Samples of Flowcharts with Repetition Structures

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					  Engaging Auditors:
Field Investigation of a
       Courtship
   Shyam Sunder, Yale University
  (work of Fiolleau, Hoang, Jamal,
            and Sunder)
       Accountancy Workshop
    City University of Hong Kong
         December 18, 2009
                An Overview
•    A field investigation of market process for audit services
•    Clients and prospective auditors acquire information to
     decide on their engagement
•    Knowledge they need for contracting is not readily
     known to them
•    It must be acquired through a complex courtship
•    Private and conflicting incentives in the process
•    We obtained documents and conducted interviews on
     requests for audit proposal (RFPs) by a publicly traded
     Canadian company (and a Canadian government
     organization) and find:
1.   Management exercises significant control over
     selection of the external auditor
2.   Asymmetry of transparency (client gathers detailed
     information about prospective auditors, but the auditors
     are reluctant to press prospective clients for
     information)
3.   A selection process that requires the auditor to provide
     references from senior officers of current and past
     clients, and repeatedly demonstrate their
     responsiveness and commitment to the prospective
     client‘s management
4.   Extensive price competition: one audit firm offered a bid
     materially below the previous year‘s audit fee; another
     offered three fee levels for different bundles of services
5.   Implications of these observations for opacity of audit
     quality, auditor risk management, expertise
     differentiation, and auditor rotation

                        Sunder: Engaging                      2
                            Auditors
      Information and Audit
            Reforms
•   Regulatory reforms (e.g., mandatory rotation of
    auditors) often assume that relevant information is
    readily available—even common knowledge—to the
    contracting agents
•   Hayek (1945): Most such information is dispersed
    among members of society who have little incentive to
    reveal it to a central planner for fear of hurting self-
    interest
•   Therefore, central tasks facing individual decision
    makers, markets and regulators is to acquire,
    aggregate and interpret the relevant information
•   Information dispersal, and conflicts between private and
    collective interest, are ―sand in the gearbox‖ of even
    well-intentioned reforms
•   Before deciding whether, and on what terms, they
    should engage each other, auditors and their
    prospective clients participate in a courtship to gather
    information about each other
•   A detailed field examination of this process can help us
    better understand how and what information is
    collected by them
•   It also yields insights into the potential consequences of
    increasing their frequency (e.g., through a regulatory
    mandate for rotation of auditors)




                       Sunder: Engaging                      3
                           Auditors
Client-Auditor Courtship
•   Courtship: interaction between clients and auditors
    before they engage
•   Interaction deliberate, individualized, dynamic,
    strategic, under significant uncertainty, and
    consequences for both parties
•   Parties develop their expectations, and then judge the
    quality and suitability of their prospects
•   What information is sought and gathered during the
    courtship?
•   Justifying regulation of auditing: audit quality is opaque,
    the end users of audit are at an informational
    disadvantage and have difficulty assessing audit quality
•   How does a client view audit quality?
•   What does the client (and audit committee) know about
    the quality of audit services at the time of engagement?
•   How well does the auditor understand the prospective
    client? While client selection and risk management are
    important functions for an audit firm, how, and how well,
    do these processes work?
•   Is the risk profile of the prospective client also largely
    unknown and opaque to the audit firm during the client
    selection process?




                        Sunder: Engaging                      4
                            Auditors
    A Case for Case Study
•   Case study of exchange of information between the
    prospective auditor and client
•   How do managers, the board and auditors express their
    desires, formulate responses, distinguish themselves
    and make distinctions to seek a preferred engagement?
•   Different disciplinary approaches to the same
    phenomenon choose different abstractions to attain
    useful insights.
•   Case study: opposite of abstraction—delving into rich,
    diverse, complex interactions of auditors and clients
    (raw, grassroots observations, possible inputs into
    traditional analyses)
•   Supplement observations with discussion and
    conjectures
•   Detailed direct observation and analysis of a single
    instance of phenomena is a rich tradition in social
    sciences (Graham 1971, Cuban missile crisis; Downs
    1967, bureaucracies)
•   Importance of direct observation in an institutionalized
    discipline such as accounting (Cooper and Morgan,
    2008; Cushing and Loebbecke, 1986 on audit methods
    of accounting firms; Hirst and Koonce,1996 on audit
    analytical procedures; and Hilton and O‘Brien, 2009 on
    asset impairment)
•   Methodological has room for case studies of small
    samples that permit the details to bring the
    phenomenon to life and potentially yield newer insights
    (different from large sample studies)


                       Sunder: Engaging                    5
                           Auditors
    Unintended Consequences of
          Auditor Rotation
•   Obtained access to confidential records from
    companies
•   Client requests for proposal for audit services (RFPs),
    board and audit committee minutes, and executive
    notes
•   Audit firms (bid documents submitted in response to
    RFPs)
•   18 interviews (client executives and bidding audit
    partners)
•   Both RFP processes arose from auditor rotation
    mandate
•   Case 1: mandatory engagement partner rotation led the
    client to invite bids and, ultimately, to un-mandated
    change of audit firm.
•   The audit committee chair and the CFO: availability of
    senior audit partners with relevant industry experience
    due to rotation in their own firms was a major factor
•   Opportunity to assess the potential benefits (or lack
    thereof) from rotation of the audit partner/firm
•   Extend prior studies of forced audit partner rotation
    (GAO Reports 2004; Kaplan and Mauldin 2008)
•   Case 2: a government organization implemented
    decided to put the audit up for bid every three years
•   Illuminate potential unintended consequences of
    mandatory rotation: perennial courtship of clients
•   Both cases study prestigious, profitable, growing, and
    successful organizations targeted by Big-4 firms

                      Sunder: Engaging                    6
                          Auditors
                    Findings
•   New details of engagement, absent in public records
•   Useful to examine assumptions; new variables for
    models
•   New questions, thought and conjectures about
    engagement
•   Documenting the process (for auditors, managers,
    boards, and regulators)
•   Understanding how information is produced,
    exchanged and used in auditing
•   Rich materials for nuanced class discussion of
    accounting and governance
•   Involvement of the audit committee in the auditor
    selection, although management runs the process
•   Management the main producer and gatherer of
    information and controls what, when, and how it is
    distributed to the audit committee and auditors
•   Auditors struggle to differentiate themselves through
    their technical expertise
•   Relationship building is critical to success in the
    courtship process
•   This effort raises concerns about independence
•   Significant differences in proposed audit fees
•   Audit partner rotation can catalyze the RFP process;
    rotation influenced client satisfaction with the incumbent
    auditor, freed up expert resources at other audit firms,
    and fueled auditor courtship practices.



                       Sunder: Engaging                      7
                           Auditors
                    Method
• Approval from the research ethics board
• Each participant (and firm) signed a consent form,
  promised confidentiality, a copy of the written
  research report, and the opportunity to suggest
  corrections of any errors or misunderstandings
• Obtained RFPs (Client 1, >$10 Billion assets,
  listed on TSX with NYSE sub, regulated,
  financially healthy) sent to the Big-4 audit firms
  (Auditors 1-4) in Appendix A
• Obtained bid documents directly from all Big-4
  audit firms, releases authorized by local managing
  partners, Auditor 1 – incumbent, Auditor 2 –
  winning bidder, Auditor 3, and Auditor 4.
• Interviewed the CFO and the chair of the audit
  committee (60-90 minutes each, generally
  following a standard script given to them in
  advance (Appendix B), recorded on audio tape
  and hand notes, within 6-12 months of completion
  of the RFP process
• After clearance from the CFO, the MDs of the four
  audit firms identified the proposed lead
  engagement partner; interviewed each proposed
  engagement audit partner (sometimes with the
  local managing partner) who oversaw the
  development of the bid documents; guiding script
  in Appendix C; taped and handwritten notes


