Chapter 5

Management of Public
Accounting Practice
 Establishment and Organization of Public
Accounting Practice
SOLE PROPRIETORSHIP FORM OF PARTNERSHIP FORM OF PUBLIC
PUBLIC ACCOUNTING PRACTICE ACCOUNTING PRACTICE
Advantages:
Advantages:
1. The practitioner is his own boss and is
1. The practice has greater stability and continuity.
independent.
2. Responsibility, risks and cost of practice can be
2. He does not keep regular office hours.
shared.
3. He can earn more than a mere salaried
3. Opportunity for specialization is increased.
employee can.
4. A partnership can handle larger engagements more
4. He can attain self-fulfillment or
efficiently and adequately.
satisfaction from the sources of his own
5. Partners can combine their talent, resources, time,
practice.
and experience to serve the clients better.
Disadvantages:
Disadvantages:
1. He assumes all the risks and
1. Personal differences between partners may arise
responsibilities of entrepreneurship.
and therefore good and close working relationships
2. His income may not be regular and
may not be established.
therefore should be supplemented form
2. One partner may feel that the other partner is not
other sources.
contributing to the welfare of the firm.
3. He must rely on his own judgment in
making decisions.
 Factors influencing the organizational
structure of CPA firms
A corporation is not allowed to engage in the practice of public accounting in
the Philippines and therefore the SEC shall not register any corporation
organized for the practice of public accountancy.

The organizational structure of CPA firms is influenced by the following

factors:
(1) The need to be independent from clients to enable the auditor to remain
unbiased in drawing conclusions about the FS;
(2) The need of a structure to encourage competence to enable the auditor to
conduct audits efficiently and effectively; and
(3) The increased risk of litigation faced by auditors.
Representation Letter to SEC
SOURCES OF CLIENTS:
1) Referrals from businessmen
through active participation in
civic and community affairs.
2) Referrals from clients by
maintaining his integrity and
rendering prompt and efficient
services to them.
3) Referrals from financial and
government institutions by
keeping his standards high.
4) Referrals from other CPAs by
active involvement in
professional organizations of
CPAs.
5) Referrals from legal and other
professional firms.
 Marketing Professional Services
Sections 250.1 and 250.2 of the Revised Code of Ethics for
Professional Accountants in the Philippines, provide the guidelines
in marketing professional services as follows:
1. When a professional accountant in public practice solicits new work through
advertising or other forms of marketing, there may be threats to compliance with the
fundamental principles. For example, a self-interest threat to compliance with the
principle of professional behavior is created if services, achievements or products are
marketed in a way that is inconsistent with that principle.

2. A professional accountant in public practice should not bring the profession into
disrepute when marketing professional services. The professional accountant in
public practice should be honest and truthful and should not:
-Make exaggerated claims for services offered, qualifications possessed or
experience gained; or
- Make disparaging references to unsubstantiated comparisons to the work of
another.
 Professional Fees
The CPA in public practice shall comply with the provisions of Section 240 of the Revised
code of Ethics for Professional Accountants on professional fees and other types of
renumeration.
1. When entering into negotiations regarding professional services, a professional
accountant in public practice may quote whatever fee deemed to be appropriate. The
fact that one professional accountant in public practice may quote a fee lower than
another is not in itself unethical.

2. The significance of threats depend on factors such as level of fee and the services to
which it applies. In view of these potential threats, safeguards should be considered
and applied as necessary to eliminate them or reduce them to an acceptable level.
Fees charged for assurance engagements should be a fair reflection of the value of
the work and should take into account, among others:
(a) the skill and knowledge required for the type of work involved.
(b) the level of training and experience of the persons necessarily engaged on the work
(c ) the time necessarily occupied by each person engaged on the work
(d) the degree of responsibility and urgency that the work entails.
 Professional Fees (continued…)

3. Contingent fees are widely used for certain types of non-assurance engagements.
They may, however give rise to threats to compliance with the fundamental principles
in certain circumstances. They may give rise to a self-interest threat to objectivity.

