AS 3 Auditing Standard No. (3) PDF

# Auditing Standard No. (3): Terms of Audit Engagement ## Introduction - The purpose of this Auditing Standard for Islamic Financial Institutions (ASIFI) is to establish standards and provide guidance on the appointment of an auditor to audit the financial statements of a financial institution whi...

# Auditing Standard No. (3): Terms of Audit Engagement ## Introduction - The purpose of this Auditing Standard for Islamic Financial Institutions (ASIFI) is to establish standards and provide guidance on the appointment of an auditor to audit the financial statements of a financial institution which conducts business in conformity with Sharia Rules and Principles. - The main points are: - Agreeing the terms of the engagement with the Islamic Financial Institution (Client) - The auditors response to a request by a client to change the terms of an engagement to one that provides a lower level of assurance. - The auditor and the client should agree on the terms of the engagement. The agreed terms need to be recorded in an audit engagement letter or other suitable form of contract. - This ASIFI is intended to assist the auditor in the preparation of engagement letters relating to the audits of Islamic Financial Institution's financial statements. The standard is also applicable to related services. When other services like tax, accounting or management advisory services are to be provided, separate letters may be appropriate to distinguish clearly the statutory audit from other services. - In some countries, the objectives and scope of an audit and the auditor's responsibilities are established by law. Even in those situations, the auditor may still find audit engagement letters informative for their clients. ## Audit Engagement Letters - It is in the interest of both client and auditor that the auditor should send an engagement letter, preferably before the commencement of the engagement, to help in avoiding misunderstandings with respect to the engagement. ## Basic Contents of the Engagement Letter - The engagement letter documents and confirms the auditor's acceptance of the appointment, the objectives and scope of the audit, the extent of the auditor’s responsibilities to the client and the form of any reports to be provided by the auditor. ## Objective of the audit of the financial statements - The objective of an audit of financial statements is to enable the auditor to express an opinion as to whether the financial statements are prepared, in all material respects, in accordance with the fatwas, rulings and guidelines issued by the Sharia supervisory board of the Islamic financial institution, the accounting standards of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), national accounting standards and practices, and relevant legislation and regulations applied in the country in which the Islamic financial institution operates. - The phrase used to express the auditor's opinion is whether the financial statements "give a true and fair view" in accordance with the above. ## Management's responsibility for the financial statements - The financial statements are the responsibility of the management of the Islamic financial institution, which is also responsible for maintaining an effective internal control system, for properly recording transactions in the accounting records, for safeguarding assets, and for the overall true and fair presentation of the financial statements. - The audit report should include a statement to the effect that the financial statements and the Islamic financial institution’s undertaking to operate in accordance with the Shari’a Rules and Principles are the responsibility of the Islamic financial institution’s management. The auditor is responsible for attesting as to whether the management has adhered to the fatwas, rulings and guidelines issued by the Sharia supervisory board of the Islamic financial institution. - The management of the Islamic financial institution should provide the auditor with all the fatwas, rulings and guidelines issued by its Shari’a supervisory board, and other relevant documents, e.g., reports of the Shari’a supervisory board. ## Management's representation - The auditor will make specific inquiries of management about the representations contained in the financial statements and the operation of the internal control over the financial reporting process. The auditor should obtain representation letters from the client about oral representations made to him. The auditor would expect management to provide him with complete, accurate, and timely information. ## Scope of an Audit - The scope of the Audit includes reference to ASIFIs and applicable national standards or practices and a description of the work the auditor would perform. Matters to which the engagement letter ordinarily makes reference include the following: - The audit is to be conducted in accordance with ASIFIs, International Standards on Auditing and national standards shall apply in respect of matters not covered by ASIFIs providing International Standards on Auditing and the national standards do not contravene Sharia'a Rules and Principles. - The auditor needs to obtain an understanding of the accounting system in order to assess its adequacy as a basis for the preparation of financial statements. - The auditor needs to obtain relevant and reliable evidence sufficient to enable them to draw reasonable conclusions therefrom. - The nature and extent of the auditor's procedures vary according to his assessment of the internal control system. - The auditor shall endeavor to plan his audit so that he has a reasonable expectation of detecting material misstatement in the financial statements or accounting records resulting from fraud, instances of non-compliance or errors which may exist. - Due to the test nature and other inherent limitations of an audit, together with the inherent limitation of any accounting and internal control system, there is an unavoidable risk that even some material misstatement may remain undetected. ## Form of Reports - The engagement letter shall refer to the form of reports or other communications of results of the engagement to be issued by the auditor in addition to the statutory reports to the equity holders, such as a report to management on any identified material weaknesses in, or observations on, the accounting and internal control systems. - The engagement letter shall state that the auditor must have unrestricted access to whatever records, documentation and other information requested in connection with the audit. The engagement letter should also state the auditors’ expectations of receiving from management written confirmation concerning representations made in connection with the audit. ## Fees - The engagement letter should state the basis on which fees