                   Sunder: Engaging                8
                       Auditors
                      Method
•   Follow up with Client 1 to clarify our initial observations
    from last four steps; obtain additional records: minutes
    of board and audit committee meetings on auditor
    selection; outline of the client‘s prescribed RFP
    process; written correspondence between the audit
    committee and management; completed evaluation
    forms assessing the auditor bids; and management‘s
    completed scorecard recording deliberations about
    each audit firm
•   As a cross-check on our observations in this case,
    steps a-d were repeated for an audit put up for bid in a
    government-funded organization (Client 2: a large,
    complex, prestigious organization with a budget of
    more than $2 Billion in 2008)
•   RFP to all Big-4 firms plus one national firm, received 3
    Big-4 bids. Obtained bid documents from all bidders
    and conducted interviews with the three proposed
    engagement partners (sometimes local MD
    participated) as well as three executives from Client 2.
    The interview process commenced within weeks of
    auditor selection
•   Supplemented our observations from our primary and
    secondary cases by obtaining additional, recent RFPs
    for audit services of five other organizations, together
    with the written bids submitted by one Big-4 audit firm
    on all five potential engagements (Clients 3-7). These
    organizations included one publicly traded company,
    one private company, and three public sector
    enterprises.
•   The documents and information gathered in the study
    are summarized in Table 1
                        Sunder: Engaging                      9
                            Auditors
    RFP and the Bid Process
•   Client 1‘s RFP describes the engagement, lists auditor
    selection committee members, and outlines the
    communication process, including deadlines for
    responses and page limits. Respondents required to
    address specific topics, including firm expertise,
    transition, rapport, cultural fit.
•   Client 2‘s RFP presents a similar but more detailed
    template, requiring a more rigid structure in auditor
    proposals
•   Clients 3-7 RFPs had similar specifications.
•   In all cases, signing a confidentiality agreement,
    auditors were invited to an information acquisition
    process. Clients 1 and 2 provided access to private and
    public documents in a ―data room‖ and made
    executives available for discussion. Clients 3-7
    provided less information (much smaller firms)
•   Client 1‘s RFP Process overview: After auditor‘s
    information acquisition phase, the auditors submitted
    their written proposals. Written proposals were read,
    summarized, compared with pros and cons, and
    evaluated by management. Management (i.e., the
    CFO) then provided the proposals and the summary to
    all selection committee members. Auditors invited to
    give oral presentations to the selection committee. The
    selection committees deliberated on the proposals. The
    selection committee made its recommendation to the
    audit committee, and the audit committee then
    approved and submitted the recommendation to the
    board. The selected auditor was notified of
    appointment; losing firms debriefed
•   Table 2 details the timeline and records of the RFP
    process for Client 1Sunder: Engaging                  10
                           Auditors
  Table 1:Documents and Information Gathered
                             Client 1             Client 2   Clients 3 -7
Type of           Publicly held                Public        Includes 1
organization      Large                        sector        publicly
                  Complex                      Large         held
                  Industry subject to          Complex       Moderate
                  regulation                                 size and
                                                             complexity
Request for       YES                          YES           YES
Proposal (RFP)
obtained

RFP incl udes     YES                          YES           NO
information
available in
“data room”
Proposal (bid)    Auditor 1 - Incumbent        Auditor 1 -   Auditor 1
documents         Auditor 2 – Winner           Winner
obtained          Auditor 3                    Auditor 2 –
                  Auditor 4                    did not bid
                                               Auditor 3 –
                                               Incumbent
                                               Auditor 4
Other             Meeting minutes              None          None
documents         Auditor selection decision  -
obta ined from    making aids (e.g.,
management        evaluation forms and
                  scorecard)
                  Correspondence among
                  management, board
                  members and auditors
Interviews with   CFO         Sunder: Engaging CFO           None    11
                                   Auditors
management                                      Accounting
                                                Manager
 Guidelines for analysis
• One author summarized the interviews
  transcripts, RFPs, and bid documents,
  categorizing it into broad themes.
• Two independent coders, both Canadian CAs,
  independently read all materials and coded them
  into the same summary table. Coding differences
  were discussed and resolved by the two
  independent coders.
• The five results sections of the paper discuss the
  elements coded in this table using the framework
  of the RFP to organize our observations
  (selection, information acquisition, expertise,
  relationships, and fees)
• We developed expectations of the information
  produced and requested in the clients‘ RFP
  documents based on available practice
  guidebooks: (1) a sample request for proposal
  letter for CPA services from the AICPA (2004),
  and (2) a Canadian Big 4 audit firm guide to RFP
  preparation (Audit Firm 2007).
• Interviewed a Big-4 firm audit partner from the
  U.S. This partner had been identified by the U.S.
  firm as being experienced in responding to RFP‘s
  for audit services. We use this interview to explore
  similarities and or differences between U.S. and
  Canadian practices


                    Sunder: Engaging                12
                        Auditors
      1. Auditor Selection
•   The regulations (OSC, TSX, NYSE) require the
    company to have an audit committee: selecting and
    recommending the independent external auditor to the
    board of directors is a key function
•   AICPA: ―With the passage of the Sarbanes-Oxley Act
    (SOX), audit committees now ‗own‘ the relationship
    between the independent auditor and the organization‖
    (AICPA Audit Committee Effectiveness Center).
•   We therefore expected the audit committee to run the
    selection process.
•   Studies of audit committees in Canada (Gibbins et al.
    2001) and the U.S. (Beasley et al. 2009) have found
    that many audit committees play a limited and
    sometimes only a ceremonial role, not a substantive
    and engaged monitoring role
•   Management Takes the Wheel
•   But management controlled most aspects of the
    process, including all communication and the flow of
    information to both the audit committee and the bidding
    firms
•   The RFP was sent out to auditors by the CFO with the
    approval of the audit committee.
•   Examination of Clients 2-7 and interviews with audit
    partners suggests this practice of having CFOs
    establishing contact and controlling the interaction with
    prospective audit firms is currently the norm in Canada.
•   The process we observed is inconsistent with the ―best
    practice‖ we had expected (audit committee contacts
    prospective audit firms, cover letter jointly signed by the
    CFO and audit committee chair, suggested by the
    AICPA guide)        Sunder: Engaging                      13
                            Auditors
     …Auditor Selection
• Client 1: Auditor selection committee of six
  managers (CEO, CFO, etc.) listed by name and
  position with audit committee chair plus
  remaining four as anonymous members
• Client 1‘s VP Finance named single point of
  contact for auditor inquiries and site visits, no
  contact information provided for the audit
  committee chair or members; respondents
  prohibited from any direct contact with officers or
  directors of Client 1 under threat of disqualification
• The chair, (no other members) of audit committee
  met auditors individually for half hour each
• No meeting between the prospective auditors and
  the audit committee without executives present
• The CFO in follow up interviews: such a meeting
  would have taken place if the audit committee
  was dissatisfied by the selection process or
  management‘s choice
• The AICPA (2004) guide lists management (e.g.,
  CEO, CFO), and the AC chair to meet prospective
  auditors
• The audit firm RFP guide (Audit Firm 2007)
  includes all audit committee members to meet
  prospective auditors
• The U.S. audit partner: impractical to require all
  audit committee members to be available for
  meetings with prospective auditors given
  geographical challenges. The actual practice of 14
                     Sunder: Engaging
  Client 1 is closer to that of the AICPA guide.
                         Auditors
      …Auditor Selection
•   Signed confidentiality agreement; auditors access to a data
    room with public and private client information (see RFP for a
    list)
•   Executives available for interview could be interviewed by
    appointment.
•   The auditors submitted written proposals (maximum of 30
    pages) to provide audit services to Client 1.
•   The written proposals evaluated and summarized by the CFO
    and VP Finance. Copies of the written proposals, together with
    the CFO‘s summary evaluation provided to members of the
    selection committee
•   Auditors invited to make oral presentations to all members of
    the selection committee
•   The selection committee discussed each presentation for half
    hour; each member ranked the four firms on an evaluation and
    to evaluate each bidder on a three-point scale, on a set of
    relevant attributes that were aligned with the RFP (e.g.,
    knowledge of business, people, relationship, organization fit,
    commitment, audit methodology, other services, and fees).
•   The audit committee chair and other selection committee
    members provided additional qualitative comments on each
    auditor to the CFO, and asked for management‘s recomm.
•   The CFO, in collaboration with the VP Finance, compiled the
    evaluation form, as well as a scorecard for each firm with
    detailed criteria and justification for every score.
•   The six management members of the selection committee
    held a meeting, selected the top two candidates, and then
    examined the CFO‘s summary of the pros and cons of the two
    finalist firms to arrive at a recommendation.
•   The audit committee accepted the recommendation, and
    forwarded its recommendation to the board and the
    shareholders.
•   The timeline in Table 4 shows a six-day interval during which
    auditors made their presentation to the selection committee
                             Sunder: Engaging
    and the board approved the change of auditor, with the audit 15
                                  Auditors
    committee and board meetings being held on the same day.
     …Auditor Selection
• Client 1 audit committee followed the letter of the
  Ontario Securities Commission rule of
  recommending the auditor to the board, but its
  influence on the selection process can hardly be
  described as ―owning‖ the process as suggested
  by the AICPA guide
• All auditors interviewed said that their level of
  engagement with the audit committee of Client 1
  was do usually drive the process.
• A review of RFP documents from Clients 2-7 also
  shows the process being coordinated by
  management, primarily the CFO.
• The AICPA guide and Audit Firm RFP guide also
  recommend that management control and
  coordinate the flow of information, and the
  scheduling of interviews and meetings.
• The RFP and interviews of Client 2 indicate that
  the audit committee‘s involvement was limited to
  attending the ―all hands meeting‖, where all
  bidding firms asked questions of management
  before developing their proposals. The audit
  committee authorized the information that could
  be shared in the RFP process but did not weigh in
  on the selection of a new auditor.
• For Clients 3-7, one of which is publicly traded,
  the audit committee chair (but no other member)
  was involved in the selection process.
                    Sunder: Engaging               16
                        Auditors
    Audit committee oversight of
            the courtship
•   Audit committees‘ ―ownership‖ of the auditor-client relationship
    limited to comfort with the process, not as decision makers
•   Participate in meetings with prospective audit partners, assess
    their suitability, and offer their assessment. This level of
    involvement is consistent with the substantive practices
    reported by Beasley et al. (2009)
•   Confirm Gendron and Bédard (2006): an auditor conjectures
    that management drives the selection process by giving the
    audit committee a recommendation and supporting
    arguments; an audit committee member does not think that
    the committee would not have the power to reverse
    management‘s choice of auditor
•   U.S. field study, Cohen, Krishnamoorthy and Wright (2009):
    management is perceived as the dominant force in auditor
    hiring/firing decisions; audit committee and auditor identify the
    committee‘s responsibility on paper, but recognize
    management‘s influence in practice.
•   One of the audit partners in our study lamented that the audit
    committee had asked management for a recommendation; felt
    more appropriate to ask management for its assessment, with
    the final decision by the audit committee.
•   Our field study suggests that management controls the
    courtship process, with the audit committee in the passenger
    seat. Management sets the destination, they read the auditors‘
    signs and signals, and the audit committee signs off at the end
    of the journey safely executed. The Audit Committee Chair
    summarized the process as follows:
•   ―Our AC saw its primary role as one to ensure that a robust
    selection process was followed by the company, where the AC
    had substantive oversight, and, had the final decision. We
    didn't see this role as requiring, or necessarily being
    compatible with, the AC actually conducting all work.‖


