AUDITING
A RISK-BASED APPROACH TO
CONDUCTING A QUALITY AUDIT
9th Edition
Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg
CHAPTER 14
ACTIVITIES REQUIRED IN COMPLETING A
QUALITY AUDIT
Copyright © 2014 South-Western/Cengage Learning
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
Review, summarize, and resolve detected
misstatements and identified control deficiencies
Review and assess the appropriateness of the
client’s accounting for and disclosure of loss
contingencies
Review and assess the appropriateness of the
client’s significant accounting estimates
Review the adequacy of disclosures
Review and assess the implications of
noncompliance with laws and regulations
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LEARNING OBJECTIVES
6.
7.
8.
9.
Review the appropriateness of the going-concern
assumption using relevant professional guidance
Perform final analytical review procedures
Review management representations in
certifications required under the Sarbanes-Oxley
Act (for public clients) and describe the contents of
a management representation letter
Review subsequent events that occur after the
balance sheet date and assess proper treatment
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LEARNING OBJECTIVES
10.
11.
12.
13.
Determine how to address situations in which
omitted audit procedures come to the auditor’s
attention after the audit report has been issued
Assess the adequacy of supervision and perform an
engagement quality review
Identify issues to communicate to the audit
committee
Identify issues to communicate to management via
a management letter
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LEARNING OBJECTIVES
14.
15.
16.
Describe the process by which audit firms make
client acceptance and continuance decisions
Identify the requirements concerning mandatory
partner rotation and mandatory audit firm rotation
for publicly traded audit clients
Apply the frameworks for professional decision
making and ethical decision making to issues
involved in completing the audit
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THE AUDIT OPINION FORMULATION
PROCESS
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PROFESSIONAL JUDGMENT IN CONTEXT - A CASE OF
POOR REVIEW QUALITY AND IMPROPER PROFESSIONAL
CONDUCT
• The Practice Office Assurance Director for BDO’s
Philadelphia office assigned an audit manager to the
audit of Hemispherix Biopharma Incorporated
• BDO’s internal quality control review team selected
Hemispherix for inspection
• Led to the director forcing the manager to sign the audit
papers in spite of the papers not being reviewed
• PCAOB detected the fraud and barred the director
from performing audits of public companies for at
least one year
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PROFESSIONAL JUDGMENT IN CONTEXT - A CASE OF
POOR REVIEW QUALITY AND IMPROPER PROFESSIONAL
CONDUCT
• During the conduct of the audit engagement, reviews
of work performed by lower-level staff are necessary
to be sure that audit steps have been competently
completed. Toward the end of the audit, what other
types of reviews should be conducted? (LO 1, 2, 3, 4,
5, 6, 7, 8, 9, 10, 11)
• Why are engagement quality reviews important? (LO
11)
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PROFESSIONAL JUDGMENT IN CONTEXT - A CASE OF
POOR REVIEW QUALITY AND IMPROPER PROFESSIONAL
CONDUCT
• Why were the director’s actions harmful to the BDO
and the Hemispherx audit? (LO 11, 16)
• What was the ethical dilemma faced by the
manager? (LO 16)
• What alternative courses of action could the director
have taken when he discovered that the engagement
had not been reviewed and that it was about to be
inspected during the engagement quality review? (LO
10, 11, 16)
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LEARNING OBJECTIVE 1
REVIEW, SUMMARIZE, AND RESOLVE DETECTED
MISSTATEMENTS AND IDENTIFIED CONTROL
DEFICIENCIES
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REVIEWING, SUMMARIZING, AND
RESOLVING DETECTED MISSTATEMENTS
• Misstatement may be:
• Difference between the amount reported in the
financial statements and what should be reported
under Generally Accepted Accounting Principles
(GAAP)
• Omission of an amount that should be disclosed in
accordance with GAAP
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CATEGORIES OF MISSTATEMENTS
Known or factual misstatements
• Specifically identified
Projected misstatements
• Best estimate of misstatement in a given population
Judgmental misstatements
• Differences in auditor and management judgment
concerning:
• Accounting estimates
• Selection or application of accounting policies
