Obtaining and accepting a new audit engagement

An audit firm in Ibadan is invited to tender for the audit of a manufacturing company. The fee on offer is low, the finance director has a reputation for aggressive reporting, and the present auditor has not been told the firm is being approached. Should the firm accept? An audit practice is a business and wants fees, but it cannot take every engagement offered.

The law, the professional code and good sense all require checks before a firm says yes, and further steps after it says yes.

This topic follows an audit appointment from beginning to end: how audit work is won, how a firm decides whether to accept, what it must do about the outgoing auditor, how the appointment is made and recorded under the Companies and Allied Matters Act 2020 (CAMA 2020), and how an auditor leaves office by removal or resignation. The next topic covers the engagement letter.

Key terms in plain English

Syllabus check

This topic is in syllabus area A, process of audit and assurance (20% of marks). It covers:

• nomination and acceptance of an audit engagement
• the ethical matters to consider before acceptance
• appointment, removal and resignation of auditors

CAMA 2020 and the appointment of auditors

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

Why a firm may decline an engagement

A firm is a business and aims at profit, but it should not accept every audit it is offered. It may decline for commercial or ethical reasons, for example if the client's reputation is poor, if the firm lacks the skills, or if the fee is too low for a proper audit. Firms and clients must also follow the requirements of CAMA 2020.

Obtaining audit work: advertising and publicity

Professional codes generally let members advertise, but the advertising must not harm the member, the professional body or the profession, and must not create a self-interest threat to the principle of professional behaviour. Advertisements and promotional material must not:

• discredit the services of others, for example by claiming superiority;
• be misleading; or
• fall short of local regulations or legislation.

The ICAN Code of Ethics (Chapter 8) says a Chartered Accountant in public practice must be honest and truthful and must not make exaggerated claims for services, qualifications or experience, or make disparaging references or unsubstantiated comparisons to the work of another Chartered Accountant. In doubt, he should consult ICAN through the Registrar and Chief Executive.

Fees and introductions

Where promotional material refers to fees, it must not mislead about the range of services and the time commitment covered. Comparison with others' fees is allowed if it is not misleading and follows local rules, and discounts or a free consultation about fees may be offered. Many countries allow fees or commissions to be paid to third parties for introducing clients, with safeguards such as disclosure to the client.

In Nigeria, however, paragraph 7.1.5 of the ICAN Code of Ethics says a Chartered Accountant in public practice must not pay or receive a referral fee to obtain a client, because it creates a self-interest threat to objectivity and to professional competence and due care.

Tendering and low-balling

Large companies often invite tenders from several firms. A tender normally contains a detailed written proposal with a fee estimate based on the time to be spent and the grade of staff, and may include a presentation. Low-balling means quoting a deliberately low, perhaps unprofitable, fee to win the work, usually to raise the fee over several years or to make up the shortfall with more profitable non-audit work.

It is not itself unethical, but it creates a self-interest threat to independence, so the firm must show it has enough time and qualified staff to carry out a quality audit in line with International Standards on Auditing (ISAs).

Accepting the appointment: client acceptance

Before taking on a new client the firm asks whether acceptance would threaten compliance with the fundamental ethical principles. Threats to integrity or professional behaviour may arise from questionable issues about the client's owners, management and activities, such as involvement in illegal activities like money laundering, dishonesty, or questionable financial reporting. The firm judges how significant any threat is.

If a threat is more than clearly insignificant, safeguards are considered, such as:

• learning about the client, its owners, managers and those responsible for governance and business activities; and
• getting the client's commitment to improve governance or internal controls.

If the threat cannot be reduced to an acceptable level, the firm must decline. For recurring engagements, the acceptance decision is reviewed periodically.

Accepting the appointment: engagement acceptance

A Chartered Accountant should agree to provide only services he is certified and competent to perform. A self-interest threat to competence and due care arises, for example, if the team has not got and cannot get the skills needed. Safeguards include:

• understanding the client's business, the complexity of its operations, the requirements of the engagement and the purpose, nature and scope of the work;
• gaining knowledge of relevant industries or subject matters;
• assigning enough staff with the right skills;
• using experts where necessary;
• agreeing a realistic time frame; and
• following quality management policies designed to give reasonable assurance that engagements are accepted only when they can be performed competently.