                          Sunder: Engaging                         17
                              Auditors
    Information Acquisition
•   The RFP document outlines the information the client
    wants about the auditor and uses in its decision
•   These specifications closely reflected the available
    guidelines
•   Included: experience and expertise relevant to client
    industry; transition and continuity plans; audit and
    quality control approach; dispute resolution process;
    fees; and references.
•   Absent although recommended by the AICPA and
    Audit Firm guidelines: relationships and infractions with
    regulators; identification of large clients lost, with
    reasons; and peer review reports.
•   Both Client 1 and Client 2 used of decision aids, such
    as evaluation forms and scorecards, to assess and
    rank the bidding firms on predetermined criteria.
•   Extensive documents available to prospective auditors:
    annual and quarterly reports to shareholders,
    confidential documents (such as business and strategic
    plans, Board and committee minutes, and investment
    listings).
•   We had expected that the auditors would be highly
    interested in risk related documentation made available
    to them by the clients. The academic literature on the
    market for audit services reports that auditors integrate
    risk information into engagement pricing and client
    acceptance decisions (Adams, Bedard and Johnstone
    2005; Johnstone and Bedard 2003; Johnstone, 2000;
    Bell Landsman and Shackelford, 2001; and Simunic
    1980).
•   Yet, the auditor interviews suggested a different
    approach to information acquisition.
                       Sunder: Engaging                   18
                           Auditors
    Management Gives a Little,
          Gets a Lot
•   Client exerts much effort in acquiring information to
    reduce uncertainty about the auditor
•   Auditor hesitates to request client for information and
    submits proposal in the face of uncertainty.
•   The client defines audit quality in their own terms,
    establishes criteria and collects information about
    auditors from multiple sources, develops a clear picture
    of auditor
•   Managers of Client 1 quite assertive in obtaining the
    answers they were interested in
•   For example, they wanted to know the auditors‘
    reasoning and process for arriving at critical accounting
    estimates and judgments. They also wanted to make
    sure that there were no accounting policy differences
    between the company and the auditor, especially any
    that might lead to a restatement
•   Client 1‘s audit committee chair: ―We were very
    concerned about making sure that they believed they
    knew enough of the company‟s results, and the
    company‟s transactions, to ensure that they did not
    view the risk of restatement as being even a low
    probability. We wanted to clear that outright from the
    start.‖
•   The U.S. audit partner: prior to engagement, wants to
    understand significant transactions and the accounting
    for such transactions to reduce the likelihood of a
    potential restatement; felt confident that he could
    identify potential accounting issues by reviewing the
    public filings by the client, and discussing significant
    transactions with management; discuss restatement
    concerns during the proposal process, so as not to
                         Sunder: Engaging                    19
                              in the
    surprise the client later Auditorsengagement.
       Meticulous Client, Hungry
                Auditor
•   Client 1 interested in any lawsuits against the auditor and
    whether they would distract the auditor and /or create a
    reputation risk for the company.
•   Management contacted all client references, and even
    reached out through informal channels to other industry
    colleagues who were not included in bid references, to form an
    impression of each prospective audit partner.
•   Management did not ask for results of Canadian Public
    Accountability Board (CPAB) reports, which are issued
    privately to registered audit firms.
•   Using a combination of formal information obtained through
    the RFP process, and informal information from outside
    sources, management could visualize how their relationship
    with the auditor would unfold.
•   Auditors bidding on Client 1 did not pay attention to internal
    control weaknesses of the client reported in the most recent
    management letter from the incumbent auditors.
•   Interviews: many clients do not provide such information.
    Auditors did not investigate the details of accounting
    adjustments and reporting issues raised by the incumbent
    auditor, nor whether these items were booked or carried
    forward to future periods.
•   Although management letters issued by the incumbent Auditor
    1 for the last two years were available to them in the data
    room, two of the three other auditors stated that they had not
    read the management letters.
•   Auditors showed limited interest in an assessment of the
    internal auditing system of Client 1, and assumed internal
    audit must be adequate since the company was subject to
    review by the industry regulator
•   Auditors in both Canada and the U.S. felt that they could not
    ask Client 1 for certain items, such as the schedule of
    unadjusted errors, although they had the right to do so.
    Instead they asked indirect questions to try and gauge the 20
                            Sunder: Engaging
    number of items that came up for negotiation
                                Auditors
    Private and Public Clients
•    Auditors did not ask to see correspondence with the
     federal regulator on accounting related issues, any
     internal reports that had been prepared for the board
     and audit committee, or breakdowns of how the
     incumbent auditor allocated staff time
•    One audit partner explained it as follows: ―Company X
     would be such a big frog in a small pond for any of the
     audit firms that I can understand why they probably all
     had the attitude of „we don‟t care how ugly it is, we want
     the brand and we want the business.‟”
•    Client 2 made significantly more detailed information
     available to the auditors. The data room included
     budget breakdown of hours for each account and
     location, control weaknesses and management‘s
     implementation status on improvements, and issues
     raising audit concerns. This information accessibility is
     a circumstance of the client being a public sector
     organization
•    To ensure an even playing field, one common question-
     and-answer session was organized at Client 2‘s office,
     where all bidding auditors were asked to submit written
     questions ahead of time, and a single set of responses
     was provided. The auditors were reluctant to ask
     questions in this common forum out of fear of giving
     away strategic information to competitors. Instead, they
     relied more on examination of documents provided by
     management, and less on the personal contact we
     observed to be dominant in the case of Client 1.



                        Sunder: Engaging                     21
                            Auditors
    Bargaining Power Imbalance
•   The difference in the information acquisition by client
    and auditors may be attributable to the auditors‘ lack of
    bargaining power vis-à-vis management
•   Probing a client too deeply on sensitive issues during
    courtship may generate enough antagonism to lose the
    hoped-for engagement
•   Some aspects of auditors‘ apparent lack of interest in
    what we had thought was critical information might be
    attributable to their prior due diligence, overall
    assessment of the client as being low risk, and the
    desirability of this client. But, they could not have
    known the unadjusted errors through their own
    independent investigations.
•   Auditor efforts were centered on personal meetings and
    conversations to understand the clients, to build a
    relationship, and to sell themselves.
•   Less attention on papers, and more on cues from
    interpersonal encounters with the management
•   It appears that to assess and manage risk, the auditors
    focused on assessing senior management‘s candor,
    forthrightness, competence and integrity.
•   The results from interview with the U.S. audit partner
    was very similar to those conducted with Canadian
    partners.
•   The proposals indicated a good understanding of how
    to serve the client prospectively; relying on their
    personal judgment from interacting with key
    management personnel