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RESOLVING DETECTED
MISSTATEMENTS
• Audit firms use a schedule to:
• Accumulate known and projected misstatements
• Carryover effects of prior-year uncorrected
misstatements
• Immaterial misstatements are waived (left
uncorrected)
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EXHIBIT 14.1 - SUMMARY OF POSSIBLE
ADJUSTMENTS
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RESOLVING DETECTED
MISSTATEMENTS
• Materiality of a misstatement is based on:
• Quantitative amount of the misstatement
• Nature of misstatement to determine the qualitative
features that would make it material
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AUDITING IN PRACTICE - THE PCAOB POSITION ON
MANAGEMENT BIAS IN CORRECTING DETECTED
MISSTATEMENTS
• Decide whether refusal to correct a detected
misstatement is indicative of intentional bias
• Management bias should lead auditors to reevaluate:
• Risk assessments
• Risk of fraud
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ADDITIONAL CONSIDERATIONS FOR AN
INTEGRATED AUDIT
• Assessing whether financial statement misstatements
were a result of:
• Significant deficiencies in internal control
• Material weaknesses in internal control
• Evaluating severity of each individual control deficiency
to determine whether it is a material weakness
• Accumulating deficiencies less severe than material
weaknesses, on a summary work sheet
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LEARNING OBJECTIVE 2
REVIEW AND ASSESS THE APPROPRIATENESS OF
THE CLIENT’S ACCOUNTING FOR AND
DISCLOSURE OF LOSS CONTINGENCIES
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REVIEWING CONTINGENCIES
• Categories of potential losses
• Probable
• Reasonably possible
• Remote
• Management is responsible for designing and
maintaining policies and procedures to identify,
evaluate, and account for contingencies
• Auditor is responsible for determining that client has
identified, accounted for , and disclosed
contingencies
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AUDITING IN PRACTICE - CONTINGENT
LIABILITIES AT BRITISH PETROLEUM (BP)
• In July 2010, BP released its second quarter earnings
report discussing:
• Risks associated with ongoing events and cleanup
effort in the Gulf of Mexico due to an oil spill
associated with BP
• BP’s auditors should have obtained assurance that
the contingency in connection with oil spill was
accurately reported and disclosed
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SOURCES OF AUDIT EVIDENCE
RELATED TO CONTINGENCIES
• Description and
evaluation of
contingencies
• Assurance that
accounting and
disclosure requirements
have been met
• Information about
major contracts in
which contingencies
may be present
• Documentation of
communication the
legal counsel of the
client
• Documentation of
contingent liabilities
contained in:
• Corporate minutes and
bank confirmations
• Correspondence from
governmental agencies
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LETTER OF AUDIT INQUIRY
• Letter that the auditor asks the client to send to its
legal counsel to gather corroborative evidence
concerning litigation, claims, and assessments
• Legal counsel should be instructed by the client to
respond directly to the auditors
• Scope limitation - If a lawyer refuses to furnish the
requested information
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LEARNING OBJECTIVE 3
REVIEW AND ASSESS THE APPROPRIATENESS OF
THE CLIENT’S SIGNIFICANT ACCOUNTING
ESTIMATES
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JUDGMENTAL ESTIMATES INCLUDED IN
FINANCIAL STATEMENT BALANCES
• Fair value of many assets
• Net realizable values of inventory and receivables
• Property and casualty insurance loss reserves
• Revenues from contracts accounted for by
percentage-of-completion method
• Warranty expenses and associated liabilities
• Depreciation and amortization methods
• Impairment of depreciable assets and goodwill
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JUDGMENTAL ESTIMATES INCLUDED IN
FINANCIAL STATEMENT BALANCES
• Useful lives and residual values of productive
facilities, natural resources, and intangibles
• Valuation and classification of:
• Financial instruments
• Pensions
• Other postretirement benefits
• Compensation in stock option plans
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REVIEWING SIGNIFICANT ESTIMATES
• Auditors should be alert to period-end adjusting
journal entries
• They are responsible for providing assurance that:
• Estimates are reasonable
• Estimates are presented in conformity with GAAP
