Engagement Letter vs Audit Report
Understanding the difference between an engagement letter and an audit report is essential for committees, treasurers and organisations because the engagement letter establishes the auditor’s responsibilities and scope of work before the audit begins, while the audit report provides the independent audit opinion issued after the audit has been completed.
Understanding the Difference
One of the most common questions clients ask during an audit is:
“What is the difference between the engagement letter and the audit report?”
Although both documents are important, they serve very different purposes in the audit process.
Understanding the distinction helps committees, treasurers, boards and management understand:
what the auditor is agreeing to do,
what management is responsible for, and
what the final audit opinion actually means.
What Is an Engagement Letter?
An engagement letter is issued before the audit begins.
It is the formal agreement between the auditor and the client that sets out:
the scope of the engagement,
responsibilities of management,
responsibilities of the auditor,
reporting framework,
audit timelines,
fees,
access to records, and
limitations of the audit.
In simple terms, the engagement letter explains:
“What work will be performed and who is responsible for what.”
What Is an Audit Report?
The audit report is issued after the audit work has been completed.
It contains the auditor’s opinion on whether the financial report presents a true and fair view in accordance with the applicable financial reporting framework.
“The audit report is the final outcome of the engagement and is attached to the financial statements.”
It is typically the document read by:
members,
regulators,
grant providers,
banks,
funding bodies, and
stakeholders.
The engagement letter and audit report work together — but they are not the same document.
The engagement letter starts the process.
The audit report concludes it.
Technical Note for Auditing Students: Audit Reports under ASA 700 and ASA 701
Audit reports explain the auditor’s independent opinion on whether a financial report has been prepared, in all material respects, in accordance with Australian Accounting Standards and the requirements of ASA 700 Forming an Opinion and Reporting on a Financial Report and ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report.
Introduction
The audit report is the final and most visible outcome of the audit engagement. It communicates the auditor’s opinion on whether the financial report has been prepared, in all material respects, in accordance with the applicable financial reporting framework.
Under Australian Auditing Standards, the format and content of the audit report are governed primarily by:
ASA 700 Forming an Opinion and Reporting on a Financial Report, and
ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report.
The auditor’s opinion is formed only after evaluating whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an acceptably low level.
Forming the Audit Opinion
The final stage of the audit requires the auditor to evaluate all audit evidence obtained during the engagement.
This process involves four key steps:
1. Evaluate the Audit Evidence Obtained
The auditor assesses whether the audit evidence gathered throughout the engagement is:
sufficient (quantity), and
appropriate (quality and reliability).
The objective is to determine whether audit risk has been reduced to an acceptably low level.
2. Evaluate Unrecorded Misstatements and Accounting Practices
The auditor evaluates:
identified misstatements,
whether uncorrected misstatements are material individually or in aggregate,
accounting estimates,
accounting policies, and
qualitative aspects of financial reporting.
This includes consideration of:
management bias,
aggressive accounting practices,
inconsistencies in disclosures, and
adequacy of explanations.
3. Evaluate Compliance with the Reporting Framework
The auditor assesses whether the financial report complies with the applicable financial reporting framework, ordinarily:
Australian Accounting Standards, and
International Financial Reporting Standards (IFRSs).
This includes:
recognition,
measurement,
classification,
presentation, and
disclosure requirements.
4. Evaluate Fair Presentation
Finally, the auditor evaluates whether the financial report as a whole achieves fair presentation.
This involves considering:
overall transparency,
understandability,
adequacy of disclosures, and
whether the financial report faithfully represents the entity’s financial position and performance.
Components of the Audit Report
ASA 700 requires the audit report to be in writing and contain specific mandatory components.
The major components include:
1. Title
The report must clearly indicate that it is the report of an independent auditor.
Example:
Independent Auditor’s Report
Independence is fundamental to the credibility of the audit opinion.
2. Addressee
The report is addressed to the intended users, commonly:
shareholders,
members,
trustees, or
those charged with governance.
3. Introductory Section
This section:
identifies the entity,
identifies the financial report audited,
specifies the reporting period,
refers to the notes and accounting policies, and
states that the financial report has been audited.
4. Management’s Responsibilities
Management is responsible for:
preparing the financial report,
maintaining internal controls,
selecting accounting policies, and
making reasonable accounting estimates.
Importantly, management — not the auditor — is responsible for the financial statements.