                       Sunder: Engaging                    22
                           Auditors
    Client to Auditor Feedback on
             RFP Process
•   Client 1‘s RFP listed post-selection debriefing
•   Interviews with the auditors: extensive knowledge about
    their competitors; well-informed about their competitors‘
    proposals and the client‘s assessment of each
    competitor
•   Some auditors even offered their opinions on the
    viability of competitor proposals.
•   A similar detailed and informative feedback process at
    Client 2
•   In both Canada and the U.S., the bidding audit partners
    sought and received feedback from the client (why‘s for
    both winners and losers)
•   Uncertain about the reasons for providing such
    debriefing by the client, and its consequences; not
    common in most areas of the economy
•   Linked to (1) the client‘s desire to gain advantage by
    promoting intense competition among auditors; (2)
    clients retaining losing firms for other professional
    services and gleaned additional feedback from
    interaction with the client outside of the formal RFP
    debriefing
•   This level of debriefing also suggests that it is difficult
    for an audit firm to develop proprietary strategies or
    response formats. Bids from audit firms appear very
    similar (making it harder for audit firms to differentiate
    themselves) partly because of structure imposed by the
    client, but also as a result of common knowledge
    amongst firms from receiving client feedback about
    what features were effective and ineffective in the bid
    process.             Sunder: Engaging                       23
                             Auditors
                    Expertise
•   All clients demanded auditor expertise in their RFPs
    (AICPA and Audit Firm guidelines)
•   In all seven cases, auditors responded by assembling
    an audit team of relationship partners, engagement
    partners, managers, and senior/junior audit staff.
•   All senior personnel, had industry specific experience
    spelled out in detail
•   Client 1: introduced industry specialists from head
    office, tax partners, and the lead IT partner; dedicated
    5-12 pages to staff profiles, lengthy descriptions of their
    industry-specific experience, firm‘s industry-specific
    market share regionally and globally; industry-specific
    clients as references; all bids listed thought leadership
    resources in the firm (forums, websites, roundtables, e-
    mail alerts and industry specific publications)
•   Client 2: similar approach to demonstrating auditor
    expertise, although emphasis on local office resources
    and IT qualifications, in line with the client‘s needs
•   These strategies consistent with common practices
    suggested by the U.S. audit partner: importance of
    demonstrating expertise through industry leadership
    and knowledge resources.
•   RFPs demanded, and audit bids conveyed expertise
•   Prior research: audit team composition (expertise and
    seniority) important elements of client satisfaction
    (Behn et al. 1997); satisfaction a determinant of audit
    fees (Behn et al. 1999)
•   Firms use experts to impress a desirable client, and not
    only to respond to a client‘s risk characteristics (Bedard
    and Johnstone, 2004; Johnstone, 2000)
                        Sunder: Engaging                     24
                            Auditors
          All Auditors Look Good
•   All auditors appear to be suitable prospects for the
    client
•   Differentiation by commitment of senior personnel to
    Client 1 (national CEO attend the oral presentation and
    designated as the relationship partner; location of
    expertise and involvement of experts in the industry)
•   Auditor 3 proposed to move a partner with industry
    experience, and Auditor 2 proposed to move a senior
    manager with industry experiencefor Client 1.
•   The U.S. audit partner also suggested moving a partner
    to the head office city as a way of showing
    commitment.
•   Client 1 valued membership of audit firm personnel on
    advisory committees in the relevant industry
    associations or regulatory advisory bodies, and all
    auditors responded by including team members with
    such credentials in their proposals, and included
    industry peers of Client 1 as references.
•   All Big-4 bidders had the technical expertise to perform
    a satisfactory audit of this client and closely bunched in
    management and audit committee scores for industry
    expertise; Client 1‘s CFO:
•   ―We all unanimously felt that every firm could do the job
    very well with the team they had presented.‖
•   The same sentiment was expressed by the selection
    committee of Client 2.
•   During interviews, an audit partner frustrated that the
    standardized accounting environment made
    differentiation difficult, reducing it to price competition
                        Sunder: Engaging                     25
                            Auditors
     Management Seeks Softer
     Dimensions of Expertise
•   Client 1 RFP explicitly asked auditors to provide a
    ―Summary of relevant training and/or networking
    opportunities (with locations) offered to your clients.‖
•   The RFP guides (AICPA; Audit Firm) list involvement
    with other clients in the industry, and other participants
    in the value chain (e.g., customers, suppliers) as
    desirable considerations
•   Networks keep auditors at the forefront of technical
    knowledge, but also provide a platform for management
    views and issues to be given due consideration by
    regulators;
•   Auditor‘s potential as a connecting link to opportunities
    with industry competitors and regulators dominate
    concerns about conflict of interest and leakage of
    proprietary information
•   Auditor seen as client‘s leads to new customers as well
    as competitors with whom Client 1 wanted to
    collaborate
•   Audit engagement viewed as more than an audit—a
    relationship that brings opportunities for business
    advantage and future connections.
•   Management wishes not stated in RFP: respnsiveness
    to management; Client 1 wanted to be treated like a
    first tier client; Client 2 wanted its own complexity to be
    appreciated, and overcome geographical challenges
•   Expressed through subtle cues in meetings and
    interviews (responsiveness, cultural fit, chemistry,
    sharing wavelength)
                        Sunder: Engaging                     26
                            Auditors
    Building Relationships
•   “There are processes and there are structures, but
    people do business with people.”---a Big-4 Managing
    Partner
•   The interviews: the issuance of the RFPs by Clients 1
    and 2 was not the beginning of the courtship
•   Client 1: all invited auditors knew of the coming RFP
•   All non-incumbent audit firms had active business
    development processes through which they had
    already targeted Client 1, and visited senior managers
    (CFO/CEO) of Client 1 in their offices, or invited them
    to dinner and presentations (express their interest,
    exchange information, and develop personal rapport)
•   Client 1 and Client 2: auditors established prior
    relationships from providing other services or through
    involvement in business and social communities.
•   Early courting targeted at Client 1‘s senior managers
    (i.e., the CEO, CFO), and not the audit committee, as
    the key decision makers in this process
•   The U.S. audit partner also indicated that the key
    people who would be involved in courting would be the
    CFO and Controller, and sometimes the CEO, even
    though the appointment formally made by the audit
    committee
•   Prior research: weakly linked relationships (i.e., past
    client experience) with auditor satisfaction (Behn et al.
    1997).
•   Our cases: importance of relationships for clients and
    auditors; effort in building them; possible impact on
    auditor independence.
                       Sunder: Engaging                     27
                           Auditors
         Rapport and Cultural Fit
•   The neutralization of expertise shifts importance to rapport and
    cultural fit in the courtship process, stated in RFP
•   Interviews indicated that the Client 1 had been dissatisfied with
    the ―bedside manner‖ of the newly rotated engagement
    partner
•   Clients 1 and 2 clearly expressed in their RFP documents and
    interviews that demonstrating rapport was paramount to
    auditors winning the engagement.
•   Imitating the style, dress, appearance, and manners of those
    one wishes to please is a deliberate strategy as old as human
    history (Gremler and Gwinner 2008).
•   Auditors also employ such tactics in courting their clients.
•   Written proposals mirror the clients: client references whose
    positions closely matched those of selection committee;
    majority of the references provided were executives of other
    clients; over 75% of the references that auditors provided to
    Client 1 were from CFOs, and only one audit committee chair.
•   Interviews with audit partners confirm that the audit firms
    identify the key decision makers, and then choose referees to
    match the roles of the key decision makers
•   The U.S. audit partner indicated that the key variable in
    choosing references was to identify the key decision maker
    and then choose a peer (the CFO, in this case) as the key
    reference.
•   Auditors considered references from clients as being very
    credible and having a significant influence on the hiring
    decision.
•   Auditors adopting client mottos and slogans in
    proposals and presentations (fit, culture, thinking,
    attitudes, chemistry, resonance of values)



                          Sunder: Engaging                        28
                              Auditors
          Past Guides the Present
• Auditors‘ reputation with the clients wins new
  ones
• Reputation and past experience with their client
  was a major deciding factor with Clients 1 and 2.
• The AICPA guide even recommends that clients
  include in the RFP a request for the auditors to list
  major clients recently lost and explain the loss.
• For Client 1, the CFO and the audit committee
  chair interpreted auditor reputation as the
  engagement partners‘ personal reputation with
  other CFOs
• Client 1: Do other CFOs classified the auditor as
  either rigid (undesirable) or flexible (desirable).
  Rigid was sometimes described as issuing edicts
  (undesirable) versus discussing rationale
  (desirable) for an accounting treatment
• The audit committee chair said: ―The most
  important issue for us is their reputation; that we
  can discern by references on how they operate
  with other companies in our industry.‖
• No evidence of reputation with investors or any
  third party users of financial statements being a
  consideration.
• Auditors‘ reliance on references from current
  clients to get future clients is potentially troubling
  for auditor independence; this reliance may bias
  auditors to gain favor with clients to serve as
  references.
                     Sunder: Engaging                 29
                         Auditors
  Independence of Auditor
• What does it mean to be an independent auditor?
• Absence of a prior relationship?
• Yet, in both Canada and U.S., having a prior
  relationship with the prospective client is an
  important qualification to be on the audit team
  (Client 1 and 2).
• Interviews reveal that including people with pre-
  existing relationships with the client in the audit
  team is a critical factor in engagement
• This relationship preference not limited to the
  engagement partner but percolates down all the
  way to junior auditors
• Audit firms sees auditing as a ―relationship‖
  business, and interested in assigning people to
  their teams who already knew management and
  had a cordial relationship with the prospective
  client
• U.S. partner revealed that auditors seriously
  consider the RFP process as a relationship-
  building opportunity to establish a connection with
  client even if the there is no immediate
  engagement
• Another channel for the prospective auditor‘s past
  to influences success in the present courtship

