APPOINTMENT OF THE FIRST AUDITOR

Selection of an auditor is a two way process, and as well as the client being satisfied with the audit firm, the
audit firm must ensure they have no reservations about the engagement or the client. Before accepting a
new audit engagement the auditor must consider the following:

• Their competence to undertake the work and the availability of resources. They will need to
consider the timing of the audit, and how it fits in with the current commitments of the firm.
• Any threats to their independence and objectivity, and whether adequate safeguards can be
established to mitigate these threats
• Any reservations regarding the integrity of the owners, directors and management of the company.
• The risks attached to the engagement e.g. is there any risk of litigation arising from the
engagement
• The economics of the engagement e.g. will the fee be sufficient to cover costs?

As part of their acceptance procedures the auditor will make enquiries into these matters by discussions with
third parties, obtaining written references and searching relevant databases. The company will need to give
permission for communication between the prospective auditor and relevant third parties.

Once the final decision has been made the directors are allowed, under the Companies Act, to appoint the
first auditors. However at the next AGM the shareholders will need to pass an ordinary resolution with
special notice (28 days). The auditor then holds office until the following AGM.

ENGAGEMENT LETTERS

An auditor will issue an engagement letter to signify his acceptance of appointment. It forms a contract
between the auditor and client. It should clearly define the scope of the audit and the extent of the auditor's
responsibilities. Each engagement letter should be individual to the client. However it is likely to contain the
following sections:

• Confirmation of the appointment.

• The responsibilities of the directors and the auditor under the Companies Act and the professional
responsibilities of the auditor.
• The scope of the audit. The auditor will ascertain the accounting systems and evaluate controls.
The nature and extent of tests he then carries out will vary according to this assessment. Any significant
weaknesses found will be reported to management.
• Management representations. Where appropriate the auditor should confirm that prior to
completion of his audit he might seek written confirmation of certain matters affecting the financial
statements.
• Other information with published accounts. The auditor will request to see any other information
that is to be issued with the financial statements prior to publication.
• Irregularities and fraud. The responsibility for the detection and prevention of fraud lies with
management. Fraud detection is not the main purpose of the audit but the auditor will plan his work so
that he has a reasonable expectation of detecting material mis-statements in the financial statements,
whether caused by error or irregularity. However the audit should not be relied upon to disclose
irregularities and fraud.
• Post balance sheet events. The auditor’s responsibility ends when he signs his audit report.
However he will request management to inform him of any relevant post balance sheet events occurring
between the date of the audit report and the AGM.
• Other services. Reference will be made to any services the auditor is providing in addition to the
statutory audit. It is likely that a separate engagement letter will be issued in respect of these services.
• Fees. The general basis on which they are computed, rendered and paid should be set out.
• The law governing the terms of the contract.
• The complaints procedure should the company be dissatisfied with the service provided.

The auditor will discuss the content of the letter with the directors and agree the terms with them (although
the requirements of the Companies Act cannot be varied). A formal letter will be issued and the client
requested to confirm his understanding, usually by signing and returning a copy of the letter. Once issued
the letter remains in force until replaced. A revised letter may be issued if, for example there is a change of
management or a significant change in the nature of the business.
CHANGING AUDITORS

Auditors are normally appointed for one year at a time - their term of office expires at the next AGM. Many
companies re-appoint the same auditor each year. Whilst this may be due to satisfaction it is sometimes a
result of inertia or dislike of change. However, at regular intervals the company should reconsider their
choice of auditor. Reasons for changing the auditors include the following:

• Reduction in fees. If a new firm is keen to win the audit they may well undercut the current auditors
fees. Whilst a cost is saving is obviously attractive to the company the prospective auditor should be
carefully questioned to ensure that standards will be maintained, all required services will be provided
and that fees will not rise sharply in the future.
• Dissatisfaction with audit quality e.g. through inexperienced staff being assigned to the audit etc. If
there are any concerns over audit quality these should be discussed with the auditor prior to considering
a change. However if the client’s concerns are not resolved then a change in auditor may be the best
course of action.
• Disagreements over accounting principles. Companies may decide to appoint a new auditor after
receiving a qualified audit report. However it is likely that the new auditor will agree with the first auditor,
and future accounts will also be qualified. A change of auditor following a qualified audit report may
attract bad publicity for the company. For example, when Jarvis plc announced a change of auditors
after concerns about unusual accounting treatments their share price fell.
• Need for a larger firm. If the company has grown faster than the audit firm has then the current firm
may no longer have the resources or geographic spread to provide an adequate service.
• Group audit rationalisation. If a group acquires the company the holding company may insist all
subsidiaries appoint the same auditor. This can result in audit efficiencies and hence cost savings.
• Current auditor lacks independence because he provides too many services to the company.
• Personality clash with the engagement partner. Provided the firms is sufficiently large a change of
partner rather than changing the firm can resolve this.
• Obtain a fresh outlook. Whilst this will be obtained with a new auditor it may also be achieved, with
less disruption, by rotation of audit staff within the existing firm.

Changing an auditor will incur management time and costs. In addition the first audit is always more difficult
as the auditor lacks the cumulative knowledge of the client that is built up over time. The company should
ensure the benefits of the change outweigh the disadvantages.

Procedures on change of auditor

Under the Ethical Guidelines an auditor cannot accept nomination to replace an existing auditor without first
communicating with that auditor. The company should inform the existing auditor about the proposed
change, and will need to give permission to both firms to discuss the relevant issues. The proposed auditor
will write to the existing auditor and enquire about the following matters:

• The reasons for the change in the appointment.

• Any significant differences of principle or practice which have arisen between the auditor and client.
• Whether the client, its directors or employees are guilty of an unlawful act, which is relevant to the
audit and should be investigated by the appropriate authority.
• Any serious doubts the existing auditor has regarding the integrity of the directors and or senior
management.
• Whether the client, its directors or employees have deliberately withheld information or limited the
scope of the audit.

The prospective auditor will give due weight to the existing auditor’s reply, along with any other information
he has obtained in order to make his decision.

If the company decides to appoint a new auditor the incumbent auditor will need to make a statement of
circumstances surrounding the change in auditor (or a statement that there are no circumstances). This
statement should be circulated to all those entitled to receive a copy of the accounts. This is to ensure the
shareholders are armed with all the relevant information. The new auditor can then be appointed by passing
an ordinary resolution with special notice.