Factors affecting the threats:

- The nature of the engagement.
- The range of possible fee amounts.
- The basis for determining the fee.
- Whether the outcome or result of the transaction is to be reviewed by an
independent third party.

4. The significant of such threats should be evaluated and, if they are other than clearly
insignificant, safeguards should be considered and applied as necessary to eliminate
or reduce them to an acceptable level.
 Professional Fees (continued…)
5. In certain circumstances, a professional accountant in public practice may receive a
referral fee or commission relating to a client.

6. A professional accountant in public practice may also pay a referral fee to obtain a
client, for example, where the client continues as a client of another professional
accountant in public practice but requires specialist services not offered by an
existing accountant.

7. A professional accountant in public practice should not pay or receive a referral fee or
commission, unless the professional accountant in public practice has established
safeguards to eliminate the threats or reduce them to an acceptable level.

8. A professional accountant in public practice may purchase all or part of another firm on
the basis that payments will be made to individuals formerly owning the firm or to
their heirs and estates.
 Methods of Billing Clients
1. Actual time charges basis or Per Diem basis
- Billing is done on the basis of actual time spent by the staff
multiplied by the hourly rates agreed upon.
2. Flat or Fixed fee basis
- Client is billed a flat but all-inclusive pre-arranged amount for the
entire engagement.
3. Maximum fee basis
- Client is charged on a per diem basis, with the agreement that the
total charges will not exceed a certain agreed maximum amount.
4. Retainer basis
- The auditor is paid a fixed pre-determined fee for all services
rendered during a designated period of time either on a monthly,
semi-annual or annual basis.
Organization of CPA Firms

Audit
Partner

Audit
Manager /
Supervisor

In-Charge (Senior) Auditor

Staff Auditor
 Audit Partner
Audit partners are concerned about the overall quality of each audit. An
audit partner signs the audit report, accepting ultimate responsibility
for each audit, and is generally involved in maintaining client
relationships, planning audits, and evaluating the audit findings.

Duties of a partner:
1. To plan and review all phases of an audit engagement.
2. To sign the audit report.
3. To approve the firm’s billing to the client.
4. To obtain/establish contracts with clients.
5. To determine office operating policies.
 Audit Manager/Supervisor
An audit manager administers important aspects of audit engagements,
scheduling the audit work to be done with client personnel,
assigning work to audit staff, supervising staff, and reviewing staff
work.
Tasks of a manager or supervisor:
1. To act as a liaison officer between partners and other members of
the staff.
2. To discuss with the client problems that may arise in the course of
the audit.
3. To exercise direct supervision on seniors in charge of specific audit
engagements.
4. To review working papers and drafts of audit report.
5. To discuss reports and results of audit with clients.
6. To take charge of training programs.
 In-Charge (Senior) Auditor
In-charge auditors work under the direction of audit managers and
assist them in administering the audit. They generally participate in
audit planning and provide direct supervision to staff auditors.
Duties of In-Charge Auditors:
1. To prepare the audit programs for an engagement subject to review
by the partner, principal or supervisor.
2. To assign particular phases of the audit work to staff and to
exercise direct supervision over them.
3. To perform certain audit procedures requiring skill and experience.
4. To take up with the client or with the partner or principal, problems
or questions that arise in the course of the audit.
5. To assemble the working papers in an audit, and prepare a draft of
the report and financial statements for review and approval by the
partner or supervisor.
 Staff Auditor
Staff auditors perform various audit procedures and gather audit
evidence to use as a basis for the audit reports. They may perform
procedures that relate to a variety of aspects of a client’s activities.
For example, one staff auditor might test payroll, the value of
money, or whether all accounts payable are recorded.
Tasks of a staff auditor:
1. To prepare schedules and reports of findings.
2. To work on tax returns.
3. To check the accuracy of footings and extensions on books of
accounts and other records.
4. To check the postings of entries from the journals to the ledger.
5. To examine vouchers supporting minor disbursements.
6. Generally, to serve as an assistant.
 Acceptance and Retention of Audit Clients
Pre-engagement planning includes procedures that are employed
before the auditor begins to plan for the collection of evidential
matter. It begins with the evaluation of the prospective client.