                    Sunder: Engaging               30
                        Auditors
Demonstrating The Locus
of Decision Making Power
•   Clients consider the decision making powers of the
    local team vis-à-vis the head office
•   RFP guides (AICPA and Audit Firm) recommend asking
    the auditor to describe dispute resolution in the audit
    approach.
•   Client 1: preferred to have senior audit expertise
    available locally to handle and resolve all complex
    accounting issues by the engagement partner.
•   Clients impatient with rules imposed by distant
    bureaucracies and would rather deal with a person they
    know; understand the thought process of the partner
    who makes final decisions
•   After the collapse of Enron and Arthur Andersen, LLP,
    this insistence on local partner autonomy is a sensitive
    issue for Big-4 audit firms; partners in Canada and the
    U.S. thought it was reasonable for the client to express
    a preference for engagement partner autonomy.
•   One reasons given for the collapse of Arthur Andersen
    was the transfer of authority for making the final call on
    disputed technical issues from its vaunted headquarters
    unit of experts in Chicago to the local engagement
    partners (Toffler 2003)
•   Apparently, the headquarters unit serve several
    important functions, including: (1) having a high level of
    expertise available to all audit engagements; (2)
    enforcing a uniform application of judgment across the
    firm; and (3) protecting the engagement partners from
    undue pressure from client executives by allowing them
    a shelter behind the opinion of the headquarters
    experts when differences with client executives arise 31
                         Sunder: Engaging
                           Auditors
Local vs. HQ Decisions
•   Interviews: Clients want local partner autonomy
    including all complex accounting decisions
•   Auditors 1 and 4 emphasized the seniority of their
    proposed audit partner and provided a description of
    their process to identify, discuss, and communicate
    such issues without promising local control
•   Auditors 2 and 3 promised that final and binding
    decision on complex accounting matters will be made
    by the engagement partner. One firm promised that
    they ―do not hide behind the head office.‖
•   One of the latter two firms: a communication and not
    substantive issue, because of firm‘s normal
    consultation and quality control processes (the
    engagement partner would be a single point of contact
    for all accounting discussions with the client, not an
    important concession)
•   The second firm indicated that the audit partner did, in
    fact, have autonomy and could decide if and when
    (s)he needed to consult head office
•   The client cannot know whether the local partner or the
    head office makes the decision; they can only identify
    the person who negotiates with them on a contentious
    item and communicates the firm‘s position
•   Prior research: involvement of technical partners in the
    negotiation is beneficial to the audit firm (Gibbins et al.
    2001).
•   Auditors appear to be split on the benefits of involving
    head office technical experts in communication and
    negotiation
•   Local partners‘ share of engagement revenue exceeds
    their share of the cost of reputation damage, audit firm
    faces a difficult agency problem that clients seek to
    exploit              Sunder: Engaging                     32
                            Auditors
                  Audit Fees
•   Client 1‘s RFP invites bids for two years, constraining
    auditor ability of auditors to low-ball the fees
•   Incumbent fee for the current year as a benchmark
    (reflects knowledge of the client, assessment of risks
    and the extent of audit work necessary for the
    engagement)
•   Best reflects the literature on determinants of audit
    pricing (Bedard and Johnstone 2004; Johnstone and
    Bedard, 2001; Choi et al. 2008)
•   Beck and Barefield (1986), suggest that bidding
    auditors‘ judgments about the prospective engagement
    will vary
•   Client 1: bids for total engagement fee varied from
    materially below to materially above the current fee
•   The successful bid materially below the current fee,
    although the management had stressed repeatedly that
    fees were not a major motivation for issuing the RFP.
•   Incumbent was expected by others to bid (publicly
    disclosed) current fee, and this common knowledge
    was accurate.
•   Client 1: the RFP preference for greater involvement of
    senior auditors, the low (winning) bidder proposed
    higher staff hours and lower partner/manager hours
    relative to incumbent‘s current time budget
•   Interviews: Client 1 audit chair and CFO concerned that
    a low bid meant the auditor might not have understood
    the amount of work involved. The CFO said: ―For Audit
    Firm 2, we were not sure on how they would do
    because the audit fee was too low…I think they may
    have underestimated the work they needed to do on a
    couple of our subsidiaries.‖
                       Sunder: Engaging                  33
                           Auditors
           Hours and Rates
•   Auditor 3 bid marginally lower, and Auditor 4 bid
    marginally higher than the current fee for substantially
    more partner/manager hours and more than double the
    staff hours
•   The AC chairman of Client 1‘s did not consider the
    Auditor 4 hours credible
•   RFP solicited hourly rates, but did not factor in the
    clients decision
•   Auditor 4 may have misinterpreted the importance of
    this number, and undermined his own credibility
•   Client 2: auditors believed fees would be a major
    determinant; management indicated it wasn‘t a key
    factor; the incumbent bid 100% of current fee, and the
    rest bid just below that
•   All audit firms developed a table breaking down fees by
    rank and financial statement cycle, (e.g., sales,
    receivables), and auditors claimed that estimating the
    total required hours was important in determining their
    fee, though Client 1 appeared not to have paid much
    attention to these numbers
•   RFP indicated that future billings for audit fees had to
    identify each person by rank, hours worked, and the
    hourly rate quoted in the proposal (bid).
•   This practice supported by RFP guides
•   Conjecture: Breakdown of total quoted fee into hourly
    rates, hours, and task components may be a client
    strategy to reduce auditors‘ degrees of freedom,
    serving as additional bargaining and monitoring
    instrument, facilitating cross-checking the auditor
    billings against the accepted bids
•   Client 2 requested a blended hourly rate, which
                         Sunder: Engaging                    34
    facilitated comparison of bids
                              Auditors
      Multiple Bids from a Single
                Auditor
•   Auditor 4 submitted bids for three different levels of
    audit service; middle bid for marginally higher than the
    current fee, the other two bids were priced at materially
    above and marginally below the current fee
•   The premium priced service: more experienced partner
    and staff on the engagement, and many other ‗non-
    audit related‘ items such as more frequent meetings ,
    more ―free‖ time to consult on issues, more customer
    satisfaction discussions, and more industry and
    strategy related discussions.
•   The discounted fee option required extensive work
    commitment from Client 1‘s internal audit department,
    less frequent meetings and fewer advisory discussions.
•   This endogenous appearance of multiple bids for
    service of variable quality/quantity in a regulated
    domain raises several intriguing questions.
•   What should be the regulatory stand on such variety of
    service levels? Auditor bundling its consulting services
    into the audit fee? Parallels in other learned
    professions?
•   Unclear how widespread this strategy is in practice, as
    we did not observe fee levels in any other cases
    studied
•   Unexpected appearance of this practice provokes some
    rethinking about pricing of audit services; one way in
    which auditors might convey that their service is not a
    commodity, and it documents the perception that
    auditors hold of their value to the client. We extend the
    literature on audit pricing by presenting this auditor-
    centric perspective on audit pricing, beyond the lines of
    studies on Big 4 firm premiums (Choi et al. 2008),
                         Sunder: Engaging                    35
                              client
    rather than focusing onAuditors determinants.
           Gradation of Partners
•   What does the gradation of partners imply for the value
    of the audit firm and its brand?
•   Informal identification of audit managers and staff by
    seniority and industry experience (e.g., industry expert
    senior manager) is common;, this type of differentiation
    in pricing among partners by experience is uncommon
•   In professional service markets where services are sold
    to retail customers, it is common to see differential
    pricing based on the service provider‘s experience
    (Lasik eye surgery, the price increases with the number
    of operations done by an eye surgeon)
•   Can audit firms do better by such partner-level
    differentiation, as opposed to relying on the firm‘s brand
    name and a single billing rate for all audit partners
•   In this case, the multiple billing options created
    confusion, and the attempt to very explicitly price the
    experience of team members backfired and
    undermined the credibility of the audit firm.
•   When commenting on the multiple prices proposed,
    Client 1‘s AC chair said: ―I think at the end result that
    was probably a mistake on their part…I don‟t care for
    that type of stuff… I didn‟t think the idea of having an
    audit firm where the service you get depends on how
    much you pay is really the impression that they would
    want to give.‖
•   In the courtship process, setting fees is a way for
    auditors to demonstrate their value and signal their
    commitment to the clients. Some of the competing audit
    firms were aware of the three price strategy used by
    Auditor 4 and disapproved of it.

