A written agreement between an auditor or accountant and a client that specifies the scope of the audit engagement. It helps prevent misunderstandings and sets expectations.
Typically, it is issued for engagements involving audit, reviews, or compilations of financial statements. However, it can be issued for other recurring services as well.
Scope of the Audit
Obtaining an engagement letter is a best practice and provides an opportunity for the practitioner to clearly define the nature of the audit and what work will be performed. It also helps to prevent misunderstandings and defines responsibilities between the practitioner and the client. Additionally, it can help reduce liability risks and may allow the practitioner to qualify for reduced premiums from malpractice insurance carriers.
A good Audit Engagement Letter should include an introduction describing the type of service to be rendered, identification of the entity, its name and fiscal year end and a description of the financial statements that are to be audited, reviewed or compiled. The letter should also include the auditor’s qualifications and a statement of scope.
In determining the scope of the audit, the team should consider issues from previous years as well as current circumstances and emerging risks. In addition, the team should determine whether or not to perform follow-up work on a prior engagement and how to incorporate this follow-up into the overall scope of the current audit.
During the entrance conference, the audit team should review the scope of the audit and request any documentation required. They should also ask the client to discuss any areas of inherent risk, such as prepaids, fixed assets and encumbrances. This will help to identify any additional work that may be necessary to complete the audit in a timely manner.
Responsibility of the Auditor
The auditor is responsible for performing the audit in accordance with generally accepted accounting standards. This includes assessing the risks of fraud and material misstatements, examining management’s internal controls, and examining financial statements and disclosures. The auditor’s responsibilities also include presenting a report that expresses an independent and objective opinion of the company’s financial statements.
The audit engagement letter identifies the responsibilities of each party and clarifies the scope of the audit. It can also address any billing arrangements and fees. It’s a good idea to include provisions related to confidentiality and data protection. In addition, the letter should identify any restrictions on hiring personnel who have worked on a previous audit.
The audit engagement letter should be sent to all new clients soon after their appointment as the auditor and, in any event, before the commencement of the first audit assignment. It should also be sent to existing clients who have not received one previously and who might benefit from a written assurance that the firm is able to meet their audit requirements. Where a client has subsidiary companies, a separate letter should be sent to the directors of each of the subsidiaries. Otherwise, a single letter should be sent to the parent or holding company and each of the subsidiaries. Any additional services to be rendered should be described in an addendum to the original engagement letter.
An engagement letter provides an opportunity for the auditor to describe in writing the scope of the audit and responsibilities that are to be performed. It also establishes a clear understanding between the parties regarding fees associated with the audit. Generally, the engagement letter should contain provisions for fees whether they are charged as a percentage of the company’s total assets, hourly rates, a fixed fee or a combination. It should also include identification of the entity, its name and its fiscal year end. An engagement letter should also indicate whether there are any out-of-pocket costs, absorption of start-up costs and a provision for progress billing.
The engagement letter should also contain a statement that the auditor will review all printer’s proofs of the reports prior to their release to the client. This statement is included in the letter to prevent misunderstandings and minimize the likelihood of malpractice claims. Obtaining an engagement letter is not a requirement of any generally accepted auditing standards, but it does make good business sense. It offers several benefits, including the clear definition of responsibilities between practioners and their clients, the elimination of misunderstandings and the reduction in the vulnerability of accountants to liability claims.
Obtaining an engagement letter should be considered a best practice for all accounting firms, regardless of size. In addition, it should be a standard practice for new clients and for all companies that have not received an engagement letter from an existing auditor.
If an audit is required to be completed within a certain time frame, the auditor must provide a schedule for the work to be done. The schedule should take into account the risks associated with each process and the resources that will be impacted by the audits. It should also include the time that will be spent by the client in facilitating and addressing issues that may arise from each audit.
The time schedule must include the number of hours that will be spent on each process and an explanation of why each one has been assigned a particular duration. For example, production and design processes typically require more time because they are complex and directly impact quality. In contrast, incoming inspection involves less time because it is not as complex and only affects quality indirectly.
Another important consideration when creating an audit time schedule is the frequency of each audit. The auditor should seek to create a balanced level of audits in each time period so that there is not an abundance of audits in one month and none in the next.
The audit time schedule should also include a termination clause that outlines the conditions under which the relationship between the two parties may be terminated. The termination clause should be specific to each business entity and may vary slightly between letters.