• Disclosure about estimates is adequate
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REVIEWING SIGNIFICANT ESTIMATES
• Management estimates are based on:
• Subjective factors
• Objective factors
• Events or transactions useful in identifying and
evaluating reasonableness of estimates occur:
• After balance sheet date
• Before audit report date
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REVIEWING SIGNIFICANT ESTIMATES
• Auditor should focus on factors and assumptions
that are:
•
•
•
•
•
Significant to accounting estimate
Sensitive to variations
Deviations from historical patterns
Subjective and susceptible to misstatement and bias
Inconsistent with current economic trends
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AUDITING IN PRACTICE - PCAOB FINES ERNST & YOUNG
FOR AN ISSUE INVOLVING ACCOUNTING ESTIMATES
• Medicis’ management convinced their audit
partners that their revenue recognition policy was
acceptable
• Even though it violated GAAP
• National-level consultation experts suggested that
partners involved in the Medicis audit were incorrect
• After investigation PCAOB imposed a penalty on:
• Ernst & Young
• Individual partners on Medicis engagement
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LEARNING OBJECTIVE 4
REVIEW THE ADEQUACY OF DISCLOSURES
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REVIEWING THE ADEQUACY OF
DISCLOSURES
• Auditor’s report must indicate if disclosures are not
reasonably adequate
• Disclosures can be made:
• On face of financial statements
• In form of classifications or parenthetical notations
• In notes to statements
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AUDITING IN PRACTICE - RELATED PARTY
DISCLOSURES AT OAO GAZPROM
• Company’s International Financial Reporting
Standards (IFRS) based disclosures led to difficulty for
PwC due to:
• Complex nature of related-party transactions
• High-level interrelationships between executives in
companies operating in the Federation
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REASONABLE ASSURANCE THAT AUDITORS SHOULD
HAVE WHEN ASSESSING ADEQUACY OF DISCLOSURES
• Disclosed events and transactions have occurred and
pertain to the entity
• All disclosures that should have been included
• Disclosures are understandable to users
• Information is disclosed accurately and at
appropriate amounts
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LEARNING OBJECTIVE 5
REVIEW AND ASSESS THE IMPLICATIONS OF
NONCOMPLIANCE WITH LAWS AND
REGULATIONS
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AUDITORS’ RESPONSIBILITIES REGARDING CLIENTS’
NONCOMPLIANCE WITH LAWS AND REGULATIONS
• Noncompliance: Acts of omission or commission,
either intentional or unintentional, contrary to
prevailing laws or regulations
• Limitations in an auditor’s ability to detect material
misstatements
• Information systems relating to financial reporting may
not capture noncompliance
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AUDITORS’ RESPONSIBILITIES REGARDING CLIENTS’
NONCOMPLIANCE WITH LAWS AND REGULATIONS
• Management may:
• Act to conceal noncompliance
• Override controls
• Intentionally misrepresent facts to the auditor
• Legal implications of noncompliance are ultimately a
matter for legal authorities to resolve
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AUDITING IN PRACTICE - TRITON ENERGY AND
NONCOMPLIANCE WITH LAWS AND REGULATIONS
• When violations like these occur the auditor should
notify audit committee about:
• The violations
• Their circumstance
• The effect on the financial statements
• Consider whether risk assessments made prior to
knowledge of violations are still appropriate
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MAIN PROVISIONS OF FCPA FOR COMPANIES
WITH SECURITIES LISTED ON U.S. MARKETS
• Anti-bribery provision - No company may make a
payment to a foreign official for obtaining or
retaining business
• Financial records should accurately reflect
transactions
• Adequate system of internal accounting controls
should be designed and maintained
• Certain payments to foreign officials are acceptable
• Grease payments - Made to an official to expedite
performance of his duties
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LEARNING OBJECTIVE 6
REVIEW THE APPROPRIATENESS OF THE GOINGCONCERN ASSUMPTION USING RELEVANT
PROFESSIONAL GUIDANCE
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EVALUATING THE GOING-CONCERN
ASSUMPTION
• Responsibility of management - Assessing
company’s going concern status for a reasonable
period of time
• Reasonable period of time: A period of time not to