                       Sunder: Engaging                     36
                           Auditors
                     Discussion
•   Client 1 developed an elaborate RFP, and engaged its
    internal stakeholders in meeting and rating exercises to
    determine its preferred auditor
•   In the courtship, Client 1 wanted, expected, and
    received numerous gestures and promises from the
    audit firms, who were all seeking to show their
    commitment to providing good client service and
    responsiveness to management‘s needs
•   Management knew its definition of audit quality—a
    partner with a reputation for working well with
    management, and visible signs that they would be a
    preferred client, and how to get the relevant information
    needed to make its assessments and rank the
    prospective audit firms
•   Audit quality was not opaque for management.
•   Audit committee was involved in the selection process;
    they relied on management to collect, evaluate and
    summarize information. At the end of the auditor-client
    courtship, the audit committee asked for, received, and
    endorsed the recommendation of management.
•   The auditors had also done their homework, and based
    their pre-courting behavior on the desirability of
    becoming the auditor of Client 1.
•   Courtship emphasized demonstrations of auditor
    commitment to the client, audit reliance on CFOs of
    current clients to vouch for them, and the inability of
    auditors to access crucial information for assessing risk
    (e.g., schedule of unadjusted errors).
•   Significant power imbalance between the client and
    prospective auditors; auditors had surprisingly limited
    understanding of the underlying quality of internal
    controls, the disagreements (if any) between the client37
                         Sunder: Engaging
                             and the
    and incumbent auditor,Auditors unadjusted errors they
    might inherit
                  Discussion
•   Client‘s quality of internal control and future accounting
    problems remained opaque and not well understood
•   Suggest that new auditors are not only more vulnerable
    to fraud (Treadway 1978), but also to errors in early
    years (Johnson et al. 2002).
•   Auditors‘ lack of proper risk assessment during
    engagement ; Placing high reliance on management
    reputation and oral representations is a risky strategy
    for audit firms.
•   Client perception that all four audit firms had the
    capacity to do a good job on engagement neutralized
    the auditor efforts in assembling teams of experts for
    engagement
•   Auditors ifferentiate themselves through (1) pre- and
    post-RFP courting of the client (bringing the national
    CEOs); being responsive to client desires for local
    expertise, offering to move an industry specialists;
    mirroring the client in presentations of self and selection
    of referees; promising engagement partner autonomy;
    and lowering their fees
•   Inability of audit firms to create a clear expertise-based
    differentiation and reliance on referrals from CFOs of
    current clients may undermine the profitability and
    independence of audit firms.
•   Auditor rotation has often proposed as a way of
    preserving the independence of auditors from their
    clients. Rotation of auditors (partners or firms) will bring
    a fresh set of eyes (Tan 1995), fewer blinders, and
    uproot entrenched relationships that may override their
    objectivity and independence. There are also well-
    known arguments against rotation as time and
    repetition can help the auditor develop perspective and
                           Sunder:
    expertise (Arel et al. 2005)Engaging                       38
                             Auditors
                     Discussion
•   A counterargument from this field investigation: process
    of engagement, combined with competition in the
    market for audit services, weaken auditor
    independence, promotes perennial courtship by audit
    firms, and repeat this weakening of independence more
    often. Rotation affords clients the opportunity to shop
    for opinion and avoid auditors who they don‘t like
    without having to fire them (regulatory red flags)
    Rotation pressures on auditors to demonstrate
    commitment and responsiveness to the management of
    prospective as well as current clients (to win new
    engagements)
•   Reforms and regulations often based on the mistaken
    assumption that the relevant information for making
    decisions is readily available, perhaps even as common
    knowledge
•   Regulatory debates about auditor independence ignore
    the selection processes, the level of information
    asymmetry between contracting agents and the
    difficulty in gathering the relevant information for
    making good decisions are underestimated
•   Lack of alignment of private incentives of contracting
    agents and their public duties adds an additional layer
    of friction in this process (Jamal and Sunder 2009).
    Dispersed information and conflicting incentives can
    undermine most well-intentioned regulatory reforms
•   Auditor rotation requirement will drive small- and
    medium-sized audit firms out of the market, and
    increase the concentration of the audit market
•   Questions: Does increasing the frequency of courtship
    through mandatory audit rotation serves to increase the
    welfare of shareholders? The only benefit to
    shareholders from the process documented here was a
                          Sunder: Engaging                  39
    lower audit fee, which is offset by transition costs
    incurred by Client 1 Auditors
    Thank You.

Shyam.sunder@yale.edu
www.som.yale.edu/facult
       y/sunder
        RFP: Introduction
•   Introduction
•   X Company …At close to $XX billion in balance sheet
    assets and more than Y years of strong growth
    including XX percent over the last 12 months, the
    necessity to continually review business strategies and
    risks is paramount in ensuring sustained success.
•   Of late, there have been multiple and significant
    changes in accounting standards, regulations and the
    XYZ industry that have all combined to add a great deal
    of complexity to our business with no slowdown in
    sight. To name a few, the recent adoption of XYZ
    accounting standards, the upcoming implementation of
    the XYZ Industry regulations and the transition to IFRS
    over the next 5 years represent major changes to our
    business organization.
•   Against this backdrop, X company has determined it is
    timely to review the availability of financial services
    audit expertise and resources in Canada and is
    undertaking a Request for Proposal (RFP) for
    independent audit services. This document outlines the
    general principles of the RFP. We highlight that our
    preference would include the most senior expertise to
    be based in Region of Canada, but it is not essential.
•   All information will be provided to you in strict
    confidence. Please complete the RFP Acceptance and
    Confidentiality Agreement (Appendix A) and return it to
    Mr G as outlined in the Communications Section. The
    supplemental information package will not be
    distributed prior to the receipt of the RFP Acceptance
    and Confidentiality Agreement. Please note this RFP is
    being extended to Deloitte, Ernst & Young, KPMG and
    PricewaterhouseCoopers.Engaging
                          Sunder:                           41
                           Auditors
    RFP: Scope of Services
•   Your audit should be conducted in accordance with Canadian
    Generally Accepted Auditing Standards and will commence
    with the period ending year end date. The audit will be for the
    consolidated financial statements of X company.
•   The mandate will include a review of the interim financial
    statements for each of the interim periods. For greater clarity,
    the first interim review would be for the three months ending
    Date.
•   The mandate also includes:
•   The statutory audit of Subsidiary 1, 2, and 3;
•   Communication of weaknesses found in internal controls
    during the course of the financial statement audit;
•   Analysis of accounting questions and issues in the context of
    the audit;
•   Review of Management‘s Discussion and Analysis, Annual
    Information Form, and Annual Report to the extent required by
    professional standards;
•   Review of quarterly report to shareholders (including financial
    statements and notes);
•   Specified audit procedures for Subsidiary 4 as required by the
    New York Stock Exchange;
•   Specified audit procedures and audit report on specified
    financial information for X Company as required by Industry
    Association;
•   Review of audit working papers of Subsidiary 5‘s external
    auditors (Audit firm);
•   Audit of financial statements of Special entity (non-
    consolidated special purpose entity).
•   Note: The RFP does not include the audit of Subsidiary 5.



                          Sunder: Engaging                        42
                              Auditors
             RFP: Process
              Description
• The RFP process will be conducted in the
  following phases:
• Information gathering;
• Submission of a written offer of services;
• Presentations; and
• Selection.
• The Audit Committee has established a Selection
  Committee to oversee the RFP process. The
  Selection Committee is comprised of:
    –   A, Chair of the Audit Committee,
    –   Members of the Audit Committee,
    –   B, Chief Executive Officer,
    –   C, Chief Financial Officer,
    –   D, Head Internal Auditor,
    –   E, Senior Vice President,
    –   F, General Counsel, and
    –   G, VP Finance
• The Selection Committee will make
  recommendations to the Audit Committee and the
  Audit Committee will select the external auditor for
  recommendation to the Board and shareholders.

                      Sunder: Engaging              43
                          Auditors
    RFP: Communications
•   The RFP process will be open and equitable for all firms. We will
    endeavor to ensure all firms have access to the same information. No
    information in one proposal will be disclosed to another firm in the RFP
    process.
•   Management will be available to answer questions throughout the
    process. To aid in the information-gathering phase, a schedule of
    availability with management will be established.
•   To help ensure an efficient and equitable proposal process, Company X
    is requesting that each proposing firm comply with the following general
    guidelines:
•   All inquiries relating to this proposal process, including arrangements
    for site visits and interviews, are to be directed to G, VP Finance. He
    will be your single point of contact. Contacting any other member,
    officer or director of X Company could lead to disqualification. G‘s
    contact information follows:
•   Contact information
•   To facilitate the review of the Company‘s information, a data room will
    be established at X Company‘s corporate office located at address. A
    list of information that will be available in the data room is attached as
    Appendix C.
•   In addition, the following individuals will be available to meet with and
    provide each firm with their perspective of the critical business issues
    facing Company X. The individual interviews will be restricted to 30
    minutes, unless an alternative time frame has been agreed upon in
    advance, and no more than three people from your firm should attend
    each interview. The VP Finance will coordinate the interviews.
•   B, Chief Executive Officer,
•   A, Chair of the Audit Committee,
•   C, Chief Financial Officer,
•   G, VP Finance,
•   F, General Counsel,
•   H, Treasurer,
•   D, Head Internal Auditor,
•   I, Senior Vice President, Operations,
•   J, Chief Technology Officer.

