BRAC Business School BRAC University Fall Session 2011

Course Title: ACT 425 (Principle of Auditing) Class No: 03 Dated: 25 September 2011 Class Time: 5:00 p.m to 6:20 p.m Class Taken By: Nanda Dulal Saha, FCA
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Class Synopsis on Terms of Audit Engagement (Ref: ISA and BSA 210)

Definition of Engagement Letter: An engagement letter defines the legal relationship between a professional firm and its client. This letter states the terms and conditions of the engagement principally addressing the scope of the engagement and the terms of the compensation for the firm. An engagement letter confirms the terms and conditions of the audit and sets forth the respective responsibilities of the firm and the client and defines the limitations of firms responsibilities. It thus helps minimize the risk that the client may rely on the firm inappropriately to protect the entity against certain risks or to perform certain functions that the firm consider to be the client's responsibility. An engagement letter is a legally enforceable contract to provide professional services, and is not used as a selling document. Obtaining an engagement letter upon acceptance of a new audit provides reasonable assurance that potential misunderstandings are identified and resolved at the start of the relationship. It helps in the efficient conduct of the firms work and maintenance of good client relationships.

When should an Audit Engagement Letter be issued? It should be issued during the planning stages of an audit.

Is Audit Engagement Letter is relevant for Internal Auditor or External Auditor? Before starting discussion about the above point, we want to know the activities of the Internal Auditor and External Auditor

Internal Auditor: Internal auditor is a part of the company management. Internal auditor is appointed by the company management. Internal auditor is the employee of the company. Internal auditor report on the daily operational controls of the company. Internal auditors scope is determined by the company management.

External Auditor: External auditor is appointed by the shareholders of the company. External auditor is required to comply the regulatory or statutory compliances. External auditors scope is determined by the statue.

Based on the above discussion, it is cleared that Audit Engagement Letter is only required for the External Auditor. Because the scope of External Auditor is determined by the Audit Engagement Letter

Requirements of Audit Engagement Letter: The requirements of audit engagement letter can be discussed by the following points: A. Pre-conditions for an audit: In order to establish whether the pre-conditions for an audit are present, the auditor shall Determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable; and Obtain the agreement that it acknowledges and understands its responsibility.

B. Agreement on audit engagement terms: The auditor shall agree the terms of audit engagement with management or those charged with governance, as appropriate.

C. Recurring audit: On recurring audits, the auditor shall assess whether circumstances require the terms of the audit engagement to be revised and whether there is a need to remind the entity of the existing terms of the audit engagement. D. Acceptance of a change in the terms of the audit engagement: The auditor shall not agree to a change in the terms of the audit engagement where there is no reasonable justification for doing so. But if the terms of audit engagement are changed, the auditor and management shall agree on these.

Minimum Contents in Audit Engagement Letter At a minimum, the engagement letter includes: The scope of engagement; A description of deliverables; The responsibilities of the client; A timetable; Limitation of liability provisions where permissible; The fees or description of fee arrangements; Governing law and jurisdiction; A statement that the engagement letter is the entire agreement and provisions regarding modifications to the engagement letter; and The signature of the contracting parties or other acceptance by them.

Key Summary When an audit firm is invited to accept an engagement, it must Consider whether it is ethically barred from acting; Consider whether it has resources available to undertake the engagement; Obtain permission to contact the outgoing auditors, and do so.

When an audit firm accepts an engagement it must Check the outgoing auditors removal was carried out properly; Ensure its appointment is valid; Set up Letter of Engagement a. Clarifies terms of engagement; and b. Must be sent prior to first audit.

Appointment Decision Tree

Approach by potential new clients Prospective auditor can make own decision

Yes

Is this the first audit?

No

Does client give permission to contact old auditor?

Yes

No

Write for all information pertinent to the appointment

Yes

Prospective auditor should consider carefully, the reason for this refusal

Does client give old auditor permission to reply?

Yes

No

Does old auditor reply with information relevant to new appointment?