exceed one year beyond the date of the financial
statements being audited
• Responsibility of auditor - Evaluating appropriateness
of that assessment
• Use of bankruptcy prediction models to analyze
whether a particular client might have a goingconcern problem
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EXHIBIT 14.3 - GOING-CONCERN
PROCESS
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EVALUATING THE GOING-CONCERN
ASSUMPTION
If substantial doubt about
entity’s ability to continue as a
going concern is alleviated
If substantial doubt about
entity’s ability to continue as a
going concern for a reasonable
period of time remains
Consider disclosure of
conditions that initially
caused auditor to believe
there was substantial doubt
Include an emphasis-ofmatter paragraph in
auditor’s report to reflect
that conclusion
Consider possible effects of
such conditions or events,
and any mitigating factors,
including management’s
plans
Audit report will include
phrase - Substantial doubt
about entity’s ability to
continue as a going
concern
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REASONS AUDITORS MIGHT RESIST ISSUING A
GOING-CONCERN AUDIT OPINION
• It can be a self-fulfilling prophecy that the company
will go bankrupt
• It is difficult to know beforehand whether a
financially distressed client will:
• Cease operations
• Pull itself away from that outcome
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INDICATORS OF POTENTIAL GOINGCONCERN PROBLEMS
• Negative trends
• Internal matters
• External matters
• Significant changes in:
• Competitive market
• Competitiveness of client’s products
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INDICATORS OF POTENTIAL GOINGCONCERN PROBLEMS
• Altman Z-scores: Series of ratios that have predictive
power in indicating the likelihood of bankruptcy
• Five-ratio model - For publicly owned manufacturing
companies
• Four-ratio model - For public or privately owned
manufacturing and service companies
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EXHIBIT 14.4 - ALTMAN Z-SCORE
MODELS
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MITIGATING FACTORS FOR A GOINGCONCERN PROBLEM
• Identify and assess management’s plans to
overcome this problem
• Identify factors most likely to resolve the problem
and gather independent evidence to determine
success of such plans
• Consider, and independently test, adequacy of
support for major assumptions
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MITIGATING FACTORS FOR A GOINGCONCERN PROBLEM
• Evaluating reasonableness of other assumptions
made by the management
• Increasing prices or market share is analyzed in relation
to current industry developments
• Cost savings related to a reduction in work force is
recomputed and evaluated
• Selling off assets is evaluated in relation to current
market prices
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LEARNING OBJECTIVE 7
PERFORM FINAL ANALYTICAL REVIEW
PROCEDURES
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FOUR-STEP PROCESS FOR USING
ANALYTICAL PROCEDURES
Develop an expectation
Define when difference between auditor’s
expectation and client’s balance would be
considered significant
Compute the difference between auditor’s
expectation and client’s balance
Follow up on significant differences
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TECHNIQUES USED FOR ANALYTICAL
PROCEDURES
Ratio analysis
Common-size analysis
Analysis of dollar and percentage changes in
income statement item over previous year
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LEARNING OBJECTIVE 8
REVIEW MANAGEMENT REPRESENTATIONS IN
CERTIFICATIONS REQUIRED UNDER THE SARBANES-OXLEY
ACT (FOR PUBLIC CLIENTS) AND DESCRIBE THE CONTENTS
OF A MANAGEMENT REPRESENTATION LETTER
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CERTIFICATIONS REQUIRED UNDER SARBANES-OXLEY
ACT OF 2002 (SOX) FOR PUBLIC COMPANIES
• Signing officers of publicly traded companies
required to certify that financial statements are fairly
presented in accordance with GAAP
• Management representation letter: Letter to the
auditors that the client’s chief executive and chief
financial officers are required to sign
• Specifies management’s responsibility for the financial
statements
• Confirms oral responses given to the auditor during the
audit
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MANAGEMENT REPRESENTATION
LETTER
• Purpose is to help promote audit quality by:
• Reminding management of its responsibility for
financial statements
• Confirming oral responses obtained by auditor
• Reducing the possibility of misunderstanding