                             Sunder: Engaging                              44
                                 Auditors
    RFP: Proposal Form and
           Content
•   Eight (8) copies of the submissions are to be received
    by the undersigned no later than date. Your
    submissions should be no longer than 30 pages, plus
    curriculum vitae for proposed team members. The
    submission should contain the following:
•   1.     Detailed description of audit approach
•   Approach
•   Methodology for assessment of risks and establishing
    audit approach
•   Risks identified
•   Scope and approach of work (including adoption of new
    significant accounting policies)
•   Objectives
•   Split of work among various locations and corporate
    functions
•   Communication with audit committee, including all
    communications required by X Company‘s Audit
    Committee Terms of Reference
•   Engagement Letter
•   Breakdown of audit hours for X Company audit broken
    down by major financial section for field staff (i.e. cash,
    …, other assets) with partner and manager time noted
    in total.
•   Use of Internal Audit
•   Quality control
•   Independence policy
                        Sunder: Engaging                     45
                            Auditors
    RFP: Proposal Form and
           Content
•   Expertise
•   Experience and location of the audit team members
     – Partners
     – Senior Managers / Managers
         • Industry expertise by location
         • Brief summary of Industry 2 audit and assurance experience
         • Availability and location of resources for complex accounting
           questions
              – Functioning and size of professional practice groups
              – Availability of local resources
•   Confirmation that the firm is duly registered with the
    Canadian Public Accountability Board (CPAB)
•   3.    Transition plan (if applicable)
•   Description of transition plan to ensure minimum
    disruption to X Company management
•   Description of team experience in transition of audits,
    references if applicable
•   4.    Independence
•   Confirmation of your independence from X. Company.
•   If confirmation not available, then an explanation of the
    process to ensure independence.
•   5.    Fees (including any separate fee for CPAB)
•   An itemized fee quotation for the year ended Year 1.
•   An itemized fee estimate for the year ended Year 2
•   An itemized fee estimate for each entity and
    requirement listed.

                           Sunder: Engaging                            46
                               Auditors
    RFP: Proposal Form and
•
           Content
    References
•   The Firm shall provide a list of clients (minimum three (3):
    maximum five (5)) that are significant Companies in Industry X
    who are currently major accounts of the Firm for services
    similar or identical to the Services outlined in this RFP. The
    firm will describe how the services provided to these
    references are similar to the services proposed to X Company.
•   The Firm must include the client‘s company name, address,
    contact name, telephone number and e-mail address, and the
    length of the association. The Firm‘s references will be
    contacted.
•   7.     Tax
•   We would like you to address your view on the nature and
    extent of work that you could provide for tax compliance or tax
    planning activities.
•   8.     Other services offered by your firm
•   We would like your proposal to include an overview of the
    other services offered by your firm, remaining independent.
    Overview could include:
•   Listing of relevant publications available
•   Summary of relevant training and/or networking opportunities
    (with locations) offered to your clients
•   9.     Presentation
•   The objective of the presentation is to allow you to present
    your offer for services, respond to the questions from the
    Selection Committee and allow us to meet your engagement
    team. Presentations to the Selection Committee are expected
    to be scheduled for Date with the Board decision to follow on
    Date.
•   We request that your oral presentation not exceed 60 minutes.
    After your presentation, thirty minutes will be allotted for
    questions and discussion.
                         Sunder: Engaging                        47
                             Auditors
        RFP: Expectations
•   Throughout the auditor/client relationship we expect:
•   An open and professional rapport with direct access to
    decision makers for all accounting/auditing matters
•   An efficient and effective risk-based audit process
•   Significant and relevant industry experience of the members of
    the audit team
•   As partners or managers assigned to the engagement change
    over time, the firm will agree to provide resumes of new
    personnel to ensure that each have the requisite technical
    knowledge and industry expertise to conduct a thorough and
    efficient audit
•   All billings will be cleared in advance of submission. All billings
    should provide a detailed description of the work performed
    and a summary of the hours and rates billed by person.
•   The annual audit plan will be reviewed with X Company and its
    Audit Committee in sufficient detail to allow X Company to
    understand your audit approach (including the assessment of
    significant risks) and efficiently prepare for the audit process.
•   Timeline
•   RFP request letters sent to firms.Day 02.
•   Return of RFP Acceptance and Confidentiality AgreementDay
    7
•   Distribution of Supplemental Information packageDay 7
•   Data room availabilityDays 7-35
•   InterviewsDays 35-36
•   Receipt of submissionsDay 51
•   Presentation to Selection CommitteeDay 81
•   Board approves selectionDay 87
•   Communication of decisionDay 88
•   Debrief for firmsDays 98-102.


                           Sunder: Engaging                          48
                               Auditors
 RFP: Acceptance and
Confidentiality Agreement
•   RFP Acceptance and Confidentiality Agreement
•
•   To: C, Chief Financial Officer
•   Fax: X Company
•   We accept the request to present a proposal to
    provide external audit services to the X Company
    . We agree to keep in confidence all information
    received by us in connection with the proposal
    process, including the Supplemental Information,
    not to disclose it to third parties, not to use it for
    any other purpose than for the proposal, and to
    destroy all paper and electronic information in the
    event that our firm is not selected to be the
    independent auditor as a result of this proposal
    process.
•   Firm Name:
•   Partner:
•   Contact Information:
•   e-mail:




                      Sunder: Engaging                   49
                          Auditors
 RFP: Supplemental Information
    (To be provided on receipt of signed RFP Acceptance and
                   Confidentiality Agreement)

1. Organization structure
2. 200X Annual Report, Annual Information Return and
    Management Information Circular.
3. Q3 200X Report to Shareholders
4. Data room details and arrangements
5. List of statutory audits and most recent financial statements
6. Appendix C
7. Information to Be Available in the Data Room
8. Organizational Charts
9. Corporate structure
10. Executives
11. Finance
12. Internal Audit
13. Corporate Office
14. 200X Strategic Plan; 200X Business Plan
15. Consolidation worksheet (and entries) as at Date, 200X
16. Operating Manual
17. Board and Committee Minute Books
18. Accounting Policy Manual
19. Certification Project flowcharts for key controls
20. Quarterly financial reporting disclosure framework
21. Timeline for Interim and Annual Audit
22. Internal Audit Scope and Plan
23. Overview of IT Systems
24. Risk reports
25. Asset listings
26. Year-end working paper files – X Company, Subsidiary 1 and
    2
27. Additional information
                         Sunder: Engaging                      50
                             Auditors
    Table 2: Timeline of RFP process for Client 1
Event                   Timeline Description of records              Made
                        (Days)   produced                            available to
                                                                     researchers
                                                                     (indicated
                                                                     by *)
1. Client sends RFP     0          RFP document                      *
   request letters to
   firms
2. Firms return RFP     7          Agreements from 4 firms
   acceptance and
   confidentiality
   agreement
3. Client distributes   7              Organizational
   supplemental
   information                          information
   package
                                       Financial reports and
                                        shareholder
                                        communications
                                       Data room details and
                                        arrangements
4. Data room            7-35           Organizational
   availability
                                        Information
                                       Strategic and business
                                        plans
                                       Policy manuals
                                       Internal control reports –
                                        IT, Internal Audit,
                                        flowcharts
                                       Board meeting minutes
                                   Refer to RFP in Appendix A for
                                   complete list
5. Prospective firm     35, 36     n/a
   and client
   interviews
6. Receipt of           51       Sunder: Engagingproposal (bid) *
                                   Audit firm                                 51
   submissions                     documents
                                     Auditors
7. Read,                           Table listing Pros and Cons of *
Interview Script for Clients
•   I. Background
•   Q1. How long did your previous audit firm audit you before you
    put out the request for Proposal (RFP) ? _______Years.
•   Q2. Why did you decide to put the audit up for bid? Please list
    the reasons in the order of importance (highest first):
•   1.
    __________________________________________________
    _________
•   2.
    -------------------_____________________________________--
    -----------------------________________________
•   3.
    -------------------_____________________________________--
    -----------------------________________________
•   Q3. When you issued the RFP, what chance did you think the
    incumbent firm had of retaining the audit engagement?
    ------------------______ %
•   Q4. How did you decide which audit firms to invite to bid on
    the engagement?
•   Q5. Did you consider any non Big-4 audit firms? Explain why
    or why not.
•   Q6. On a 9 point scale, how would you rate your 2007 audited
    financial statements ____
•   Where 1= extremely conservative, 5 = average, and 9 =
    extremely aggressive
•   Q7. What other professional services do you procure through
    external contracts (e.g. actuarial, valuation, legal), and are
    these service providers subject to periodic bidding (every n
    years)?
•   Service ProviderAverage Periodicity of Being Put up for Bid (in
    years)Not Put Up For Bid1.2.3.4.5.