Steps in considering a new client:

I. Identify potential client
II. Evaluate relationship between auditor and potential
client
III. Evaluate auditability
IV. Evaluate management’s integrity
V. Prepare engagement letter
 I. Identify potential client
Reasons why clients change auditors:
a) to obtain a lower audit fee
b) to obtain new or additional services
c) to avoid disagreements with the auditor
d) to meet contractual obligations

A CPA may be approached by a potential client for a number of

reasons including
a) recommendation from others
b) first hand knowledge from other business, civic or professional
contacts
c) a firm literature sent to it
 II. Evaluate the Relationship Between
Auditor and Potential Client
In this step, the auditor must determine whether any relationship the
auditor and auditor’s firm have with the potential audit client violates
the Code of Ethics for Professional Accountants.

The auditor should also consider:

(1) circumstances that might increase audit risk or business risk (e.g.,
senior managers were convicted of an illegal act or partners in a
closely held company were having disputes); and
(2) the expertise and availability of the personnel to do the audit.
 III. Evaluate Auditability
The auditor must determine whether a potential
client is auditable; that is, will the auditor be able
to accumulate sufficient, competent evidence to
render an opinion on the FS. The auditor should
consider
(1) adequacy of accounting records, and
(2) quality of internal control
 IV. Evaluate Management’s Integrity
The auditor should evaluate management’s integrity before accepting a
client. A lack of management integrity may make audit risk so great
that a cost-effective audit cannot be performed.
Procedures that may be adopted include the following:
1. Review the company’s FS.
2. Discuss the company’s management with the predecessor auditor.
(Note: The company’s permission is needed to communicate with
the predecessor auditor.)
3. Discuss the company’s management with the members of the
financial community.
4. Consider engaging professionals/investigators to evaluate the
principals associated with the prospective client.
5. Obtain credit reports when deemed necessary.
 V. Prepare Engagement Letter
PSA 210 (Redrafted, “Agreeing the Terms of Audit Engagements”,
establishes standards and provides guidelines on agreeing the
terms of the engagement with management and, where appropriate,
those charged with governance.

An engagement letter is a formal written agreement between an

auditor and a client which generally serves:
(1) to minimize misunderstandings,
(2) to alert the client as to the purpose of the engagement and the role
of the external auditor, and
(3) to help minimize legal liability for services neither contracted for nor
performed.
 V. Prepare Engagement Letter (continued…)
Principal Contents of the Engagement Letter
• The objective of the audit of FS.
• Management’s responsibility for the FS as described in PSA 200 (Revised and
Redrafted), “Overall Objectives of the Independent Auditor and the Conduct of an
Audit in Accordance with PSA.”
• The financial reporting framework adopted by management in preparing the FS.
• The scope of the audit, including reference to applicable legislation, regulations, or
pronouncements of professional bodies to which the auditor adheres.
• The form of any reports or other communication of results of the engagement.
• The fact that 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 unavoidable risk that even some material misstatement may remain
undiscovered.
• Unrestricted access to whatever records, documentation and other information
requested in connection with the audit.
 V. Prepare Engagement Letter (continued…)
The auditor may also wish to include in the letter:
•Arrangements regarding the planning of the audit.
•Expectation of receiving from management written
confirmation concerning representation made in connection
with the audit.
•Request for the client to confirm the terms of the
engagement by acknowledging receipt of the engagement
letter.
•Description of any other letters or reports the auditor
expects to issue to the client.
•Basis on which fees are computed and any billing
arrangements.
Management’s
responsibility

Objective of
the audit of
FS

Financial
Reporting
Framework
Scope of the
audit

Form or report as
a result of
engagement Unrestricted
access to
whatever records
The risks involved in connection with
because of the the audit
test nature of audit
 Audit Components
When the auditor of a parent company 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.
 Client Continuance
Auditors must not only decide whether to accept new
clients, they also should periodically review their list of
current clients and remove those clients the firm no
longer wants to be associated with.
Reasons for discontinuing clients might be:
1. Evidence indicating a client’s management may lack integrity;
2. Difficulty in working with client personnel;
3. Inability to negotiate an acceptable increase in the audit fee;
4. Client need for specialized services the current audit firm is unable
to unwilling to provide.
 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:
1. Any indications that the client misunderstands the objective and
scope of the audit.
2. Any revised or special terms of the engagement.
3. A recent change in senior management, board of directors, or
ownership.
4. A significant change in nature or size of the client’s business.
5. 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.