If the accountant intends to rely on an expert, he must judge whether reliance is justified by looking at the expert's reputation, expertise, resources and the professional and ethical standards that apply. The duty to comply with ethical requirements continues throughout the engagement.

Communicating with the current auditor

The firm should communicate with the current auditor, if there is one, to find out whether there is any matter it should know about when deciding to accept. This is partly professional courtesy and gives the firm a view on whether it wants to act for the client. The rules are:

1. When first approached, the firm explains to the prospective client that it has a professional duty to communicate with the existing auditor.
2. The client's permission is needed. If the client refuses, the appointment should not be accepted.
3. If the client does not allow the current auditor to answer relevant questions, the appointment should not be accepted.
4. If the current auditor gives no information, the firm decides on other information available.
5. If the current auditor does give information, the firm assesses it all and decides whether to accept. It may still accept, with proper professional and commercial judgement.

Unpaid fees. A member must not accept an assignment held by another member without first ensuring that the other member was properly removed and that all fees due to him have been paid.

Confidentiality. The prospective auditor normally keeps in confidence what the existing auditor tells him. But may have to disclose to the client's officers or employees matters that need proper investigation, and no wider than necessary.

Defamation. The existing auditor who tells his successor things damaging to the client or to an individual has the protection of qualified privilege: he is not liable for damages for defamatory statements even if they turn out to be untrue, if he made them without malice.

Malice is unlikely to be found if he states only what he sincerely believes to be true and does not make reckless imputations that he has no reason to believe.

Other situations. A firm nominated as a joint auditor should communicate with all existing auditors, and if a joint appointment is to become sole, the surviving auditor communicates formally with the outgoing joint auditor. A firm invited to accept nomination after the death of a sole practitioner should get information from his alternative, the administrators of the estate or other sources.

A replaced auditor must promptly transfer to the client or to the successor all books and papers belonging to the client, unless exercising a lien for unpaid fees. But the courts have held that no lien exists over books or documents of a registered company that must be open to public inspection.

A member invited to do work additional to work done by another chartered accountant should normally notify that accountant, so that he can pass on information, and should be sensitive when asked for opinions on the application of accounting standards.

Procedures after accepting

1. Ensure that the current auditor has resigned properly, or has been removed in line with the law.
2. Ensure that the appointment is valid in law and properly documented.
3. Prepare and send an engagement letter to the board of the new client (the next topic).

Appointment of auditors: section 401 of CAMA 2020

Every company must appoint auditors at each annual general meeting, to hold office until the end of the next. A retiring auditor is re-appointed without a resolution unless he is not qualified, a special resolution appoints someone else or says he is not to be re-appointed, or he has given written notice that he does not wish to be re-appointed.

Where notice is given of a resolution to appoint someone in place of the retiring auditor and the person cannot proceed because of death, incapacity or disqualification, the retiring auditor is not automatically re-appointed. If no auditor is appointed or re-appointed at the meeting, the company must tell the Corporate Affairs Commission (the Commission) within one week, and the company and each officer in default commit an offence.

First auditors may be appointed by the directors before the company is entitled to commence business and hold office until the first annual general meeting. The company may remove them in general meeting and appoint another person nominated by a member, if notice of the nomination was given to members at least 14 days before the meeting. If the directors fail to appoint, the company may do so in general meeting.

The directors may fill a casual vacancy, and while it continues the surviving or continuing auditor may act.

Remuneration is in principle set by whoever appoints the auditor. In practice shareholders usually delegate it to the board, because directors know the scope of the work, and the board may delegate recommending or approving the fee to the audit committee. Section 408(1)(b) provides for the fee to be fixed in general meeting or as the meeting decides.

Removal of auditors: section 409 of CAMA 2020

Directors may fill vacancies but should not be able to remove auditors, because they could silence the auditors by dismissing them after a disagreement over an item in the financial statements or over the conduct of the audit. The proper course is for the directors to recommend new auditors and for the shareholders to decide.

In Nigeria the ordinary shareholders dismiss the auditor by an ordinary resolution with special notice at a general meeting. The company must then tell the Commission within 14 days in the prescribed form, failing which the company and each officer in default commit an offence.