5. Auditor’s Responsibilities
The auditor’s responsibility section explains:
the audit was conducted in accordance with Australian Auditing Standards,
compliance with ethical requirements,
the concept of reasonable assurance,
risk assessment procedures,
consideration of internal controls,
evaluation of accounting policies and estimates, and
obtaining sufficient appropriate audit evidence.
The auditor also states that the evidence obtained provides a basis for the audit opinion.
6. Auditor’s Opinion
The opinion section is now presented first under ASA 700 (Revised).
The opinion states whether the financial report:
gives a true and fair view, or
is presented fairly, in all material respects.
The opinion may be:
unmodified,
qualified,
adverse, or
a disclaimer of opinion.
Key Audit Matters (KAMs)
One of the most significant changes introduced by ASA 701 was the requirement to communicate Key Audit Matters for listed entities.
KAMs are matters that, in the auditor’s professional judgement, were of most significance in the audit of the current period.
KAMs are selected from matters communicated with those charged with governance.
Examples may include:
impairment assessments,
revenue recognition,
valuation of complex financial instruments,
going concern assessments, or
provisions and estimates.
Required Elements of a KAM
Each KAM must explain:
why the matter was significant, and
how the matter was addressed during the audit.
The auditor must also refer to the related disclosure in the financial report where applicable.
KAMs improve:
transparency,
audit communication, and
user understanding of areas involving significant judgement and audit focus.
Example of a Key Audit Matter (KAM)
Key Audit Matter — Revenue Recognition
Revenue recognition was considered a key audit matter due to:
the high volume of transactions processed during the year,
the risk of incorrect cut-off near year end, and
the significance of revenue to the financial performance of the entity.
The auditor identified revenue recognition as an area of higher assessed risk because inappropriate recognition of revenue could materially impact the financial report.
How the matter was addressed in the audit
Audit procedures performed included:
evaluating the design and implementation of key internal controls over revenue processing,
testing a sample of revenue transactions to supporting documentation,
performing cut-off testing around year end,
reconciling revenue recorded to bank deposits and underlying records, and
assessing whether the accounting treatment complied with the applicable accounting standards.
The auditor also assessed whether the disclosures relating to revenue in the financial report were appropriate.
Going Concern Reporting
ASA 700 and related standards significantly enhanced auditor reporting relating to going concern.
The audit report now includes:
management’s responsibilities for assessing going concern,
the auditor’s responsibilities regarding going concern,
separate disclosure of material uncertainty relating to going concern where appropriate.
Where a material uncertainty exists and is adequately disclosed, the auditor includes a separate section titled:
Material Uncertainty Related to Going Concern
This is distinct from an Emphasis of Matter paragraph.
The auditor must also challenge the adequacy of disclosures in “close call” situations where events or conditions may cast significant doubt on the entity’s ability to continue as a going concern.
Basis for Opinion
The “Basis for Opinion” section follows the opinion section.
This section:
confirms compliance with Australian Auditing Standards,
confirms auditor independence,
references ethical requirements, and
states that sufficient appropriate audit evidence has been obtained.
The basis for opinion supports the credibility of the auditor’s conclusion.
Other Reporting Responsibilities
In Australia, auditors may also have additional reporting responsibilities, including:
reporting on the remuneration report under the Corporations Act,
independence declarations, and
ethical compliance statements.
Signature, Date and Address
The audit report concludes with:
auditor’s signature,
audit firm name,
date of the report, and
auditor’s address.
The report date is important because it indicates:
the completion of audit procedures, and
the date up to which subsequent events have been considered by the auditor.
Importantly, the auditor cannot sign the audit report until:
the financial statements have been approved and signed by management or those charged with governance, and
the client representation letter has been signed and returned to the auditor in accordance with ASA 580 Written Representations.
This is because the auditor’s opinion is based on management accepting responsibility for the preparation and presentation of the financial report, including confirming key representations made during the audit process.
Importance for Auditing Students
Auditing students should understand that the audit report is not merely an administrative document.
It represents:
the culmination of the entire audit process,
the auditor’s professional judgement,
the evaluation of audit evidence, and
communication of assurance to users.
The wording, structure and presentation of the report are governed closely by auditing standards because users rely heavily on the auditor’s opinion when making economic and governance decisions.
Understanding the audit report is therefore fundamental to understanding the purpose and value of external auditing itself.