management agrees to provide additional disclosures in the financial statements to avoid the financial statements being misleading;
(ii) It is recognized in the terms of the audit engagement that:

• Our report on the financial statements will incorporate an Emphasis of Matter paragraph, drawing users’ attention to the additional disclosures.
• Our opinion on the financial statements will not include such phrases as “present fairly, in all material respects,” or “give a true and fair view” unless it is expressively required to be stated under the law or regulation.

If the above conditions are not present and still we are required by law or regulation to undertake the audit engagement, we shall:

• evaluate the effect of the misleading nature of the financial statements on report;
• include appropriate reference to this matter in the terms of the audit engagement.

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Question 17a - December 2017 Sample

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• Q17a

You are an audit supervisor of Cupid & Co, planning the final audit of a new client, Prancer Construction Co, for the year ending 30 September 20X7. The company specialises in property construction and providing ongoing annual maintenance services for properties previously constructed. Forecast profit before tax is $13·8m and total assets are expected to be $22·3m, both of which are higher than for the year ended 30 September 20X6.

You are required to produce the audit strategy document. The audit manager has met with Prancer Construction Co’s finance director and has provided you with the following notes, a copy of the August management accounts and the prior year financial statements.

Meeting notes
The prior year financial statements recognise work in progress of $1·8m, which was comprised of property construction in progress as well as ongoing maintenance services for finished properties. The August 20X7 management accounts recognise $2·1m inventory of completed properties compared to a balance of $1·4m in September 20X6. A full year-end inventory count will be undertaken on 30 September at all of the 11 building sites where construction is in progress. There is not sufficient audit team resource to attend all inventory counts.

In line with industry practice, Prancer Construction Co offers its customers a five-year building warranty, which covers any construction defects. Customers are not required to pay any additional fees to obtain the warranty. The finance director anticipates this provision will be lower than last year as the company has improved its building practices and therefore the quality of the finished properties.

Customers who wish to purchase a property are required to place an order and pay a 5% non-refundable deposit prior to the completion of the building. When the building is complete, customers pay a further 92·5%, with the final 2·5% due to be paid six months later. The finance director has informed you that although an allowance for receivables has
historically been maintained, it is anticipated that this can be significantly reduced.

Information from management accounts
Prancer Construction Co’s prior year financial statements and August 20X7 management accounts contain a material overdraft balance. The finance director has confirmed that there are minimum profit and net assets covenants attached to the overdraft.

A review of the management accounts shows the payables period was 56 days for August 20X7, compared to 87 days for September 20X6. The finance director anticipates that the September 20X7 payables days will be even lower than those in August 20X7.

Required:
(a) Describe the process Cupid & Co should have undertaken to assess whether the PRECONDITIONS for an audit were present when accepting the audit of Prancer Construction Co. (3 marks)

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MC Question 3 - September 2016 Specimen

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• MCQ3 Specimen Sept 16

You are an audit manager of Buffon & Co, and you have just been assigned the audit of Maldini Co (Maldini). The audit engagement partner who is responsible for the audit of Maldini, a listed company, has been in place for approximately eight years and her son has just been offered a role with Maldini as a sales manager. This role would entitle him to shares in Maldini as part of his remuneration package.

Maldini’s board of directors is considering establishing an internal audit function, and the finance director has asked Buffon & Co about the differences in the role of internal audit and external audit. If the internal audit function is established, the directors have suggested that they may wish to outsource this to Buffon & Co.

The finance director has suggested to the board that if Buffon & Co is appointed as internal as well as external auditors, then fees should be renegotiated with at least 20% of all internal and external audit fees being based on the profit after tax of the company as this will align the interests of Buffon & Co and Maldini.

In line with ACCA’s Code of Ethics and Conduct, which of the following factors must be considered before the internal audit engagement should be accepted?

(1) Whether the external audit team have the expertise to carry out the internal audit work
(2) If the assignments will relate to the internal controls over financial reporting
(3) If management will accept responsibility for implementing appropriate recommendations
(4) The probable timescale for the outsourcing of the internal audit function

A. 1, 2 and 3
B. 2 and 3 only
C. 1 and 4 only
D. 1, 3 and 4

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MC Question 10 - June 2015

Is the following statement true or false?

A significant change in the ownership of an existing audit client is a factor which makes it appropriate for the auditor to review the terms of engagement.

A. True
B. False

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Question 4a i - December 2013

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• December 13 4a

Salt & Pepper & Co (Salt & Pepper) is a firm of Chartered Certified Accountants which has seen its revenue decline steadily over the past few years. The firm is looking to increase its revenue and client base and so has developed a new advertising strategy where it has guaranteed that its audits will minimise disruption to companies as they will not last longer than two weeks.

In addition, Salt & Pepper has offered all new audit clients a free accounts preparation service for the first year of the engagement, as it is believed that time spent on the audit will be reduced if the firm has produced the financial statements.

The firm is seeking to reduce audit costs and has therefore decided not to update the engagement letters of existing clients, on the basis that these letters do not tend to change much on a yearly basis.

One of Salt & Pepper’s existing clients has proposed that this year’s audit fee should be based on a percentage of their final pre-tax profit. The partners are excited about this option as they believe it will increase the overall audit fee. 
Salt & Pepper has recently obtained a new audit client, Cinnamon Brothers Co (Cinnamon), whose year end is 31 December. Cinnamon requires their audit to be completed by the end of February; however, this is a very busy time for Salt & Pepper and so it is intended to use more junior staff as they are available.

Additionally, in order to save time and cost, Salt & Pepper have not contacted Cinnamon’s previous auditors.

Required:

Describe the steps that Salt & Pepper should take in relation to Cinnamon:

Prior to accepting the audit. (5 marks)

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Question 4a ii - December 2013

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• December 13 4a

Salt & Pepper & Co (Salt & Pepper) is a firm of Chartered Certified Accountants which has seen its revenue decline steadily over the past few years. The firm is looking to increase its revenue and client base and so has developed a new advertising strategy where it has guaranteed that its audits will minimise disruption to companies as they will not last longer than two weeks.

In addition, Salt & Pepper has offered all new audit clients a free accounts preparation service for the first year of the engagement, as it is believed that time spent on the audit will be reduced if the firm has produced the financial statements.

The firm is seeking to reduce audit costs and has therefore decided not to update the engagement letters of existing clients, on the basis that these letters do not tend to change much on a yearly basis.

One of Salt & Pepper’s existing clients has proposed that this year’s audit fee should be based on a percentage of their final pre-tax profit. The partners are excited about this option as they believe it will increase the overall audit fee. 
Salt & Pepper has recently obtained a new audit client, Cinnamon Brothers Co (Cinnamon), whose year end is 31 December. Cinnamon requires their audit to be completed by the end of February; however, this is a very busy time for Salt & Pepper and so it is intended to use more junior staff as they are available.

Additionally, in order to save time and cost, Salt & Pepper have not contacted Cinnamon’s previous auditors.

Required:

Describe the steps that Salt & Pepper should take in relation to Cinnamon:

To confirm whether the preconditions for the audit are in place. (3 marks)

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Question 3a - December 2010

In agreeing the terms of an audit engagement, the auditor is required to agree the basis on which the audit is to be carried out. This involves establishing whether the preconditions for an audit are present and confirming that there is a common understanding between the auditor and management of the terms of the engagement.

Required:

Describe the process the auditor should undertake to assess whether the PRECONDITIONS for an audit are present. (3 marks)

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Question 4c - June 2010

Describe the steps an audit firm should perform prior to accepting a new audit engagement. (5 marks)

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