An audit engagement letter is a written agreement that outlines the scope of your work as an auditor, what the client is responsible for, how long the audit is estimated to take, and details about your fee, among other things. It is a binding contractual agreement between you and each of your clients.
Sounds boring right?
Yes, but it’s absolutely crucial for safeguarding both you and your client throughout the process.
The engagement letter clearly states expectations prior to entering into a business relationship which is especially important for an audit engagement where the client may not be as familiar with the process and responsibilities of everyone involved.
In this post, we’ll explain why audit engagement letters are important and what to include in them, so you’re never caught in a bad situation of misunderstandings with your clients because of lack of documentation again.
Why it’s essential to have an audit engagement letter
When your firm is hired to perform an audit engagement, you need to have an audit engagement letter drafted and here’s why:
- Prevents scope creep by outlining the scope of the engagement
- Provides clear expectations of fee estimates so there are no surprises
- Increases the efficiency of the audit process by clarifying expectations
- Sets clear boundaries on what auditors are allowed to do and what they will be held accountable for
- Outlines responsibilities of client so they’re aware of their role
- Protects both the auditor and client with a signed contract.
As with all contracts, audit engagement letters are used to mitigate risk related to the business arrangement and the relationship between the parties involved.
Although the engagement letter is a legally binding document, it is important not to fill the letter with legal jargon that could be confusing to your client.
When should the engagement letter be sent and signed?
The audit engagement letter should be sent after verbal confirmation of the appointment of you as the auditor and ideally signed before the start of any audit work.
If you have existing audit clients with no signed engagement letter, it is important to send one as soon as possible and get everything up to date and filed.
Another important thing to note when auditing the parent company and its subsidiaries is that it is important to send a separate engagement letter to each.
What to include in an audit engagement letter
These key sections should be included in an audit engagement letter.
The auditor's responsibilities include:
An audit engagement letter should list the auditor’s responsibilities, such as
- performing the audit for the financial statements per auditing standards and expressing an opinion on the financial statements
- performing procedures to obtain audit evidence about the amounts and disclosures in financial statements
- making a risk assessment
- getting an understanding of internal controls
- presenting the audited financial statements and informing the board of any material misstatements or fraud
This section should also discuss the inherent limitations of an audit and the auditor’s reliance on third parties.
The management's responsibilities include:
Audit engagement letters should also list management’s responsibilities, such as
- preparing the draft financial statements including selecting and applying appropriate accounting policies
- establishing and maintaining an effective system of internal control over financial reporting,
- correction of errors
- implementing and maintaining the system to prevent and detect fraud,
- disclosing related parties
- informing of subsequent events
- identifying and ensuring you comply with all applicable laws and regulations
- providing information and support to auditors on a timely basis
- providing a written management representation letter
The relevant financial reporting framework
In addition, the engagement letter should outline the financial reporting structure used to prepare the financial statements. The audit process is regulated under these guidelines and will vary by country and auditing standards.
The objective and scope of the audit engagement
An audit engagement letter must define the objectives and scope of the audit engagements. This is an important part of the agreement and helps prevent scope creep.
This section should clearly state the timeline and associated deliverables and provide information about what tests, procedures and analyses will be performed.
Estimated fee and billing schedule
This section should include a breakdown of the estimate of the costs and how they were calculated, a schedule of when the client will be billed and when payment is due.
This is also a good place to include your late payment penalty terms.
Including an explanation of the process for scope adjustments and associated incremental fees should they arise will eliminate a lot of misunderstandings down the road.
Type and scope of the audit report to be issued
Immediately after each financial statement audit, a report is released. Audit engagement letters should also describe the report issued per auditing standards, so your clients know exactly what the result will be.
Other relevant terms and conditions
These can vary depending on your firm, the client and the situation. Still, they could include terms such as confidentiality, dispute resolution, and electronic data management.
Confirmation and signature
Lastly, the audit engagement letter should end with requesting confirmation that the client has reviewed and agreed to all the terms and include both the client's and auditor's signature with the date.
Are you prepared?
Running an accounting business, particularly when providing audit services, comes with inherent risks.
Having a well-crafted, timely, clear, and accurate audit engagement letter is of utmost importance in order to safeguard yourself. By implementing this measure, you can effectively avoid numerous issues with your audit clients.