are computed and any billing arrangements. ## Agreement of the terms of engagement - The engagement letter should request the client to confirm the terms of the engagement by acknowledging receipt of the engagement letter. ## Other Matters - The auditor may also wish to include in the letter, inter alia: - Arrangements regarding the planning of the audit. - Description of any other letters or reports the auditor expects to issue to the client. - The arrangements regarding consultation with the client’s Shari’a supervisory board. - When relevant, the following points could also be made: - Arrangements concerning the involvement of other auditors and other client staff. - Arrangements concerning the involvement of other auditors and experts in some aspects of the audit. - Arrangements to be made with the predecessor auditor, if any, in the case of an initial audit. - Any restrictions of the auditor's liability when such possibility exists. - A reference to any further arrangements between the auditor and the client. - An example of an audit engagement letter is set out in Appendix (1). ## Audit of Components - When the auditor of a parent Islamic financial institution is also the auditor of its subsidiary, branch or division (component), the factors that influence the decision whether to send a separate engagement letter to the component include: - Who appoints the auditor of the component. - Whether a separate audit report is to be issued on the component. - Legal requirements. - The extent of any work performed by other auditors. - Degree of ownership by parent. - Degree of independence of the component’s management. ## Recurring Audits - On recurring audits, the auditor should consider whether circumstances require the terms of the engagement to be revised and whether there is a need to remind the client of the existing terms of the engagement. - The auditor may decide not to send a new engagement letter each period. However, the following factors may make it appropriate to send a new letter: - Any indication that the client misunderstands the objective and scope of the audit. - Any revised or special terms of the engagement. - A recent change of senior management, equity holders, members of the board of directors or in ownership, such as in a new holding Islamic financial institution. - A significant change in nature or size of the client’s business. - Legal requirements. ## Acceptance of a change in engagement - An auditor who, before the completion of the engagement, is requested to change the engagement to one which provides a lower level of assurance, should consider the appropriateness of doing so. - A request from the client for the auditor to change the terms of engagement prior to completion may result from: - A change in circumstances affecting the need for the service. - A misunderstanding as to the nature of an audit or of the related service originally requested. - A restriction on the scope of the engagement, whether imposed by management or caused by circumstances. - The auditor would consider carefully the reason given for the request, particularly the implications of a restriction on the scope of the engagement. - A change in circumstances that affects the Islamic financial institution’s requirements or a misunderstanding concerning the nature of the service originally requested would ordinarily be considered a reasonable basis for the client requesting a change in the terms of engagement. In contrast, a request for a change by the client would not be considered reasonable if it appeared that the change related to information provided by the client that is incorrect, incomplete or otherwise unsatisfactory. - Before agreeing to change an audit engagement to a related service (such as a review), an auditor who was engaged to perform an audit in accordance with ASIFIs would consider, in addition to the above matters, any legal or contractual implications of the change. - If the auditor concludes that there is a reasonable justification for changing the terms of engagement and the audit work performed complies with ASIFIs applicable to the changed terms of engagement, the report issued would be that appropriate for the revised terms of engagement. In order to avoid confusing the reader, the report would not include reference to: - The original engagement. - Any procedures that may have been performed in the original engagement, except where the engagement is changed to an engagement to undertake agreed-upon procedures and thus reference to the procedures performed is a normal part of the report. - Where the terms of the engagement are changed the auditor and the client should agree on the new terms. - The auditor should not agree to change of the terms of engagement where there is no reasonable justification for doing so. An example might be an audit engagement where the auditor is unable to obtain sufficient appropriate audit evidence regarding receivables and the client asks for the engagement to be changed to a review engagement to avoid a qualified audit opinion or a disclaimer of opinion. - If the auditor is unable to agree to a change of the terms of engagement and is not permitted to continue the original engagement, the auditor should withdraw and consider whether there is any obligation, either contractual or otherwise, to report to other parties, such as the board of directors or equity holders, the circumstances necessitating the withdrawal. ## Effective Date - This standard shall be effective for financial statements for the financial periods beginning 1 Muharram 1419 A.H. or 1 January 1999 A.D. ## Adoption of the standard - The standard of Terms of Audit Engagement was adopted by the Accounting and Auditing Standards Board in its meeting No. (13) held on 10-11 Safar 1418 A.H., corresponding to 15-16 June 1997 A.D. ## Appendix (A) - Example of an Audit Engagement Letter - The following letter is for use as a guide in conjunction with the considerations outlined in this ASIFI and will need to be varied according to individual requirements and circumstances. - "To the Board of Directors or the appropriate representative of senior management: - You have requested that we audit the statement of financial position of the Example Islamic Financial Institution as of ......... (end of period), and the related statements of income and cash flows (and the other financial statements specified in Financial Accounting Standard No. (1): General Presentation and Disclosure in the Financial Statements of Islamic Banks and Financial Institutions) for the period then ending. We are pleased to confirm our acceptance and our understanding of this engagement by means of this letter. Our audit will be made with the objective of our expressing an opinion on the financial statements. - We will conduct our audit in accordance with Auditing Standards for Islamic Financial Institutions (and refer to the relevant national regulations, legislation and standards or practices). Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements, in all material respects, are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our audit should not be relied upon to detect all defalcations or other irregularities that may have occurred, but their discovery, if they exist, may result from the audit tests we undertake and we will report such cases. Because of the test nature and other inherent limitations of an audit, together with the inherent limitations of any accounting and internal control system, there is an unavoidable risk that even some material misstatements may remain undiscovered. - In addition to our report on the financial statements, we expect to provide you with a separate letter concerning any material weaknesses in accounting and internal control systems which come to our notice. - As management of the above Example Islamic Financial Institution, you are responsible for maintaining proper accounting records and preparing financial statements which give a true and fair view and have been prepared in accordance with Shari’a Rules and Principles as determined by your Shari’a supervisory board (and in accordance with the relevant legislation and regulations). You are also responsible for making available to us, as and when required, all the Example Islamic Financial Institution’s accounting records and all other records and related information, including minutes of all management and equity holder’s meetings, and all fatwas, rulings and guidelines issued by your Shari’a supervisory board. - We have a statutory responsibility to report to the equity holders of the Example Islamic Financial Institution whether, in our opinion, the financial statements give a true and fair view of the state of financial position of the Example Islamic Financial Institution as of ... (end of financial period) and the results of its operations and its cash flows for the period then ended in accordance with Shari’a Rules and Principles as determined by the Shari’a supervisory board of the Example Islamic Financial Institution, the accounting standards of the AAOIFI and comply with.... - In arriving at our opinion, we are required to consider the following matters, and to report on any in respect of which we are not satisfied: - Whether proper accounting records have been kept by the Example Islamic Financial Institution; - Whether the Example Islamic Financial Institution’s statement of financial position and income statement are in agreement with the accounting records; - Whether we have obtained all the information and explanations which we think necessary for the purpose of our audit, and; - Whether the information in the directors’ report is consistent with that in the audited financial statements. - In addition, there are certain other matters which, according to the circumstances, may need to be dealt with in our report. For example, where the financial statements do not give details of directors’ remuneration or of their transactions with the Example Islamic Financial Institution, (state the relevant legislation and regulations) require us to disclose such matters in our report. - We remind you that the responsibility for the preparation of financial statements including adequate disclosure and the Example Islamic Financial Institution’s undertaking to operate in accordance with Shari’a Rules and Principles is that of the management of the Example Islamic Financial Institution. This includes the maintenance of adequate accounting records and internal controls, the selection and application of accounting policies, and the safeguarding of the assets of the Example Islamic Financial Institution. As part of our audit process, we will request from management written confirmation of oral representations which we have received from you during the course of the audit on matters having material effect on the financial statements/concerning representations made to us in connection with the audit. - We understand that the Example Islamic Financial Institution has a Shari’a supervisory board which, in accordance with the Example Islamic Financial Institution’s memorandum and articles of association, is entrusted with ensuring that the Example Islamic Financial Institution complies with Shari’a Rules and Principles. We understand that we have the right to seek independent consultation with the Shari’a supervisory board. - We look forward to full cooperation with your staff and we trust that they will make available to us whatever records, documentation and other information as requested in connection with our audit. - Our fees, which will be billed as work progresses, are based on the time occupied and expenses incurred having regard to the degree of responsibility involved and the experience and skills required for the audit of the financial statements. For the year ending ... we estimate our fees to be (currency ...). Out of pocket expenses will be added to this fee. It is our practice to request an advance payment at the commencement of our work and one or more payments on account during the course of our work.. - This letter will be effective for future years unless it is terminated, amended or superseded. - Please sign and return the attached copy of this letter to indicate that it is in accordance with your understanding of the arrangements for our audit of the financial statements. - Yours faithfully - Name of Auditor - Dated this day of: - Accepted on behalf of - Example Islamic Financial Institution - (signed) - Name and Title - Date ## Appendix (B) - Example of Audit Re-Engagement Letter - Dear Sir - We are writing to confirm our re-appointment as auditors of Example Islamic Financial Institution for the year ending ... /…/… - We understand that this appointment is on the same terms as set out in our original letter of engagement dated ... /…/... - As explained in that letter our fees are charged on the basis of time occupied and expenses incurred having regard to the degree of responsibility, experience and skill involved. For the audit of the Islamic Financial Institution’s financial statements for the year ending ... /…/… we estimate our fee to be (currency ...). Out of pocket expenses incurred on your behalf shall be added to this fee. It is our practice to request an advance payment at the commencement of our work and one or more payments on account during the course of our work. - Please sign and return the attached copy of this letter to indicate that it is in accordance with your understanding of the arrangements for our audit of the financial statements. - Yours faithfully, - Name of Auditor - Dated this day of: - Acknowledged on behalf of - Example Islamic Financial Institution - (signed) - Name and Title Date