Some of the reasons that may prompt the client to request

the auditor to change the engagement are:
1. change in circumstances affecting the need for the service,
2. a misunderstanding as to the nature of an audit or related service
originally requested, and
3. restriction on the scope of the engagement whether imposed by
management or caused by circumstances.
 Management’s Responsibility for
Financial Reporting
The professional literature clearly indicates
that the responsibility for adopting sound
accounting policies, maintaining, adequate
internal control, and making fair presentations
in the financial statements rest with
management rather than with auditors.

Audit standards require that an audit be

designed to provide reasonable assurance of
detecting material misstatement in the FS.
The audit must be planned with an attitude of
professional skepticism in all aspects of the
engagement.

The concept of reasonable assurance

indicates that is neither an insurer nor
guarantor of the correctness of the FS.

The auditor’s best defense when material

misstatements are not uncovered in the audit
is that the audit was conducted in accordance
with GAAS.
 The Audit Committee
An audit committee is a selected number of members of a company’s
board of directors whose responsibilities include helping auditors
remain independent of management.

Activities of the audit committee:

1. Nominate the public accounting firm to perform the audit.
2. Review the plans for audit with the auditor.
3. Oversee internal audit activities.
4. Discuss disagreements between management and the auditor.
5. Discuss major problems the auditor encounters in doing the audit.
6. Review FS and the auditor’s report upon completion of the
engagement.
 The Audit Committee (continued…)
Matters to be communicated to the audit committee:
1. Auditor’s responsibility under GAAS which is to conduct an audit designed
to provide reasonable, rather than absolute assurance about the FS.
2. Selection of and changes in significant accounting policies and their
application, the methods used to account for significant unusual
transactions, and the effect of significant accounting policies in
controversial and emerging areas for which a lack of authoritative guideline
exists.
3. Management judgments and accounting estimates, including the process
management used to formulate particularly sensitive accounting estimates
and the basis for the auditor’s conclusions regarding the reasonableness
of those statements.
4. Significant adjustments and proposed audit adjustments that had
significant effect on the entity’s financial reporting process.
5. Auditor’s responsibility for other information in documents containing
audited statements.
Matters to be communicated to the audit committee: (continued…)

6. Disagreements with management about the application of accounting

principles to the entity’s specific transactions, the scope of the audit,
disclose in the FS, or the wording of the auditor’s report, and whether the
matter is satisfactorily resolved.
7. Consultation with other accountants about accounting or auditing matters
that management has had.
8. Major issues discussed with management prior to retention of the auditor,
including discussions regarding the application of accounting principles and
auditing standards.
9. Difficulties encountered in performing the audit, including the unreasonable
delay in permitting the beginning of the audit or in providing information.

Activity: Watch a video on “Recap of Governance” – (8:47)

 Auditing in a Globalized Environment
All kinds of businesses have for the last forty years expanded their operations
in foreign countries. Some companies invest in foreign firms while others
establish foreign production facilities to service their companies in a
particular region.

Public accounting firms have found that to retain their multinational clients they
have had to develop the capacity to provide services worldwide.
The following figure presents tie-up of some local firms in the Philippines and
international accounting firms in the United States and other countries in the
world.
Philippines United States / Other Countries
Sycip, Gorres, Velayo & Co. -Ernst & Young
Isla, Lipana & Associates -PriceWaterhouse Coopers
Manabat, Sanagustin & Co. -KPMG
Punongbayan, Araullo & Co. -Grant Thornton
Manabat, Delgado, Amper & Co. -Deloitte Touche Tohmatsu
R. Alba & Co. -BDO