• Management’s refusal to sign the letter:
• Implies their untruthfulness in verbal representations
• Considered a scope limitation
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LEARNING OBJECTIVE 9
REVIEW SUBSEQUENT EVENTS THAT OCCUR
AFTER THE BALANCE SHEET DATE AND ASSESS
PROPER TREATMENT
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REVIEWING SUBSEQUENT EVENTS AND
SUBSEQUENTLY DISCOVERED FACTS
• Events occurring after balance sheet date that
require special audit attention
• Those that provide evidence of conditions that existed
at the date of financial statements
• Those that provide evidence of conditions that arose
after the date of financial statements
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EXHIBIT 14.8 - SUBSEQUENT PERIODS
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REVIEW OF SUBSEQUENT EVENTS
• Subsequent events: Occur between the date of the
financial statements and date of the auditor’s report
• Subsequent events review: Review of events in the
period between the balance sheet date and the audit
report date to determine their effect on the financial
statements
• Type I subsequent events: Existed at the balance
sheet date (adjustment to financial statements)
• Type II subsequent events: Did not exist at balance
sheet date (disclosure)
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AUDITING IN PRACTICE - DELOITTE, LIGAND, AND THE
PCAOB: A CASE WHERE SUBSEQUENT EVENTS WERE
IMPORTANT
• Audit plan required procedure related to product
returns
• After year end
• Before completion of audit
• Audit plan was not:
• Executed by Deloitte personnel
• Adequately reviewed by Fazio
• Deloitte resigned from Ligand engagement in 2004
• Ligand restated its 2002, 2003, and some of its 2004
financial statements
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AUDIT PROCEDURES CONCERNING THE
REVIEW OF SUBSEQUENT EVENTS
• Cutoff tests
• Reviewing subsequent collections of receivables
• Searching for unrecorded liabilities
• Reading minutes of meetings
• Reading and comparing interim financial statements
to audited financial statements
• Inquire of management concerning:
• Significant changes noted in the interim statements
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AUDIT PROCEDURES CONCERNING THE
REVIEW OF SUBSEQUENT EVENTS
• Existence of significant contingent liabilities or
commitments at balance sheet date or date of inquiry
• Significant changes in working capital, long-term debt,
or owners’ equity
• Status of items for which tentative conclusions were
drawn earlier in audit
• Any unusual adjustments made to accounting records
after balance sheet date
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DUAL DATING
• Awareness of an event occurring after audit report
date but before report release date
• Report release date: Grant of permission to the entity
to use the auditor’s report in connection with financial
statements
• Options for dating the audit report:
• Using date of this event as date of audit report
• Dual-date the report
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SUBSEQUENTLY DISCOVERED FACTS THAT BECOME
KNOWN TO AUDITOR AFTER REPORT RELEASE DATE
• If facts had been know at the report date, then
auditor should determine:
• Reliability of new information
• Whether development or event had occurred by report
date
• Whether users are likely to still be relying on financial
statements
• Whether audit report would have been affected had
facts been known at report date
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APPROPRIATE ACTION FOR SUBSEQUENTLY
DISCOVERED FACTS
• Key action - Notify users very soon so they do not
continue to rely on incorrect information
• If possible quickly revise and distribute financial
statements and audit report
• Reasons for revision described in a footnote and
referred to in auditor’s report
• Revision and explanation can be made in subsequentperiod audited financial statements if distribution is
imminent
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SUBSEQUENTLY DISCOVERED FACTS THAT BECOME
KNOWN TO AUDITOR AFTER REPORT RELEASE DATE
• If extended amount of time is needed to develop
revised financial statements, notify users that:
• Previously distributed financial statements and auditor’s
report should no longer be relied on
• Revised statements and report will be issued as soon as
possible
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SUBSEQUENTLY DISCOVERED FACTS THAT BECOME
KNOWN TO AUDITOR AFTER REPORT RELEASE DATE
• For clients who do not cooperate, notify:
• Client and regulatory agency having jurisdiction over it
