Activity Based Risk Evaluation Model of Auditing

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Client acceptance/retention stage: planning:
Strategic planning

ACTIV- ITIES	STAGES
	CA/R	AP	CT	ST	OF
PL	SP	TP	OP	OP	OP
EG	PK	DK	EofO	EofM	CFS
EE	AR1	DR*2	DR*3	AR4	AR5
DM	A/R	AA	CR?	CAB	AO

In the client acceptance/ retention stage, auditors evaluate prospective audit clients, and periodically review their association with existing clients, based on certain criteria. In each audit stage, auditors undertake certain planning activities. In this audit stage, audit firms plan the criteria that they will use to determine which prospective clients will be accepted or existing clients retained. It is strategic planning (or long-term planning) as these plans are not normally subject to revision each year. The criteria identified by a particular audit firm then becomes the strategic plan for each audit engagement within the firm.

In general terms, the criteria that an audit firm identifies provides the basis for determining what information (that is, what audit evidence) auditors within the firm need to gather in order to make the accept/ retain decision for prospective/ existing engagements and how they evaluate this evidence. The criteria not only specify the factors that auditors take into account, but also the relative emphasis that auditors place on each factor. Such factors include:

• the value of the acceptable audit risk AR*₁ at the financial statement level.
• the value of the achievable audit risk AR*₁ at the financial statement level.

An auditor rejects/ relinquishes a prospective/ existing client where the estimated (achievable) audit risk cannot be reduced to an acceptable level ^[fn].

• other factors such as:
  • whether the audit fee provides an appropriate return on the audit firm's investment. An auditor estimates the fee based on the amount of time the auditor and each staff member is expected to spend on the engagement and this time is costed at the audit firm's standard billing rates. Normally, these rates are set to provide the owners of the audit firm with their required return on investment.
  • whether appointment as auditor could violate legal statutes. For example, in many jurisdictions, a director of a corporation cannot also be the auditor.
  • whether the appointment could violate professional standards or ethics. For example, the Code of Ethics issued by IFAC requires professional accountants in practice, inter alia, (i) to be independent in both fact and appearance; (ii) not to be involved in activities that might impair the good reputation of the profession; (iii) to communicate with the existing auditor to ensure all relevant facts surrounding the proposed appointment are known. However, note that the independence of the audit firm is a factor normally considered when evaluating the achievable audit risk (above).
  • the political and social consequences of the appointment. For example. the audit firm's image may be adversely affected if the client is accepted. Alternatively, there may be a potential conflict between the prospective client and an existing client. (See CICA's Task Force Report entitled Conflict of Interest.)
  • the future potential of the entity as a growth client.
  • whether a scope limitation exists ^[fn].

See The CPA Journal article entitled Client acceptance: what to look for and why.

After the audit firm determines the criteria, they are documented as the "strategic plan" for client acceptance/ retention for all audit engagements. The strategic plan is then used as the basis for gathering and evaluating evidence to assist in the client acceptance/ retention decision in relation to each specific engagement. When this evidence is gathered, it is referred to as obtaining a preliminary knowledge of the client's business. Refer to the next activity.

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