What are the risks that the auditor must consider before accepting a client for an audit engagement?

Before accepting a new client, a chartered accountant firm in practice shall determine whether the acceptance would create any threats to compliance with the fundamental principles. This means that when accepting to take on a new client, the proper investigation should be donein this regarding also its owners and business activities toensure the integrity of the potential client. These investigative actions are usually performed as ‘know your client’. In detail this activity can be segregated into 4 sections as mentioned below:

1. Background information.
2. Eligibility.
3. Management assessment.
4. Investigation of industry involvement and risk factor.

I. Background Information

1. Name of Prospective Client
2. Official Contact Details such as addresses, telephone, Fax and e mail addresses
3. Description of business and industry
4. Associated Risk with such industry / business
5. Position in industry
6. Organisational Structure i.e. subsidiary and Parent etc.
7. Financial Year to which assignment is given
8. Name of Referral Source: Self-generated/ Others
9. Name of: Directors, Officersand KMP’s
10. List of Finance & Accounts department personnel
11. Shareholding pattern with details of principal shareholders
12. List of Company’s Bankers
13. Name of Lawyers/Legal Counsel

II. Eligibility

1. Based on the Eligibility norms laid down as per the relevant section of the Companies Act, 2013, determine that, is the firm eligible to accept the audit engagement.
2. Do the firm personnel who is indented to work in this assignment have knowledge of relevant industries or subject matter?

• Do the firm personnel have appropriate experience and understanding of relevant regulatory or reporting requirements or the ability to gain the necessary skills and knowledge effectively whenever required?
• Does the firm have necessary Experts, as required?
• Does the firm believe that it would be able to complete the engagement within the reporting deadline?

III. Management assessment

1. Inquire of the client whether the client or any of its officers, directors, or shareholders has ever been convicted of a crimeor investigated by any regulatory agency or the self-governing regulatory body of any business or association?
2. Is the client’s management dominated by a single person, or small group?
3. Does the management tend to accept higher than normal risk, compared to the industry trend?
4. Is there any pressure on its employees to ‘achieve’ earnings numbers that the management wishes to release (or has released) to others?
5. Is management compensation closely tied to financial?
6. Are there any cases in past where employees of the Entity have filed Civil/criminal suits against the Company/management/persons of management?
7. Do the Board and the audit committee lack sophisticated personnel?
8. Are there any instances where management override or circumvent internal controls?

IV. Investigation of Industry background and Risk Factor

1. Before acceptance, whether we have considered, if there appears, substantial doubt about the client’s ability to continue in existence for next one year from the balance sheet date.
2. Has any of the Contingent Liabilities crystallized in the recent past, and what is the prospective effect on the Profit of the entity?
3. Have we obtained client’s financial statements and tax returns for the past three years together with copies of management letters if available?
4. Are there any legal/ political/ technological changes which impact the Industry in which the client is operating?

Every Audit firms must ensure that all the above procedures have been complied with before accepting the audit engagement to mitigate the audit risk at certain level.

This content is meant for information only and should not be considered as an advice or legal  opinion, or otherwise. AKGVG & Associates does not intend to advertise its services through this.

Posted by:

CA Aman Aggarwal

AKGVG & Associates