Resignation of auditors: sections 412 and 413 of CAMA 2020

An auditor may resign, for example because management consistently lacks integrity, significant fees remain unpaid, the firm can no longer be independent after a corporate action, or the client is no longer profitable. The law protects shareholders by requiring that:

1. the auditor resigns in writing to the company at its registered office, and the company sends the letter to the regulator;
2. the auditor prepares a statement of the circumstances, if he thinks they matter to shareholders or creditors, or states that there are none;
3. the company sends the statement to the Commission within 14 days of receiving it, and to all who are entitled to the financial statements, mainly the shareholders, unless the Commission rules that the auditor is seeking to defame the company with needless publicity; and
4. the auditor may require the directors to call a meeting of shareholders to discuss the circumstances.

A company and any officer in default of these steps commit an offence and are liable to a penalty set by the Commission.

An acceptance checklist

In practice a firm works through a list like this before it signs. It can be used as a framework for any scenario question.

1. Competence: does the firm have the industry knowledge and staff, or can it get them, including experts?
2. Integrity of the client: any sign of illegal activity, dishonesty or questionable reporting by owners or management?
3. Independence: any loan, family link, shareholding, fee dependence or non-audit service that would threaten objectivity?
4. Qualification: is the firm qualified under section 403 of CAMA 2020, and registered where the entity is a Public Interest Entity?
5. Resources and time: can the work be done properly in the time available, and is the fee enough to pay for it?
6. Outgoing auditor: permission obtained, contact made, removal or resignation proper, fees paid?
7. Valid appointment: resolution passed, Commission notified where required, records kept?
8. Engagement letter: terms agreed in writing before work starts.

Why these rules protect independence

Each rule in this topic guards against one danger. The ban on referral fees removes a payment that would make the firm beholden to the person who sent the client. The check on low fees protects the quality of the audit, because an underpriced audit tempts the firm to cut corners or to make up the loss with other services that could impair independence.

Contact with the outgoing auditor tells the new firm whether the previous auditor left after a disagreement or after being pushed out for doing the job properly. The rule that only shareholders may remove an auditor stops directors from silencing an auditor who has disagreed with them. The written statement on resignation makes sure shareholders and creditors learn the real reason.

Seen together, these rules keep the auditor answerable to the shareholders and not to the directors.

Joint audits and group audits

Some companies appoint two firms as joint auditors who share the work and sign one report. Each firm must follow the same acceptance and communication steps, and each remains responsible for the whole audit unless the engagement terms say otherwise. Where the entity is a group, the firm that audits the parent often becomes the group auditor and relies on other firms for subsidiaries.

The group auditor asks for the same assurances about the independence and competence of those firms that it would ask of a new engagement team.

Worked examples

1. Paragraph 7.1.5 of the ICAN Code forbids paying or receiving a referral fee to obtain a client.
2. It creates a self-interest threat to objectivity and to competence and due care.
3. Bode and Co must decline the fee.

1. Low-balling is not itself unethical.
2. It creates a self-interest threat to independence.
3. Sule and Co must show that enough time and qualified staff are available for a proper audit and that the later consulting will not impair independence.

1. Client permission is needed to communicate with the current auditor.
2. If the client refuses, the appointment must not be accepted.

1. The company must give notice to the Commission within one week.
2. If it fails, the company and each officer in default commit an offence under section 401.

1. A consistent lack of integrity is a good reason to resign.
2. The firm resigns in writing and prepares a statement of the circumstances for the shareholders and creditors.
3. The company sends it to the Commission within 14 days, and the firm may require a meeting of shareholders.

How to score full marks

• Split acceptance into client and engagement.
• Name the threat (self-interest, integrity) and the safeguard in each point.
• Give the sequence: communicate, confirm removal, check fees, accept, engagement letter.
• Cite sections 401, 409, 412 and 413 of CAMA 2020 for appointment, removal and resignation.

Common mistakes in the exam

• Saying the directors may remove the auditor.
• Accepting a client whose permission to contact the old auditor is refused.
• Allowing a referral fee in Nigeria.
• Forgetting to check that the old auditor was properly removed and paid.

Quick revision

• Client acceptance and engagement acceptance.
• No referral fees in Nigeria; low-balling is a threat.
• No permission, no acceptance.
• Section 401 appoint; section 409 remove; sections 412 and 413 resign.
• Notify the Commission: one week (no appointment), 14 days (removal, resignation).

Practice questions

Questions 1 to 10 are multiple choice. Questions 11 to 13 are written. Try each before opening the answer.

Model answers

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