No

Guide old auditor due notice then decide on basis of knowledge obtained otherwise

Yes

Accept/reject appointment

Sample Engagement Letter

Chief Executive Officer/Managing Director ABC ------ Limited Dhaka

Contact: Mr. -------, Partner Date: 25 September 2011 Dear Sirs Audit and professional services for the year ending (Date & Month) ---- 2011 This letter will confirm our understanding of engagement to provide professional services to ABC --Limited (the Company) and the respective areas of responsibility of the company and of ourselves. The objective and scope of the audit You have requested that we audit the balance sheet of ABC ----- Ltd as at (Date & Month) ----- 2011 and the related profit and loss account, cash flow statement, statement of changes in equity (here-in-after referred to as the financial statements) for the year then ended, and a summary of significant accounting policies and explanatory notes thereto with the objective of expressing an opinion as to whether the financial statements conform with approved accounting standards and the requirements of the Regulatory Body, the rules and regulations issued by the Other Regulatory Body and other applicable laws and regulations. We are pleased to confirm our acceptance and our understanding of these engagements by means of this letter. Description of Deliverables We will conduct our audit in accordance with International Standards on Auditing (ISA) and Bangladesh Standards on Auditing (BSA) with the objective of expressing an opinion whether the financial statements conform with approved accounting standards as applicable in Bangladesh, and, give the information required by the relevant laws and other applicable laws and regulations in the manner so required and respectively give a true and fair view of the state of the ABC ---- Ltds affairs as at ---(Date & Month) 2011 and the related profit and loss account, cash flow statement and the statement of changes in equity for the year then ended, and a summary of significant accounting policies and explanatory notes thereto. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our report will be addressed to the management of the ABC ---- Ltd. We cannot provide assurance that an unqualified opinion will be rendered and circumstances may arise in which it would be necessary for us to modify our report or withdraw from the engagement. In such circumstances, our findings or reasons for withdrawal will be communicated to the management.

In view of the test nature and other inherent limitations of an audit, together with the inherent limitations of any accounting and internal control system, there is an unavoidable risk that even some material misstatements may remain undiscovered. In addition to our report on the financial statements, we expect to provide you with a separate letter concerning any material weaknesses in accounting and internal control systems, which may come to our notice during the audit. The extent to which we examine internal controls, and hence have the opportunity to observe weaknesses, is impacted by our determination of the most efficient audit approach. Requirements of Bangladesh Bank (In case of Bank and Financial Institutions) As part of our audit, we are required to form our opinion on whether: a) we have obtained all information and explanations which to the best of our knowledge and belief, were necessary for the purposes of our audit and made due verification thereof; in our opinion, proper books of accounts required by law have been kept by the Bank so far as it appeared from our examination of those books and proper returns; the Banks balance sheet and profit and loss account together with the annexed notes dealt with by the report are in agreement with the books of account and returns; the expenditure incurred were for the purpose of Banks business; the financial position of the Bank as at --- (Date & Month) 2011 and the profit/loss for the year then ended have been properly reflected in the financial statement, and the financial statements have been prepared in accordance with the Generally Accepted Accounting Principles; the financial statements have been drawn up in conformity with the Bank Companies Act 1991 and in accordance with the accounting rules and regulations issued by the Bangladesh Bank. adequate provisions have been made for advances which are, in our opinion, doubtful of recovery. the financial statements conform to the prescribed standards set in the accounting regulations issued by the Bangladesh Bank after consultation with the professional accounting bodies of Bangladesh. the records and statements submitted by the branches have been properly maintained and consolidated in the financial statements; we have reviewed over 80% of the risk weighted assets of the bank over the course of 900 hours; and the information and explanations required by us have been received and found satisfactory.

b)

c)

d) e)

f)

g) h)

i)

j)

k)

