Profiting From Smaller Audits’ Quality — Part 6by
In the sixth installment of our small audit profitability series, we’ll focus on how CPA firm leaders can be involved on small audits to produce high quality and maximize engagement profitability.
Here’s a story about “my favorite manager Fred.” Fred was a master at bringing in new business for his CPA firm. Meeting business leaders through social activities, he would solicit opportunities for making proposals for audit services. Visiting the facilities of prospective clients, he would soon ask what management paid for their last audit. Learning this, he would immediately propose a lesser audit fee…much “lesser!”
Obtaining new clients for deep fee discounts, he would direct myself and other in-charge accountants to prepare a budget based on these discounted fees. Assigning us to plan, perform and complete the audit, we would see him only occasionally until the audit was completed, or at least until we thought it was completed.
At this point, time charges had exceeded the fee long before and, after Fred’s 256 review notes, much work remained. Worse still, we were blamed for “blowing the budget.”
The truth is Fred was not really my favorite, perhaps just the most memorable. His leadership exemplified how not to function as a leader. Many auditors have learned that leaders are not controllers or manipulators of people.
Leaders train and equip team members, encouraging and motivating rather than directing and controlling. Engagement leaders (primarily partners and sole practitioners) are the “pinnacles” of quality control in CPA firms, as directed both in auditing and quality control standards.
I think it was Harry Truman that first said, “the buck stops here.” So it does with CPA firm engagement leaders.
Engagement Leader’s Supervision
Engagement supervision includes:
• Overseeing engagements from their beginning to their end.
• Making sure that engagement team members have appropriate time to perform procedures, have received appropriate instruction and have complied with the planned approach to their assignments.
• Addressing and resolving significant findings and issues and, when necessary, modifying the planned approach to the engagement.
• Consulting with more experienced team members or specialists when necessary.
Engagement Leader’s Review
A review by an engagement leader consists of consideration of whether:
• Work has been performed in accordance with professional standards and legal and regulatory requirements.
• Significant findings and issues have been considered further.
• Appropriate consultations have been made and the resulting conclusions have been documented and applied.
• The nature, timing, and extent of the work performed is appropriate.
• The work performed is appropriately documented and sufficient for the conclusions reached in the report.
• The objectives of the engagement procedures have been achieved.
Key Points in Engagements for Leaders’ Involvement
Following are some key points for leaders’ involvement on small audits to maximize both high quality and profitability:
Pre-Engagement Planning Phase
1. Pre-engagement planning conference with in-charge accountant.
This meeting may be brief on smaller engagements or it could take several hours for larger engagements. The main purposes should be for the leader to discuss the prior year’s engagement, outline a general strategy for the current year, communicate any client issues of which the leader is aware and discuss generally the nature of documentation expected by the leader.
2. Discuss preliminary planning activities with the in-charge accountant.
This discussion should focus on risks of material misstatement in the prior period’s engagement and risk at the financial statement level documented in a Client Acceptance and Continuance Form. The integrity of management of the reporting entity, the likelihood of going concern problems and the use of the financial statements are the main factors affecting risk at the financial statement level.
Engagement strategies, i.e., how much and what kind of evidence is necessary, will in part be determined based on the assessed level of risk at the financial statement level. Risk of material misstatement at the assertion or account classification level will be evaluated through risk assessment procedures and, when combined with risk at the financial statement level, will finally determine the nature and extent of engagement procedures.
3. Deliver and discuss the engagement letter with management of the reporting entity.
The engagement letter is a primary tool for obtaining management’s understanding of their responsibilities, as well as the responsibilities of the CPA firm. A good understanding before the engagement begins will prevent misunderstandings from arising later.
To accomplish a good understanding, the engagement leader should deliver the letter and discuss its contents with the client’s CEO or owner. Discussion of the letter with the client’s owner or manager, president, superintendent or director should be one of the primary sources for discovering potential misstatements, fraud or illegal acts, business and environmental issues and going-concern problems.
1. Review the results of risk assessment.
After the in-charge accountant has completed the documentation of the understanding of an entity’s business and environment including its internal control, and the initial risk assessment process, the engagement leader should review the assessed levels of risk of material misstatement. Depending on the nature and size of a reporting entity, risk may be assessed by individual assertions or by account classifications as a whole.
For smaller audits, risk of material misstatement is usually assessed for account classifications considered as a whole since audit responses normally will affect all relevant assertions.
2. Risk assessment documentation for smaller audits should include this, or similar minimum documentation:
• Client Acceptance and Continuance Form
• General Ledger Analysis Worksheet
• Internal control flowcharts and documentation of systems walk-through procedures
• Risk assessment documentation
• Planning Document
3. Review the materiality calculations and related plans to sample or not to sample.
One of the few absolutes of auditing is that risk always affects materiality levels. Calculations of tolerable misstatement and the lower limit for individually significant items for material account classifications, considering the assessed level of risk of material misstatement, will determine the extent of required tests of balances procedures. The engagement leader’s review of the materiality calculations and sampling plans will provide the criteria for finalizing tests of balances programs.
4. Review, or modify, a tests of balances program to reflect the assessed levels of risk of material misstatement, materiality calculations and sampling decisions.
This review or modification of the audit program should be accomplished before the yearend fieldwork begins.
5. Review the Planning Document, meet with the in-charge accountant and prepare to lead the engagement team’s planning and brainstorming meeting. After the meeting is completed, update the planning document and provide on-the-job training for staff personnel as appropriate.
1. Review the documentation for analytical and test of balances procedures, financial statements and footnotes and internal control communication letter.
Determine audit objectives have been accomplished and that the financial statements contain an acceptable level of error. Document conclusions on an Engagement Review Checklist and an Error Analysis Form.
Prepare, or review, a draft of the management representation letter. Meet with the in-charge accountant to clear final review notes and arrange for meeting with management and those charged with governance of the reporting entity. After these meetings, finalize the documentation within 60 days of the report release date.
2. Review the engagement documentation and determine all open points and review notes have been cleared.
3. Complete an engagement review checklist.
These key points for engagement leaders’ involvement must move from “nice to have” status to “need to have” to maximize quality and efficiency on smaller audits. Do away with old paradigms that say, “I’ll review this small audit when a staff person completes the work.”
Involvement of engagement leaders start to finish is the key. Train, equip and delegate, but stay involved leaders. My favorite manager Fred’s leadership paradigms are old wineskins, it is time for the new!