that audit report should no longer be associated with
client’s financial statements
• Users that audit report should no longer be relied on
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LEARNING OBJECTIVE 10
DETERMINE HOW TO ADDRESS SITUATIONS IN WHICH
OMITTED AUDIT PROCEDURES COME TO THE AUDITOR’S
ATTENTION AFTER THE AUDIT REPORT HAS BEEN ISSUED
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CONSIDERATION OF OMITTED PROCEDURES
DISCOVERED AFTER THE REPORT DATE
• Omitted procedure: After the audit report has been
issued, auditor may discover that an important audit
procedure was not performed
• If previously issued audit report cannot be supported
in light of omitted procedures
• Alternative procedures should be promptly performed
and documented
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LEARNING OBJECTIVE 11
ASSESS THE ADEQUACY OF SUPERVISION AND
PERFORM AN ENGAGEMENT QUALITY REVIEW
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PERFORMING AN ENGAGEMENT
QUALITY REVIEW
• Engagement quality review (Concurring partner
review): Review at the end of each audit conducted
by an experienced auditor having appropriate
competence, independence, integrity, and objectivity
• To help make sure that audit and audit documentation
are complete and support audit opinion
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PERFORMING AN ENGAGEMENT
QUALITY REVIEW
• Procedures that reviewer should perform as part of
the review process
• Discussing with audit team significant matters related
to financial statements and internal controls
• Evaluating judgments about materiality and disposition
of corrected and uncorrected identified misstatements
• Reviewing evaluation of firm’s independence in
relation to engagement
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PERFORMING AN ENGAGEMENT
QUALITY REVIEW
• Reviewing related audit documentation to determine
its sufficiency
• Reading financial statements, management’s report
on internal control, and auditor’s report
• Confirming with lead audit partner that there are no
significant unresolved matters
• Determining if appropriate consultations have taken
place on difficult or contentious matters
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PERFORMING AN ENGAGEMENT
QUALITY REVIEW
• Evaluating whether:
• Auditor documentation supports conclusions reached by
engagement team
• Appropriate matters have been communicated to audit
committee members, management, and other
appropriate parties
• Appropriate levels of supervision and reviews of
individual audit tasks were completed
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LEARNING OBJECTIVE 12
IDENTIFY ISSUES TO COMMUNICATE TO THE
AUDIT COMMITTEE
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REASONS FOR EXTERNAL AUDITORS TO
COMMUNICATE WITH THE AUDIT COMMITTEE
• Audit committee serves as an independent
subcommittee of board of directors
• Audit committee can assist auditor during a
disagreement between the auditor and management
• Audit committee must be assured that auditor:
• Is free of any restrictions
• Has not been inappropriately influenced by the
management
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TYPICAL COMMUNICATIONS BETWEEN THE
AUDITOR AND THE AUDIT COMMITTEE
• Auditor’s responsibility under generally accepted
auditing standards
• Overview and planned scope of audit
• Independence
• Significant accounting policies
• Management judgments and accounting estimates
• Significant audit adjustments
• Judgments about quality of company’s accounting
principles
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TYPICAL COMMUNICATIONS BETWEEN THE
AUDITOR AND THE AUDIT COMMITTEE
• Other information in annual reports
• Disagreements with management
• Major issues discussed with management before
retention
• Internal control over financial reporting
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AUDITING IN PRACTICE - GUIDANCE ON ASSESSING THE
QUALITY, NOT JUST THE ACCEPTABILITY, OF
SIGNIFICANT ACCOUNTING POLICIES
• Consistency of organization’s accounting principles
and their application
• Clarity and completeness of financial statements and
related disclosures
• Presence of items that have an impact on the
representational faithfulness, verifiability, and
neutrality of the accounting information included in
the financial statements
• Use of accounting practices by the company that are
not specifically addressed in the accounting literature
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LEARNING OBJECTIVE 13
IDENTIFY ISSUES TO COMMUNICATE TO
MANAGEMENT VIA A MANAGEMENT LETTER
