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. NONAUTHORITATIVE AICPA ILLUSTRATIONS 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. A MORE COMPREHENSIVE ENGAGEMENT LETTER 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. …