An Audit Engagement Letter is a document that solidifies audit arrangements between the auditor and client. The document outlines the auditor’s responsibilities and limits any potential liability for the auditor.
It also helps prevent any misunderstanding between the auditor and client. It should be reviewed annually to ensure that it reflects the client’s circumstances.
Scope of the Audit
An audit engagement letter defines the scope of an auditor’s services to a client. It should include the objectives of the audit, as well as provisions for fees and responsibilities of both parties. It should also describe the type of report that will be delivered to the client. This helps reduce misunderstandings between practioners and clients regarding the form of the final audit report.
The objective of an audit is to express an independent opinion on the fairness of a client’s financial statements. An opinion is based on an examination of the financial statements in accordance with generally accepted accounting principles and international or national financial reporting standards. The scope of the audit is determined by determining what to examine, which elements are of concern and how to approach the review or examination of the financial statements. This process includes identifying and defining matters of concern; determining the nature of the procedures to be performed; and considering follow-up work and using the work of others.
The responsibilities of management can vary depending on the terms of the engagement, but should include providing access to records and personnel, maintaining an effective system of internal control, and making available the information required for the audit. If the entity is a corporation, the engagement letter should be addressed to the board of directors. In the case of a small business, the letter should be addressed to the owner or the person with similar authority.
Responsibility of the Auditor
The audit engagement letter outlines the responsibilities of both the client and auditor. Responsibilities for the auditor include conducting the audit in accordance with auditing standards and obtaining sufficient appropriate evidence to express an unqualified opinion on the fairness of the financial statements. Responsibilities for the client include providing access to the necessary information, records and personnel and maintaining an effective system of internal control. The audit also aims to reduce fraud by identifying instances of mismanagement or error and by helping investors make decisions based on the financial statements’ accuracy.
The forensic audit, which investigates possible wrongdoing by management and employees, requires a much different set of procedures than a regular financial statement audit. The engagement letter should describe the type of forensic audit to be performed, as well as any limitations that may apply.
If the client is a publicly-held company, the audit engagement letter should specify that if the accountant discovers material misstatements in the financial statements, she must report them. It is also wise to include a provision stating that the audit engagement will be terminated if the auditor believes that there are significant issues related to fraud or other irregularities. This helps reduce misunderstandings between the auditor and the company, which could lead to conflict of interest or other legal issues. It also makes it easier for the company to find another auditor or accounting firm if the existing relationship is not working out.
In addition to outlining the audit’s scope, an engagement letter outlines the fees associated with the audit and when you expect to receive payment. It may also include other terms and conditions, such as a hiring restriction that stipulates the client can’t hire your firm’s current audit staff. You can also include a provision requiring the client to pay for specialists you bring on board to help with complex issues.
The audit engagement letter also provides a clear understanding between the auditor and the client of their respective responsibilities and duties, thereby reducing any potential for misunderstanding or misinterpretation. It is recommended that a letter be obtained for each new client, and also for recurring service engagements. The letters should be dated and signed before the start of any services.
Indemnification, exculpation or damage limitation language can be included in the letter as long as state law allows it. In addition, the letter should also clearly indicate which individuals the CPA will contact at the company. This can prevent confusion if business owners disagree over questions or requests and it also helps the CPA to reduce any potential liability risk. A letter is usually sent to the board of directors or a senior management person, but it can be directed to the owner of a sole proprietorship or partnership entity.
Limitation of Liability
An engagement letter provides the opportunity to limit and define responsibilities between the client and CPA. Obtaining an engagement letter from every client is a good practice, especially in recurring service engagements, and some malpractice insurance carriers offer reduced premiums for firms that use them.
The letter should clearly identify the scope of services to be performed, any responsibilities of the client and any deadlines for the completion of work by the client. It should also contain a liability limitation clause and, where permissible, indemnification provisions. A cap on liability should be carefully drafted to avoid the possibility that a court could find it to be unenforceable.
It should be a separate section of the engagement letter from the other terms and conditions. In addition to a limitation of liability, it should also include a provision that the firm’s work product will not be disclosed to third parties without prior written consent from the client. This is important in jurisdictions where the concept of privity applies to establishing auditor negligence.
The letter should also have a severability clause, which says that if any part of the agreement is found to be invalid, the remaining terms will continue to be in effect. This can help reduce the likelihood that a claim will be dismissed on the basis of a nonenforceable term or a statute of limitations issue.