Launching the Audit Process
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
Before an audit begins, the auditor and the client have to agree on what's actually happening — who's responsible for what, what the auditor will and won't do, and whether this is even a client worth taking on. That agreement gets documented in the engagement letter.
How does an auditor decide whether to accept a client?
The auditor's first concern is minimizing the chance of working with management that lacks integrity. If management lacks integrity, the entire audit becomes difficult — management may misrepresent information, and the auditor could end up issuing an unmodified opinion when a qualified one was warranted.
Once the auditor is confident in management's integrity, two preconditions have to be met before accepting the engagement:
- The applicable financial reporting framework must be acceptable — this is simply the accounting framework the company uses (for example, U.S. GAAP)
- Management must provide a letter acknowledging its responsibilities — the engagement letter
What is management responsible for before the audit begins?
Three things:
- The preparation and fair presentation of the financial statements — a phrase worth memorizing word for word
- The design, implementation, and maintenance of internal control
- Giving the auditor access to information, including employees and documents
What is the engagement letter?
The engagement letter is the most important document of the planning phase — it's the contract for the audit. It sets the terms of the engagement between the auditor and the client's management: what the auditor expects from management, and what management can expect from the auditor.
What must the engagement letter include?
- The objective and scope of the audit (for example, auditing this year's financial statements)
- The auditor's and management's respective responsibilities
- A statement that the auditor provides reasonable assurance, not absolute assurance — the auditor might not detect every material misstatement
- The applicable financial reporting framework (for example, U.S. GAAP)
- The reports the client can expect to receive from the auditor (for example, audited financial statements)
What can the engagement letter include, optionally?
- The price of the audit
- The involvement of other auditors (for example, component auditors)
- The plan to communicate with a predecessor auditor
- Any additional communications the auditor will send the client (for example, a control-deficiencies letter)
What does the engagement letter leave out — and why?
Two things never appear in the engagement letter: materiality, and the specific audit procedures the auditor plans to perform. The reasoning is the same for both — the auditor doesn't want to hand the client any information that could be used to manipulate the audit. If a client knew materiality was set at $100,000, for instance, they could intentionally keep misstatements just under that threshold.
The engagement letter protects both sides by spelling out roles and limits, not tactics. It documents what each party is responsible for and what assurance actually means, while deliberately withholding the specifics — materiality and procedures — that would let a client work around the audit.
Here's what a real engagement letter looks like:
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 90 on AUD. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.