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Enhanced engagement letters.

A properly crafted engagement letter can establish an agreement with clients on the scope of services to be performed, each party's responsibilities, the timing of the work and the expected fees among other important issues.

Authoritative support for engagement letters is spotty, however. The auditing ("AU") section of the American Institute of CPAs Professional Standards is virtually silent on the subject, referring only to specified elements, accounts or items, reports on internal control and reviews of interim information. It offers no examples of engagement letters.

In contrast, the standards are explicit about the use of these letters for accounting and review services, perhaps because the risk of misunderstanding in this area is greater. Accounting and review ("AR") section 100.08 says, "The accountant should establish an understanding with the entity, preferably in writing, regarding the services to be performed." Helpful examples of engagement letters for both compilations and reviews are given in, respectively, AR sections 100.53 and 100.54. But the term engagement letter does not appear in either the tax practice ("TX") or the consulting services ("CS") sections of Professional Standards.


Although it is not an authoritative source, the AICPA Audit and Accounting Manual (AAM) provides helpful advice on engagement letters. AAM section 3130 contains an excellent discussion of matters the CPA should address and section 3175 illustrates the forms of letters appropriate for audits, compilations and reviews in various different circumstances.

Section 3130.05 advises use of such a letter for all engagements, including those with long-term clients that may be even more likely than new clients to bring a claim against a practitioner in the belief they are entitled to a higher degree of service. The manual suggests the CPA need not issue the letter more than once a year and that one letter may cover a variety of services.


AAM section 3175.02 contains a suggested letter for an audit engagement leading to an opinion on the financial statements. The exhibit on pages 55-57 illustrates a proposed letter that incorporates the provisions of the AICPA model, with some modifications, and includes additional topics that may benefit the accountant. Here are some of the key points to consider:

* The letter's second paragraph should limit the accountant's responsibility to a specified interval, a provision that may discourage a claim related to work allegedly or actually performed at another time. This paragraph also can describe the engagement's fundamental purpose. While this may seem elementary, it sets a logical stage for the contents to follow.

* The following section should explicitly recognize all the client's and auditor's major responsibilities. As the manual points out, such definitions are especially important for write-up work leading to the preparation of financial statements for a small, nonpublic client. Should the CPA offer advice about a choice among alternative accounting principles, it is essential that the client acknowledge its responsibility for the selection decision.

* The paragraph that concerns applicable standards is, of course, based on the standard auditor's report. The additional reference to detection risk alerts the client to the possibility that material misstatements will not be discovered due to the audit process's inherent limitations.

* The audit procedures section addresses the accountant's responsibility for obtaining an understanding of the internal control structure, underscoring for the client the importance of the controls for audit purposes. It also refers to the management's discussion and analysis section and other information appearing in documents containing audited financial statements. Once client personnel understand the requirements of AU section 550, they may be particularly careful to avoid inconsistencies between the "other information" and the statements.

* A paragraph on scope restrictions can impress on the client the importance of early notification to the auditor so the work can proceed smoothly without a significant fee increase. It also points out the seriousness of significant restrictions and may discourage the client from proposing such limits.

* A fraud detection paragraph can help limit the CPA's liability for failure to detect errors and irregularities. It explains the reason for setting boundaries on responsibility and assures the client that the firm's policy reflects professional standards. The paragraph delimiting the CPA's accountability for detecting illegal acts parallels the preceding one.

* The section on internal control reports offers assurance that any reportable conditions encountered will be reported to the appropriate level so needed improvements may be implemented. It also advises that an audit fringe benefit is a letter suggesting performance improvements, which is sure to please the client.

* A paragraph identifying the audit report's intended recipients may, depending on the jurisdiction, limit the CPA's liability for negligence to foreseen users.

In an effort to limit legal liability, some practitioners include a hold-harmless clause in their engagement letters, but the courts, for public policy reasons, generally view such provisions with disfavor and clients often resist signing letters containing them.

* The Audit and Accounting Manual advises firms to request printer's proofs of statements to guard against condensation of the financial statements, omission of footnotes, erroneous layouts and misstatements of figures that might occur in narratives or statistical tables.

* A paragraph on staffing continuity (when applicable) tells company personnel they won't have to acquaint a new team with the idiosyncrasies of their accounting system. Even on new engagements, a simple staffing statement alerts the client to the number of people it can expect and the amount of space it will need to provide. Client assistance affects timely completion as well as the estimated fee.

* Fees are an essential part of the agreement. The manual suggests the fee basis may be stated as a range, a schedule of hourly rates, standard per diem charges, a maximum fee or a flat fee. Start-up costs for new clients may be included separately.

* Inclusion of a binding arbitration paragraph is controversial. It may be in the CPA's interest, but, in some states, arbitration results probably can be used in later litigation. Firms should obtain written approval from their malpractice insurance carriers before including such a provision in the engagement letter, for the compromise of a claim may breach policy terms and result in denial of coverage. Finally, the client may resist signing a letter with this provision.

* Another potentially controversial provision covers the execution of a promissory note for past-due fees. This clause may be advisable for some clients with past collection problems.

* A detailed paragraph describing the timetable for field work and report delivery helps the client and the accountant fulfill their responsibilities.

* A concluding paragraph with an acceptance statement is crucial. The client representative must acknowledge that the letter constitutes a contract and agree that he or she has read and understood its terms when the agreement is consummated.

It's better to use engagement letters to solidify the understanding about contracted services than to treat the letters as marketing tools. A readable engagement letter might prove useful in court should a plaintiff argue that it was a complex document filled with technical jargon.


The same legal liability issues apply to different services, and misunderstandings may arise on any engagement regardless of type. It is easy to adapt a model audit engagement letter to any situation. For example, a letter for consulting work would refer to the Institute's statements on standards for consulting services. For financial projections, the accountant may incorporate a summary of the procedures used to test management's assumptions.


An accurate and all-inclusive letter should be tailored to each engagement. For first-time clients the accountant might discuss the proposed contents with company personnel in a taped conversation so the final product is mutually agreeable. For greater effectiveness, the writer may wish to consult professional staff at all levels during the drafting stage.

If a change in circumstances alters engagement scope or timing, an addendum should be prepared and the client's signature secured as quickly as possible. Examples include the necessity of performing supplementary tests due to unanticipated internal control weaknesses and the expansion of the engagement to include additional services. The manual provides a sample letter for such changes that is contained in AAM section 3175.04.


Engagement letters help avoid misunderstandings, establish a basis for planning the work and may well assist in litigation. A carefully formulated letter describing the details of the agreement between CPA and client should be prepared for every one of the firm's engagements.

Well-formulated engagement letters will provide benefits for CPAs and clients.


* A PROPERLY CRAFTED engagement letter is a legal contract that can establish an agreement with clients on the scope of services to be performed, each party's responsibilities, the timing of the work and the expected fees. * ALTHOUGH AUTHORITATIVE support for engagement letters is spotty, nonauthoritative and other sources offer advice on what should be included in a good engagement letter. * IT IS EASY to adapt a model audit engagement letter for different services. * IF A CHANGE IN circumstances alters engagement scope or timing, an addendum should be prepared and the client's signature secured as quickly as possible. Examples include the necessity of performing supplementary tests due to unanticipated internal control weaknesses and the expansion of the engagement to include additional services.

A proposed comprehensive audit engagement letter

SWIFT, MARCH & BEED Certified Public Accountants [Date] Mr. Thomas Thorp, President Anonymous Company, Inc. Route 32 Nowhere, New York 10000 Dear Mr. Thorp:
Purpose of letter This letter will confirm our understanding of the arrang
ements for our audit
 of [company name] for the year ended [date].
Engagement purpose We Will audit the company's balance sheet at [date], and
 the related stateme
 earnings and cash flows for the year then ended. in all
circumstances, our r
 will be limited to this period.(*) The purpose of our en
gagement will be to
 on the fairness of presentation of these financial state
ments in conformity
 accounting principles [or other comprehensive bases of a
Responsibilities The accuracy and completeness of the financial statement
s, including the rel
 of the company's management. Management also is responsi
ble for selecting so
 principles, and for maintaining an adequate internal con
trol structure. Our
 to express an opinion on the financial statements based
on our audit.
Standards applicable We will conduct our audit in accordance with generally a
ccepted auditing sta
to engagements standards require that we plan and perform the audit to
obtain reasonable as
 the financial statements are free of material misstateme
nts. The term reason
 risk that material monetary misstatements may remain und
etected and preclude
 accuracy and completeness of the financial statements. A
n audit includes exa
 evidence supporting the amounts and disclosures in the f
inancial statements.
 assessing the accounting principles used and significant
 estimates made by m
 evaluating the overall financial statement presentation.
 We believe our audi
 basis for our opinion.
Audit procedures Our procedures will include obtaining an understanding o
f the company's inte
 and testing those controls to the extent we believe nece
ssary. We also will
 fixed assets and inventories [if applicable], and will c
onfirm receivables,
 by corresponding with selected customers, suppliers, att
orneys and banks. In
 read the other information included in the annual report
 to stockholders and
 with the financial statements.
Management At the conclusion of our audit, we will request from you
 a letter attesting
representations truthfulness of representations and disclosures made to
us during the course
Scope restrictions If you are aware of any restrictions that might limit th
e scope of our testi
 them to our attention as soon as possible. Such restrict
ions, if significant
 an unqualified opinion.
Responsibility for Generally accepted auditing standards require us to desi
gn our audit to dete
fraud ties that would have a material effect on the financial
statements. However,
 all the transactions that occurred during the preceding
year, our audit cann
 that such errors and irregularities, including fraud or
defalcations, will b
 you of irregularities that come to our attention during
the course of the au
 clearly inconsequential.
Responsibility for In performing our audit, we will be aware of the possibi
lity that illegal ac

detecting illegal acts will design our audit to detect illegal acts that have a direct and material
 Again, we will inform you of violations of government la
ws and regulations t
 attention unless they are inconsequential.
Report on internal In connection with our obtaining an understanding of the
 company's internal
control deficiencies should we encounter any reportable conditions, we will s
o notify you along w
and management for correcting them. Reportable conditions represent si
gnificant deficienci
letter of the internal control structure, which could adversely
 affect the organiza
 record, process, summarize and report financial data con
sistent with the ass
 the financial statements.) in addition, we will advise y
ou of any opportunit
 or economy of operations that we observe during our fiel
d work. We will deli
 these matters to you at the conclusion of our audit.
Identification of We will be pleased to deliver to you the 40 copies of ou
r audit report you r
intended recipients you intend to distribute copies of the company's financi
al statements, with
 to [names of third-party recipients].
Printer's proofs If you intend to publish or otherwise reproduce the fina
ncial statements and
 firm, you agree to furnish us with printer's proofs for
our review and appro
 also agree to provide us with a copy of the final reprod
uced material for ou
 distribute it.
Tax services At your request, we will prepare [or review] the company
's federal and state
 tax returns for the year ended [date]. [These returns, w
e understand, will b
 in addition, we will be pleased to advise you concerning
 any income tax matt
 our attention, including the tax effects of proposed tra
nsactions or changes
Engagement staffing You may expect a staff senior from our firm and three as
sistant auditors to
 during the course of our field work. [For continuing eng
agements:] To promot
 make every reasonable effort to assign the some audit pe
rsonnel from previou
Client assistance We understand that your accounting personnel will assist
 our staff by locati
 minutes and other documentation necessary to complete ou
r tests. In addition
 help us through the timely preparation of analyses and s
chedules. (The audit
 list of such schedules.]
Fees We will base our fees on the amount of time required at
the different levels
 and other out-of-pocket costs. Assuming adequacy of reco
rds and internal con
 of your personnel, we estimate that our fee for all serv
ices will be [specif
 you immediately of any circumstances we encounter that m
aterially affect th
Binding arbitration In the event either party claims a breach of contract of
 any term of this en
 at our option, be submitted to binding arbitration at [f
irm location].(*)
Billing We will bill you for our services monthly; invoices are
payable on presentat
 will bear interest at [percent] per annum, and we will f
ormalize any balance
 by executing a promissory note.(*)
Timing We anticipate the following timetable for the performanc
e of our audit and d
 and will promptly notify you of any necessary changes:
 [Date] We will begin our field work.
 [Date] We will observe the physical inventory.
 [Date] You agree to provide us with a yearend trial bala
 [Date] We will complete our field work.
 [Date] We will deliver our audit [and other] reports as
well as your tax ret
 [Date] We will deliver our report on your internal contr
ol structure.
Appreciation We appreciate your confidence in retaining our firm to p
erform these service
 this opportunity to serve you.
Request for If this letter correctly expresses your understanding, p
lease sign the enclo
client signature at your earliest convenience. If you have further questi
ons concerning the e
 of the detailed contents of this letter, or questions ab
out additional servi
 hesitate to call me.

Sincerely yours, [Partner's name] Acceptance The terms of this letter constitute our contract: I have read it and fully understand its terms and Accepted by:-- Title:-- Date:-- Topics to include if circumstances dictate Predecessor auditor

Soon after our appointment, we request your permission to contact your predecessor audit [name of firm] to respond fully to our inquiries. Other auditor The accounting firm [name] will audit the financial statements of [name of subsidiary] and furnish i insofar as it relates to the amounts included for [name of subsidiary], will be based solely on that Specialists During our audit of [inventories], we will use the services of [company name] to assist us in determ Other services Also at your request we will issue a report to [name of third party] concerning the company's compli agreement. (*) Denzil Y. Causey and Frances McNair suggested this idea in their article "Updating Your Audit En pages 56-59).
COPYRIGHT 1993 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
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Title Annotation:includes model for audit engagement letter
Author:Godwin, Larry
Publication:Journal of Accountancy
Date:Jun 1, 1993
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