The Bank agrees that all records, documentation, and information including minutes of all meetings we request in connection with our audit will be made available to us, that all material information will be disclosed to us, and that we will have the full cooperation of the Banks personnel. Responsibility of Management We remind you that the responsibility for the preparation of financial statements including all other adequate disclosure is that of the management of the ABC ---- Ltd. This includes the maintenance of adequate accounting records and internal controls, the selection and application of accounting policies, and the safeguarding of the assets of the ABC ---- Ltd. The management is required to prepare and present the financial statements in conformity with Bangladesh Accounting Standards (BAS) and

Bangladesh Financial Reporting Standards (BFRS) and the requirements of the Regulatory Body and other applicable laws and regulations. Management is also responsible for identifying and ensuring that the Bank complies with laws and regulations applicable to its activities. As part of our audit process, we will request from management written confirmation concerning representations made to us in connection with the audit. In addition, BSA 240, The Auditors Responsibilities Relating to Fraud in an Audit of Financial Statements, requires that we obtain specific written representations from management. We have a responsibility to report to the management that nothing has come to our attention that causes us to believe that the financial statements are not presented fairly in all material respects, in accordance with Bangladesh Accounting Standards (BAS) and Bangladesh Financial Reporting Standards (BFRS). In the alternative case we may modify or review our report should the circumstances so require in case material matters remain unresolved. As part of our review process, we will request written representations from management concerning assertions made in connection with the review. We look forward to full co-operation from your staff during our audit. Time Table If you require us to complete our work under this engagement contract or, any part of it, by a specific date or time, you will inform us in writing of your requirement. Whilst we will make every effort to complete such work by the date specified, you acknowledge that meeting any such requirement will rely on you providing reasonable notice of your requirement and the timely provision of such information, as we may need to complete the work concerned. Limitation of Liability Provisions We acknowledge that the ABC ---- Ltd may wish to publish its financial statements and our reports thereon on its website. It is the responsibility of the management to ensure that financial statements and our reports thereon being published on the Banks website are properly presented. The management would also be responsible to adopt appropriate processes and implement proper controls to maintain security and integrity of the website and financial statements and our reports being published thereon. We are not required as part of our audit to test and review the financial statements, the controls over the security and integrity of the website. We agree that we will treat as such all confidential proprietary information obtained from you and will not disclose such information to others, except to those persons engaged in providing services to you. Neither of us shall be in breach of our contractual obligations nor shall either of us incur any liability to the other if we or you are unable to comply with this engagement contract as a result of any cause beyond our or your reasonable control. In the event of any such occurrence affecting one of us, that one shall be obliged as soon as reasonably practicable to notify the other, who shall have the option of suspending or terminating the operation of the engagement contract on notice taking effect immediately on delivery. Each clause or term of this engagement contract constitutes a separate and independent provision. If any of the provisions of the engagement contract are judged by any court or authority of competent jurisdiction to be void or unenforceable, the remaining provisions shall continue in full force and effect. Fee Our fees are based on the time required by the individuals assigned to the engagement plus direct out-ofpocket expenses. Individual hourly rates vary according to the degree of responsibility involved and the

experience and skill required. We would expect to agree the payment of our fees, including payments on account, before each periods audit and performance of other professional services. Our fee notes are payable within 15 days. Audit fees will be the subject of separate correspondence without amending this letter. This letter forms the entire agreement and understanding between us with respect to the subject matter hereof. This letter supersedes all previous arrangements and understandings between the parties with respect to the subject of this letter, which shall cease to have any further force or effect. Any variation to the terms of this letter shall be made in writing and will not be effective unless signed by a partner of -----, Chartered Accountants and by a duly authorized representative of the ABC --- Ltd. Governing Laws and Jurisdiction This agreement is made under, and shall be governed by Bangladesh law, and all disputes arising from or under this agreement shall be subject to the exclusive jurisdiction of the courts in Bangladesh. This letter will be effective for future periods unless it is terminated, amended or superseded. Please sign and return the attached copy to indicate that it is in accordance with your understanding of the arrangements. Yours faithfully

We confirm the above terms of audit for and on behalf of ABC Bank Limited.

Authorised signatories:

Signature: Name: -------------------Position: Chief Executive Officer Date:

Signature: Name: -------------------Position: Head of Finance Date: