SQCS No. 8, effective January 1, 2012, requires that a CPA firm establish and document policies and procedures for the acceptance and continuance of clients and engagements. The purpose of this standard is to integrate the client acceptance and continuance evaluation into the audit process as a key element in mitigating litigation and business risk. The standard emphasizes that a firm should be aware that the integrity and reputation of a client's management could affect the reliability of a client's accounting records and financial statements and, therefore, affect the CPA firm's reputation or potential involvement in litigation.
A firm's policies and procedures should provide it with reasonable assurance that it will undertake or continue relationships and engagements only where it has made an annual evaluation of the integrity of a client's management and governance personnel, has the competency and capabilities to perform the engagement, can comply with legal and ethical requirements, and has obtained an understanding with the client as to the terms of an engagement.
Client acceptance and continuance procedures are the foundation of the risk assessment process, primarily at the financial statement level. As discussed in AU-C 315, paragraphs A109 and A110, management's integrity is one of the elements of risk at the financial statement level. High risk at the financial statement level requires more evidence to mitigate the risk. Low risk requires less evidence. (Risk at the financial statement level, sometimes called "business risk," will received further discussion in future articles in this series.)
Making the Client Acceptance or Continuance Decision
To comply with professional standards, the in-charge accountant or engagement leader should perform an investigation of new clients and their management. The following should be determined while conducting this investigation:
- The firm's independence in fact and in appearance.
- Qualifications of the firm to undertake the engagement.
- Management of the reporting entity is honest and not involved in illegal acts.
- The client's financial reporting system, and internal control system, will provide fairly presented financial statements.
The investigative procedures include:
- Obtaining credit information for the entity and its officers.
- Discussion of the prospective client with the entity's bankers and attorneys.
- Asking the potential client why the entity is changing CPAs.
- Obtaining management's permission to communicate with the entity's former auditors.
- Conducting inquiries of former auditors about disagreements, management's integrity, uncollected fees, or other reasons why the firm should not accept the audit.
- Reviewing reports of former auditors.
- Asking management if any officers and directors have been convicted of a crime.
Client acceptance and continuance forms need to facilitate new and continuing client investigations. These forms should be reviewed and updated to annually evaluate continued association with a client and an engagement.
The investigation of potential new clients and the ongoing evaluation of existing clients provide information that enables a CPA firm to determine that a client meets its quality standards. Once a decision is made to accept or continue a client relationship, the quality of client personnel generally should be evaluated as high, high in competence, and high in integrity. These attributes form the foundation for assessing risk at the financial statement level and collecting evidence on audit engagements.
A client acceptance and continuance form should contain basic information about an entity's business and environment, including a description of its applicable financial reporting framework. For entities using special purpose frameworks, the auditor should work early in the pre-engagement planning process to obtain documentation supporting the framework and become familiar with the specific policies and procedures applied by the entity. The development of cost-beneficial audit strategies and audit plans will, of course, be based on the auditor's knowledge of these policies and principles, particularly for special purpose frameworks.
You may request my illustrative (not peer-reviewed) client acceptance and continuance form by clicking on the "Contact Us" tab on my home page.
For an overview of the entire small audit engagement process, you can register for a free, one-hour webcast with CPE credit that will be presented on March 21, 2014. You can also register for 12, two-hour webcasts in my Small Audit Series by clicking on the applicable box on the left side of my home page.