Changes in a professional appointment

Auditors change. A company outgrows its firm, a new board wants its own choice, or the old auditors and the directors fall out. The incoming auditor needs to know why before taking the work, because the reason may be a warning. The outgoing auditor owes duties too: to answer honestly, to hand over what is needed and to be paid.

Institute of Chartered Accountants of Nigeria (ICAN)’s code sets out a procedure for the change, and Companies and Allied Matters Act 2020 (CAMA 2020) gives the shareholders the protection of the law: removal is in section 409, and resignation and the resigning auditor’s right to requisition a meeting are in sections 412 and 413.

This topic covers why appointments change, the steps before accepting a new appointment, client identification, professional enquiry of the existing auditor, unpaid fees, confidentiality, defamation, joint auditors and vacancies, additional work, a worked acceptance decision, and the rules on client books (lien) and working papers. Examiners test the sequence of professional enquiry and a scenario where the facts about the old auditor are a warning sign.

Why a change arises

A member may be asked to accept a new appointment where the previous (“old”) auditor will not be reappointed. Reasons include:

• the current firm is too small for an expanding client with several locations or countries;
• a change in the board, and new directors want an auditor of their choice;
• perceived lack of independence, possibly one that has just arisen;
• a disagreement between the directors and the old firm, for example over an accounting treatment; and
• a loss of confidence in the old firm.

In theory, shareholders appoint the auditor. In practice, directors recommend a change to them. If the outgoing auditor thinks the reason should be brought to the shareholders’ attention, as in a dispute, the law lets him make representations.

In Nigeria, sections 409, 412 and 413 of CAMA 2020 deal with the removal of auditors (s. 410 adds the right of a removed auditor to attend and be heard at the relevant meetings), the resignation of auditors, and the right of a resigning auditor to requisition a company meeting.

Steps before accepting a new appointment

1. Look for professional problems. For example a lack of independence, lack of technical expertise or a conflict of interest.
2. Check resources. There must be enough staff of the right level of expertise at the right time.
3. Take up references on the client and its directors if they are not known. This is client screening.
4. Communicate with the existing auditors, if any, about the appointment, the client and the audit work. ICAN’s code calls this professional enquiry.

Client identification

To meet anti-money laundering rules, the firm must confirm that the client is who it says it is and that there is no ground for suspecting money laundering.

• For a company or other entity, get documentary evidence of identity, such as a certificate of incorporation, and evidence of address, such as headed letter paper.
• For an individual, get identity from a passport or driving licence and, possibly, address from a recent utility bill.
• Consider whether the client’s business “makes commercial sense”. A very large company running a few dry-cleaning shops would not, and the declared business may be a front for hidden illegal activity.

These checks are usually a formality, and the client may be surprised by them, so the firm should explain their regulatory purpose.

Professional enquiry of the existing auditor

The new firm should communicate with the current auditors to find out whether there is anything it should know before it decides to accept. Partly this is courtesy, but it also lets the firm decide whether the client is one it wishes to act for. The rules are:

1. When a prospective client first approaches the member, he should explain that he has a professional duty to communicate with the existing auditor or adviser.
2. The client’s permission is required. If the client refuses, the appointment must not be accepted.
3. If the client does not give the current auditor permission to reply to relevant questions, the current auditor should tell the prospective auditor of that fact, who should then not accept the appointment.
4. If the current auditor gives no relevant information, the new auditor accepts or rejects on the other knowledge available.
5. The existing auditor must answer without delay. If there is nothing the newcomer should know, he writes to say so.
6. If there are such matters, he must tell the prospective auditor the facts known to him that he thinks the newcomer should know. It is not enough to say that unspecified facts exist.
7. He may prefer to explain orally. The prospective auditor should be ready to meet, and each keeps a record of the discussion.
8. If the old auditor reports a conflict of views with the client, the successor discusses it with the client and satisfies himself either that the client’s view is reasonable or that the client will accept that the incoming auditor may have to express a contrary opinion.
9. If there is no reply within a reasonable time, the successor tries other means, such as telephone, fax or email.
10. If that fails, and he has no reason to think there are untoward circumstances, he sends a final letter by recorded delivery saying that unless he hears within a stated time he will assume there are no matters to bring to his attention. A member who accepts in such circumstances may still complain to the Institute that the existing auditor did not respond.
11. If satisfied that he can act and is prepared to accept, he informs the client in writing.

Other rules in the change process

Deciding whether to accept

A firm may decide that accepting a new appointment would threaten its reputation or raise serious ethical issues. Acceptance is a matter of judgement.

Example. Backle Company is owner-managed and asks your firm to become its auditor. The current auditors have just resigned for lack of resources, having taken the audit two years before at a lower fee after the previous auditors resigned in a fee dispute.

The company has internal control weaknesses reported to management and not fixed, disputes with the tax authorities over three years’ profits, a poor public image, investigations by the police and regulators, and plans to expand using bank loans.

