(a) (i) Matters to be included in the audit proposal
Outline of Weston & Co
A brief outline of the audit firm, including a description of different services offered, and an outline of the firm’s international locations. This will be important to Jones Co given that it wishes to expand into overseas markets and will be looking for an audit firm with experience in different countries. The document should also outline the range of services which Weston & Co can provide, and any specialism which the firm has in auditing recruitment companies.
Identify the audit requirements of Jones Co
There should be an outline of the statutory audit requirement in the country in which Jones Co is incorporated, to confirm that the company is now at the size which necessitates a full audit of the financial statements. As this is the first time an audit is required, it will be important to outline the regulatory framework and the duties of auditors and of management in relation to the audit requirement.
Audit approach
A description of the proposed audit approach, outlining the stages of the audit process and the audit methodology used by the firm should be given. The description should state that the audit will be conducted in accordance with ISA requirements. Weston & Co should emphasise the need for thorough testing of opening balances and comparatives given that this is the first year that the financial statements will be audited. The risk-based nature of the audit methodology should be explained, and that it will involve an assessment of accounting systems and internal controls. Controls may not be good given the limited resources of the accounting function, so the audit approach is likely to be substantive in nature.
The audit firm may at this stage wish to explain that while the audit should not be ‘disruptive’, the audit team will require some input from Jones Co’s employees, especially the accountant, and other personnel including Bentley may need to make themselves available to respond to the audit firm’s requests for information and to discuss matters relating to the audit.
The proposal should outline the various communications which will be made with those charged with governance during the audit process, and highlight the value added from such communications, for example, recommendations on any control deficiencies.
Deadlines
The audit firm should clarify the timescale to be used for the audit. Bentley has requested that the audit is completed within four months of the year end. This seems to be reasonable; it should be possible for the audit of a relatively small company with simple transactions and a full-time accountant to be completed within that timeframe.
Quality control and ethics
Weston & Co should clarify its adherence to IESBA’s Code of Ethics for Professional Accountants, and to International Standards on Quality Control. This should provide assurance that the audit firm will provide an unbiased and credible audit report. This may be important for the venture capitalists who will wish to gain assurance on the financial information which they are provided with in relation to their investment.
Additional non-audit and assurance services
The audit proposal should describe the various non-audit and assurance related services which Weston & Co would be able to offer Jones Co. These may include, for example, business consultancy and corporate finance advice on overseas expansion and obtaining any necessary additional funding to help the planned overseas expansion. This discussion should clearly state and emphasise that the provision of such services is subject to meeting ethical requirements and will be completely separate from the audit service.
Tutorial note: Credit will be awarded for discussion of other matters which may be included in the audit proposal, where the matters are relevant to the audit of Jones Co.
(ii) Matters to be considered in determining the audit fee
Weston & Co needs to consider a number of matters in determining the audit fee. The commercial need for the firm to make a profit from providing the audit service needs to be considered alongside the client’s expectations about the fee level and how it has been arrived at.
First, the audit firm should consider the costs of providing the audit service. This will include primarily the costs of the audit team, so the firm will need to assess the number and seniority of audit team members who will be involved, and the amount of time that they will spend on the audit. There may be the need for auditor’s experts to be engaged, and the costs of this should be included if necessary.
Weston & Co will have standard charge out rates which are used when determining an audit fee and these should be used to estimate the total fee. Other costs such as travel costs should also be considered.
Bentley Jones has made some comments in relation to the audit fee which have ethical and other implications. First, he wants the audit fee to be low, and says that he is willing to pay more for other services. One of the problems of a low audit fee is that it can affect audit quality, as the audit firm could be tempted to cut corners and save time in order to minimise the costs of the audit.
Offering an unrealistically low audit fee which is below market rate in order to win or retain an audit client is known as lowballing, and while this practice is not prohibited, the client must not be misled about the amount of work which will be performed and the outputs of the audit. The issue for the client is that an unrealistically low audit fee is unlikely to be sustainable in the long run, leading to unwelcome fee increases in subsequent years.
The second issue is that Bentley Jones has suggested that the audit fee should be linked to the success of the company in expanding overseas, on which he wants the audit firm to provide advice. This would mean that the audit fee is being determined on a contingent fee basis. IESBA’s Code of Ethics for Professional Accountants defines contingent fees as fees calculated on a predetermined basis relating to the outcome of a transaction or the result of the services performed by the firm.
The Code states that a contingent fee charged by a firm in respect of an audit engagement creates a self-interest threat which is so significant that no safeguards could reduce the threat to an acceptable level. Accordingly, a firm shall not enter into any such fee arrangement.
Weston & Co should explain to Bentley Jones that the audit fee will be determined by the level of audit work which needs to be performed, and cannot be in any way linked to the success of Jones Co or advice which may be given to the firm by its auditors. The fee will be determined by the grade of staff who make up the audit team and the time spent by each of them on the audit.
Tutorial note: Credit will be awarded for discussion of other relevant current issues in relation to the setting of audit fees.
(b) Ethical threats created by long association of senior audit personnel and relevant safeguards
When a senior auditor acts for an audit client for a long period, several ethical problems can arise. First, the professional scepticism of the auditor can be diminished. This happens because the auditor becomes too accepting of the client’s methods and explanations, so stops approaching the audit with a questioning mind.
According to the IESBA Code, familiarity and self-interest threats are created by using the same senior personnel on an audit engagement over a long period of time. The familiarity threat is linked to the issues relating to the loss of professional scepticism discussed above, and is due to the senior auditor forming a close relationship with the client’s personnel over a long period of time.
As with any ethical threat, the significance of the threat should be evaluated and safeguards which reduce the threat to an acceptable level put in place. Matters which should be considered in evaluating the significance of the ethical threat could include the seniority of the auditor involved, the length of time they have acted for the client, the nature, frequency and extent of the individual’s interactions with the client’s management or those charged with governance and whether the client’s management team has changed.
Examples of safeguards which can be used include:
– Rotating the senior personnel off the audit team;
– Having a professional accountant who was not a member of the audit team review the work of the senior personnel; or
– Regular independent internal or external quality control reviews of the engagement. 
In the case of a public interest company such as Ordway Co, the Code contains a specific requirement that an individual shall not be a key audit partner for more than seven years. After seven years the individual shall not be a member of the engagement team or be a key audit partner for the client for two years. This is known as the cooling off period, and during that period, the auditor shall not participate in the audit of the entity, provide quality control for the engagement, consult with the engagement team or the client regarding technical or industry-specific issues, transactions or events or otherwise directly influence the outcome of the engagement.
Because Ordway Co is a listed company, the audit firm must apply the requirements of the Code, remove Bobby from the audit team and not allow further contact with the client or the audit process. Therefore Bobby cannot act as engagement quality control reviewer for the audit of Ordway Co, having stepped down as audit engagement partner.