                         Sunder: Engaging                        52
                             Auditors
Interview Script for Clients
•   II. Characteristics of Audit Firm That Can be Observed Externally
•   Q8. On a 9 point scale, how important is the size of the audit firm?
    ______
•   Where 1= not at all important, 5 = average, and 9 = extremely important
•   Q9. Do you perceive any differences in the size of the bidding firms, or
    are they all about equal in size? Explain
•   Q10. On a 9 point scale, how important is the reputation of the audit
    firm? ______
•   Where 1= not at all important, 5 = average, and 9 = extremely
    important.
•   Q11. Do you perceive any differences in the reputation of the bidding
    firms, or do they all have about the same reputation? Explain
•   Q12. On a 9 point scale, how important is the independence of the
    audit firm? ______.
•   Where 1= not at all important, 5 = average, and 9 = extremely
    important.
•   Q13. Do you perceive any differences in the levels of the
    independence of the bidding firms, or are they all about equally
    independent? Explain
•   Q14. On a 9 point scale, how important is the industry expertise of the
    audit firm? ____
•   Where 1= not at all important, 5 = average, and 9 = extremely
    important.
•   Q15. Do you perceive any differences in the industry expertise of the
    bidding firms, or do they all have about the same level of Industry
    Expertise? Explain
•   Q16. On a 9 point scale, how important is the audit fee quoted by the
    audit firm? ______
•   Where 1= not at all important, 5 = average, and 9 = extremely
    important.
•   Q17. Do you perceive any differences in the audit fee quoted by the
    bidding firms, or are they all approximately equal? Explain
•   Q18. How important are the following attributes of the audit firm?
    Please rank the listed categories from 1 (Very important), 2 (Medium
    important) or 3 (not important).
•   Rank (1, 2 or 3)
•            The size of the audit firm
•                              the audit firm
             The reputation of Sunder: Engaging                            53
•            The independence of the audit firm
                                     Auditors
•            The industry expertise of the audit firm
Interview Script for Clients
•   III. Characteristics of Audit Firms That Can Be Observed
    Internally :Accounting Policy Choice Issues
•   Q19. Are there a set of key accounting issues that you wish to
    know the auditors opinion on? Explain. Do bidding firms differ
    on these issues?
•   Q20. What characteristics do you desire in an engagement
    partner? How do bidding firms differ on these characteristics?
•   Q21. What characteristics do you desire in a relationship
    partner? Do bidding firms differ on these characteristics?
•   Q22. Do you have a preference for who makes the final call on
    accounting policy issues, and do bidding firms differ on this
    issue?
•   Q23. Do you care about the location of expertise required to
    deal with complex accounting issues (local, regional,
    national)? Explain.
•   Q24. Do you perceive any differences in the other services
    (e.g., tax) offered by bidding firms, or are they all have about
    the same level of other services? Explain
•   Q25. How important are the following attributes of accounting
    policy issues? Please rank the listed categories from 1 (Very
    important), 2 (Medium important) or 3 (not important).
•   Rank (1, 2 or 3)
•           The audit firms position on critical accounting issues

•         The engagement partner
•         The relationship partner
•         Who makes the final call on accounting issues

•         The location of expertise
•         The other services offered by the audit firm


                          Sunder: Engaging                        54
                              Auditors
Interview Script for Clients
•   IV. Characteristics of Audit Firms That Can Be Observed Internally:
    Audit Methodology
•   Q26. Audit Committees often ask auditors about their ―Audit Approach‖
    and ―Risk Approach.‖ What do you learn from answers to such
    questions, and how do the bidding firms differ from each other in this
    respect?
•   Q27. Audit Committees often ask auditors to specify the total number of
    audit hours worked, as well as a breakdown of audit hours by staff level
    and by functional area. What do you learn from this breakdown of audit
    hours, and how do the bidding firms differ on this audit production
    process?
•   Q28. Audit committees often ask auditors about quality control
    processes, and availability of expert advice from the professional
    practice group, as well as from the local office. What do you learn from
    responses to these questions, and how do bidding firms differ in terms
    of how expertise is made available to you?
•   Q29. Since you have an internal audit department, what do you want to
    know regarding the relationship between external and internal auditors,
    and how do the bidding firms differ in terms of their proposed interaction
    with your internal audit department?
•   Q30. What type of tax and other services would you be interested in
    purchasing from the external auditor? How do bidding firms differ in the
    quality or type of such services they can offer?
•   Q31. How important are the following attributes of audit firms? Please
    rank the listed categories from 1 (Very important), 2 (Medium important)
    or 3 (not important).
•   Rank (1, 2 or 3)
•            The Audit Approach
•            The Audit Production Plan (Total audit hours and breakdown by
    staff level)
•            Availability of Expert advice locally and from other offices

•          Engagement with Internal Audit department
•          Provision of tax and other services




                             Sunder: Engaging                              55
                                 Auditors
Interview Script for Clients
•   V Relationships with the Audit Firm
•   Q32. How do you assess your interpersonal ―fit‖ with the audit
    firm? How do bidding firms vary in terms of their fit?
•   Q33. How do you assess responsiveness of the audit firm to
    your needs? How do you define ―responsiveness‖ and how do
    the bidding firms vary in terms of responsiveness?
•   Q34. How do you assess intention and /or ability of the audit
    firm to maintain staff continuity? How do bidding firms vary on
    this attribute?
•   Q35. How do you assess skepticism of audit partner / team?
    How do bidding firms vary on this attribute?
•   Q36. How do you assess ability of the audit firm to deal with
    regulators and other external agents in the firm‘s
    environment? Do you perceive a difference in bidding firm‘s
    ability to deal effectively with external regulatory bodies?
•   Q37. How important are the following relationship attributes?
    Please rank the listed categories from 1 (Very important), 2
    (Medium important) or 3 (not important).
•   Rank (1, 2 or 3)
•           The Interpersonal fit
•           Responsiveness of the audit firm
•           Staff continuity
•           Skepticism of Audit partner / team
•           Deal effectively with regulators and other external
    agents




                         Sunder: Engaging                        56
                             Auditors
Interview Script for Clients
•   VI. Other Questions
•   Q38. What additional information / type of questions do
    audit firms ask when they meet you? Do bidding firms
    vary in the nature or amount of questions asked?
•   Q39. What do you learn from the presentations that is
    incremental to the written responses provided by the
    audit firms?
•   Q40. What (if anything) really stood out about each
    bidding firm?
•   Q41. What was the key factor(s) that led to the choice
    of your new auditor?
•   Q42. Who came second? Explain
•   Q43. Compared to purchasing other professional
    services (e.g., legal, actuarial, valuation) how
    comfortable are you with assessing the quality of audit
    service you actually receive. Please use the 9 point
    scale below. Assessing quality of audit services is
    ______
•   Where 1= completely opaque and much more difficult
    to assess than other professional services, 5 =
    average, and 9 = extremely transparent and much
    easier to assess than other professional services.
•   Q44. Please provide a copy of a RFP for audit,
    actuarial, tax or any other service that you were
    involved in, and indicate what part(s) of this RFP you
    were involved in (or is the RFP mostly a standard
    template?).


                       Sunder: Engaging                  57
                           Auditors
         Interview Script for
               Auditors
•   I. Background
•   Q1. What do you like to see in a Request For Proposal
    document? Please list in order of importance (highest
    first):
•   1.
    ____________________________________________
    ________________
•   2.
    -------------------_________________________________
    ____-------------------------________________________
•   3.
    -------------------_________________________________
    ____-------------------------________________________
•   Q2. When a RFP is issued, on average what chance do
    you think the incumbent firm has of retaining the audit
    engagement? ------------------______ %
•   Q3. What additional questions would you ask the
    prospective client?
•   Q4. Are you able to glean any additional insight
    (beyond what was written in the RFP) into the
    motivation behind the RFP? If so how, and what do you
    think the motivation was for this company?
•   Q5. What part of your proposal response is standard,
    and what part is tailored specifically to the company?




                      Sunder: Engaging                   58
                          Auditors
         Interview Script for
               Auditors
•   II. Specific Responses on Your Proposal
•   Q6. How do you decide which people (and how many)
    to ―introduce‖ to the prospective client in your proposal?
•   Q7. How do you decide which other services (skills) to
    mention in your proposal?
•   Q8. How else do you convey your expertise?
•   Q9. How do you convey your responsiveness / fit with
    the client?
•   Q10. How do you decide what fee to charge?
•   Q11. What fee do you think the incumbent auditor will
    quote? Explain
•   Q12. What fees do you expect other bidding firms to
    quote?
•   Q13. Does your presentation convey new information
    or just re-emphasize your written proposal? Or is the
    presentation meant to convey something else?
•   Q14 Do you learn anything out of this process that will
    be helpful to you on future engagements?
•   Q15. Please provide a copy of a RFP for audit,
    actuarial, tax or any other service that you were
    involved in, and indicate how these RFP differ across
    services. Are all the RFP‘s just using a standard
    template or is there some significant adaptation done?




                       Sunder: Engaging                     59
                           Auditors

				
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