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COMMUNICATING WITH MANAGEMENT
VIA THE MANAGEMENT LETTER
• Management letter: From the auditor to the client
identifying any problems and suggested solutions to
improve management’s efficiency or effectiveness
• Used to make significant operational or control
recommendations to client
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ISSUES RELATING TO AUDIT FIRM PORTFOLIO
MANAGEMENT, AUDIT PARTNER ROTATION, AND AUDIT
FIRM ROTATION
• Audit firm portfolio management - Deciding whether
to:
• Continue providing audit services to client
• Begin providing services to a new client
• Consider mandatory partner rotation and mandatory
audit firm rotation requirements for publicly traded
audit clients
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LEARNING OBJECTIVE 14
DESCRIBE THE PROCESS BY WHICH AUDIT FIRMS
MAKE CLIENT ACCEPTANCE AND
CONTINUANCE DECISIONS
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CLIENT ACCEPTANCE AND
CONTINUANCE DECISIONS
• Decisions taken by audit firms and individual
engagement partners immediately before agreeing
to conduct an audit or after completing audit
• Called client acceptance and continuance decisions
• Client acceptance decision: When a new client is
evaluated by the audit firm and individual
engagement partner prior to being accepted into the
audit firm’s portfolio of clients
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EXHIBIT 14.9 - AUDIT FIRM PORTFOLIO
MANAGEMENT
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CLIENT ACCEPTANCE AND
CONTINUANCE DECISIONS
• Client continuance decision: When existing clients
are evaluated by the audit firm and individual
engagement partner at the completion of the audit
to determine whether the audit firm should continue
to provide services again in the next period
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CLIENT ACCEPTANCE AND
CONTINUANCE-RELATED RISKS
• Client entity characteristics
• Independence risk factors
• Third party /due diligence risk factors
• Quantitative risk factors
• Qualitative risk factors
• Entity organizational or governance risks
• Financial reporting risks
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REASONS FOR NOT PROVIDING AUDIT
SERVICES TO A CLIENT
• Client does not fit the profile that the firm requires
to achieve its growth strategy
• Client not in an industry that the firm wants to
emphasize
• Client’s growth not feasible for firm anymore
• Client being potentially problematic
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AUDITING IN PRACTICE - WHY MIGHT AN AUDIT FIRM
REFUSE TO CONTINUE PROVIDING SERVICES TO A CLIENT?
• Developments that undermine the ability of the
audit firm to rely on the representations of
management
• Recently identified falsity of records
• Deliberate interference by the management in the
audit process
• Unlawful retention of audit files
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LEARNING OBJECTIVE 15
IDENTIFY THE REQUIREMENTS CONCERNING
MANDATORY PARTNER ROTATION AND MANDATORY
AUDIT FIRM ROTATION FOR PUBLICLY TRADED AUDIT
CLIENTS
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PARTNER ROTATION AND AUDIT FIRM
ROTATION
• Familiarity threat occurs when auditor has a
longstanding relationship with an important person
associated with the client
• Having a longstanding relationship with client could:
• Aid audit quality
• Knowledge that partner and members of engagement
team gain through time
• Impair auditor’s willingness or ability to perform an
unbiased assessment of audit evidence
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AUDITING IN PRACTICE - KPMG AND
GENERAL ELECTRIC COMPANY
• The United Brotherhood of Carpenters Pension Fund,
a shareholder, filed a letter and proposal to General
Electric
• Requesting to consider implementing an audit firm
rotation policy every seven years
• Proposal was ignored by company, and was not put
to vote
• Shows that General Electric and KPMG are not
supportive of the mandatory audit firm rotation
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PARTNER ROTATION AND AUDIT FIRM
ROTATION
• Differences exist internationally in terms of:
• Requirement of rotation
• Length of time:
• Auditor or audit firm may serve before rotation
• Of a cooling off period
• Cooling off period: Number of years after which individual
auditor or audit firm may resume its prior role with audit
client
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EXHIBIT 14.10 - U.S. AND INTERNATIONAL GUIDANCE
ON MANDATORY AUDIT PARTNER ROTATION AND
MANDATORY AUDIT FIRM ROTATION
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