An Audit Engagement Letter solidifies audit arrangements between an auditor and the client. In addition to reducing liability risks, it also helps to limit the scope of the assurance engagement.
Any change to the terms of an engagement should be accompanied by a revised letter. This ensures that the client understands the impact on fees, risk and other issues.
Scope of Work
An engagement letter should clearly define the scope of work for the audit. This includes the financial statements that are being reviewed, the auditor’s responsibilities, and the objectives of the audit. Having this information clearly stated can help avoid misunderstandings and reduce the risk of liability claims. It also provides assurance to your clients that you are following your industry standards and that the audit will be performed as agreed upon in the letter.
In an audit of a group company, the letter should identify the parent or holding company and all subsidiary companies for which you are being appointed as auditor. If it is possible to share the same engagement letter for all companies in the group, this may save time and cost.
Lastly, the letter should include a statement of the extent to which the client agrees with the scope of the work described in the engagement letter. In addition, it should indicate the extent to which the audit is limited by exceptions or by non-auditing services.
It is a good practice to revise the letter annually. This can be done to reflect changes in regulations or standards, as well as a change in the client’s situation. It is also an opportunity to clarify any services that might be provided by the practitioner outside of the scope of the current agreement.
An engagement letter should clearly outline the fees associated with any audit, review or compilation services. It should also identify any additional services that may be provided in the future. For example, if an auditor or accountant discovers that a company has a serious problem that needs immediate attention, they can include in their engagement letter an agreement to provide the client with additional services at an agreed upon fee. This helps to avoid potential misunderstandings between clients and their accountants or auditors.
The letter should be addressed to the individual retaining or approving the engagement. In a corporation, this is usually the board of directors, but for a small business entity that does not have a board, the letter should be addressed to the owners. The letter should include the name of the entity, its fiscal year end and a brief description of the financial statements to be audited, reviewed or compiled.
It should also detail the basis for determining the fees, including the scope of work and the expected completion date. It should also state whether the fees will be a fixed fee or an estimate based on the expected number of hours required to complete the work and the billing rates of the firm employees assigned to the engagement. Some engagement letters will include indemnification or exculpation language in order to reduce the risk of malpractice claims against the auditors or accountants. However, this type of language should be carefully considered as it may be prohibited by some state laws.
Term of Engagement
A key part of an engagement letter is determining the length of time that you will work on the client’s financial statements. For an audit, this is typically a year. For a review or compilation, the term may be shorter.
Regardless of the type of work performed, an engagement letter should also include a disclaimer that limits your liability in the event of errors or omissions. It should also state the responsibilities of both the client and you as an auditor. For example, you might include a statement that the client will provide all necessary assistance to ensure that you are able to complete the work in a timely manner. You might also add a clause that prohibits the client from hiring any of your staff members until after you finish the work.
In some cases, clients will resist signing an engagement letter. A good way to reduce resistance is to explain to the client why it’s important for them to sign. You might also give them a copy of an engagement letter sample from a fellow professional to show them how an engagement letter should look. If you are unsure of how to draft an engagement letter, contact a contract-drafting firm such as Contractbook. This service will save you time and money, while providing a document that is reliable and will provide legal protection.
In addition to describing the scope of work and fees, an engagement letter should include provisions for how billing arrangements will be made. These may include payment terms, progress billing and confidentiality and data protection provisions.
The letter should also describe the responsibilities of management and the audit team. For example, the letter should state that management is responsible for establishing and maintaining internal controls, and that the auditor will evaluate those controls. It should also address how the auditor will communicate with the client, including the preferred communication mode and a contact person for information requests.
Finally, the letter should identify whether the audit is of a single entity or a group of entities and request confirmation from the board of directors of each company in the group that it agrees to the terms of the engagement. This is particularly important in situations involving parent or holding companies with subsidiaries.
The engagement letter should be signed by an authorized representative of the audit firm and returned to the client. Many auditors and accountants anticipate resistance from clients in signing an engagement letter, especially in new engagements or those involving long-standing relationships. Explaining the reasons for the letter with the client can help reduce that resistance. In addition, a brochure published by the AICPA on “Using the Engagement Letter to Minimize Legal Liability” can be useful in educating clients about the importance of signing engagement letters.