• Reputation: the firm may not want to be linked with a client whose image is poor.
• Advocacy threat: the investigations may lead to legal action in which the firm is expected to defend the company.
• Aggressive management: management argues with auditors and wants low costs, so fee disputes are likely.
• Audit risk: bank loans mean management wants strong profits in the statements, so misstatement risk is high. The firm may consider a disclaimer in the report to limit liability to the bank.
• Weak controls not fixed also point to high risk.
• Opening balances: high risk means careful work on opening balances, which adds cost and time that management may refuse.

There is no evidence of fraud, so the firm may accept, subject to agreement on fees.

Client books, working papers and lien

When a new auditor is appointed, the outgoing auditor should arrange to transfer client books and records in his possession. Where fees are unpaid, he may exercise a lien, a right to keep property belonging to another until amounts due are paid. Auditors have a particular lien, not a general one: it covers only the books and records on which the auditor did audit work.

To apply the lien, the documents must have come into the auditor’s possession lawfully, an invoice must have been sent, and there must be no dispute over fees. In some countries the courts have held that a lien cannot be exercised over books and records the client must keep by law, which is most of them, so it is often weak.

Audit working papers are prepared by the auditors for their work and generally belong to them, unless the engagement letter or national law says otherwise. The outgoing auditor must still give the new auditor enough information for a reasonable handover, depending on the stage the audit has reached.

The rules in more depth

Why the client’s permission is the key

The outgoing auditor owes confidentiality to the client and may not speak without permission. If the client refuses to allow the conversation, the most natural reading is that there is something to hide. That is why the rule is absolute: no permission, no acceptance.

Why the old auditor must state facts

A reply that says only that “there are matters” tells the newcomer nothing but leaves a warning. The rule that facts must be given means the newcomer can make a real decision. Qualified privilege makes that safe for the old auditor, as long as there is no malice.

Why the fees rule exists

If clients could change auditors to avoid paying, auditors would be reluctant to challenge them. The new auditor’s duty to make sure the old fees are paid supports independence and fair dealing in the profession.

Numbers: the final letter

A prospective auditor sends a first letter on 2 May, reminds by phone on 16 May and sends a final recorded-delivery letter on 23 May, saying he will assume there are no matters if no reply comes within 14 days. The deadline is 6 June (23 May plus 14 days: 8 days left in May, then 6 in June). If nothing is received and there are no untoward circumstances, he may accept, and can still complain to ICAN.

Worked example: a prospective appointment

1. Professional enquiry. Yusuf must communicate with the existing auditor. The client’s permission is required, and it has been refused, so Yusuf must not accept.
2. If permission were given. Bello must reply promptly and state the facts, not just say that facts exist. Both keep records of any meeting.
3. Unpaid fees. Yusuf must make sure Bello was properly removed from office and that the ₦4 million is paid before accepting. The incoming auditor should help recovery within a reasonable time.
4. Removal. Directors cannot remove an auditor. The shareholders must do so by ordinary resolution with special notice. If the managing director “dismissed” Bello, the removal may be invalid.
5. Opinion on the contract. A second opinion on an accounting treatment needs the client’s permission to contact the auditor. Yusuf should notify Bello of additional work and be sensitive about adversarial positions.
6. Client identification and screening. Do the anti-money laundering checks, take references on the company and directors.
7. Conclusion. Decline until permission is given, fees are paid and Bello is properly removed. Tell the client in writing if declining.

How to score full marks

• For “procedures before acceptance”, give the four steps and then the extras. Professional problems, resources, screening, professional enquiry, then client identification, fees paid and proper removal, and the engagement letter.
• For professional enquiry, state the permission rule first. It is the point most often tested. Then the old auditor’s duty to reply, the facts, and what the new auditor does when there is no reply.
• Apply to the scenario. Each fact about the old auditor, the client or the fees maps to a rule. Name the rule and the consequence.
• For lien questions, give the conditions. Lawfully held, invoiced, undisputed, particular not general, and the limit where the client must keep the records by law.
• Separate confidentiality from defamation. One is about disclosure, the other about protection from claims.
• Time. Spend time in proportion to marks.

Common mistakes in the exam

• Accepting when the client refuses permission to contact the old auditor.
• Forgetting the unpaid fees and proper removal checks.
• Saying the old auditor need only say that matters exist.
• Saying a lien applies to all documents. It is a particular lien.
• Saying working papers belong to the client.
• Omitting client identification and the “commercial sense” test.
• Saying the directors may remove the auditor.
• Forgetting to notify the existing accountant of additional work.

Quick revision

• Reasons: too small, new board, independence doubt, dispute, loss of confidence.
• Before accepting: professional problems, resources, screening, professional enquiry; client identification.
• Enquiry: client permission or do not accept; prompt reply with facts; recorded delivery final letter; written acceptance.
• Fees paid and proper removal. Confidentiality no wider than needed. Qualified privilege.
• Lien: particular, lawful possession, invoiced, no dispute. Working papers belong to the auditor.
• CAMA 2020 ss. 409, 410, 412 and 413. Notify the existing accountant of additional work.

Practice questions

These are original questions written in the style of the ICAN exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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