An Audit Engagement Letter solidifies audit arrangements between an auditor and a client. This includes the scope of the audit and fees for the service.
This is an important document as it helps to reduce any potential legal liability by defining the responsibilities of both parties. Some malpractice insurance carriers even offer reduced premiums to firms that use them.
The Purpose of the Audit
An audit is an independent examination of financial statements by an external auditor in accordance with generally accepted auditing standards. The objective of an audit is to express an opinion on the fairness of the financial statements based on the examination conducted by the external auditor. This provides assurance to users of the financial statements that the financial statements are presented fairly in all material respects.
In addition to providing assurance to users, an effective audit can contribute to the credibility of financial reporting and can help build trust in the financial community. This is particularly important for businesses that receive funding from State and Commonwealth government bodies. Such funding is typically governed by an agreement which stipulates that on completion an independent audit needs to verify how the money was spent.
Obtaining engagement letters is not a requirement under the generally accepted auditing standards but it is considered good practice and reduces the vulnerability of practitioners to legal liability claims. An engagement letter clearly defines the responsibilities of both parties, which in turn eliminates misunderstandings and may decrease the likelihood of litigation resulting from professional errors or misconduct. It also allows the practitioner to limit the nature of specific services to be rendered in unusual or out-of-the-ordinary engagements and specifies fees for the service. It can also include information on the expected form of written assurance report.
The Auditors’ Responsibilities
A well drafted engagement letter clearly defines the scope of services to be rendered and sets forth the responsibilities of the auditors. This eliminates misunderstandings between the parties and reduces the vulnerability of accountants to malpractice claims. It also provides an opportunity to establish the basis for fees for the audit.
While an audit cannot detect every instance of fraud or error, it can provide reasonable assurance that financial statements are presented fairly in accordance with applicable financial reporting frameworks. It helps users of the financial statements to make informed decisions about an entity and builds trust with stakeholders.
During an audit, the auditor performs a variety of procedures designed to test and evaluate the effectiveness of internal controls over financial reporting. He also examines records, reports, operating practices and documentation to verify the existence of assets and liabilities. The auditor completes audit workpapers, identifies issues and communicates them to management, and prepares a report on his findings.
In addition, the auditor maintains independence in both fact and appearance by not allowing any interest in the client’s business to interfere with the objectivity of his duties. He is mindful of indications of potential noncompliance, such as unexplained payments to third parties and transactions with companies registered in tax havens. He is also attentive to the issuance of new and revised laws, regulations and guidance that could impact the client’s operations or finances, such as changes to securities law, antitrust, Foreign Corrupt Practices Act, anti-money laundering, price-fixing, occupational safety and health, consumer protection and employment.
The Auditors’ Fees
The auditors’ fees should be clearly described. Whether presented in tabular form or narrative, this section of the letter sets forth the fee for the audit, review, compilation and tax services to be performed, including any additional fees or expenses. It also lists the name and address of the registrant and its office, and provides the number of hours expected to be spent on the engagement. It may be helpful to include a description of the assistance that will be required from client personnel, such as the preparation of some schedules and retrieval of documents from files.
It is good practice to provide an estimate of the time needed for planning and initial analytical procedures, building the planning notes and performing the review. This will help to prevent any misunderstanding between the client and practitioner as to the length of time that will be required to complete the work.
Similarly, it is important to describe any additional charges that are related to the issuance of the report. Whether these are the costs of the printer’s proof, postage or courier charges, these should be listed and explained to the client. Finally, it is a good idea to include a statement that the client will have the right to review any draft reports provided by the auditors, and the final audit report prior to its publication.
For audits, the engagement letter is an important document that establishes a mutual understanding of the scope and terms of the audit. It describes the auditors’ responsibilities and provides a clear understanding of what to expect from the client. It also clarifies the limits of the audit and sets out the auditors’ expectations regarding the client’s responsibilities, including providing access to information, records, and personnel and maintaining a system of internal control.
The engagement letter should also detail the scope of the assurance engagement and the responsibilities of the client in relation to this, identifying whether the report will be for an individual entity or a group of entities. It should describe the basis for determining the fee for the engagement, as well as any billing arrangements and payment terms. It should also include provisions relating to the confidentiality of information and compliance with data protection regulations.
In addition, the letter may cite any additional services that lie outside of the current agreement, with an estimate of their cost. This enables the practitioner to proactively seek out ways to improve the effectiveness of an audit and provide added value for the client. It also gives the client a record of what was agreed upon. If the scope of an assurance engagement changes, it is recommended that the practitioner agrees an amended scope in writing with the client and where appropriate any other engaging parties or intended users who will rely on the report.