What is an Engagement Letter?
An engagement letter is a written agreement used by two parties to enter into a business relationship. One party in this relationship is the client that obtains products or services, while the other party is a supplier. Through an engagement letter, both parties can specify the terms for their relationship. These terms may include the costs, timing, and scope of the agreement.
Engagement letters represent a legal contract that defines each party’s rights and responsibilities. Unlike contracts, however, engagement letters are much straightforward. It is a tool that both parties can use to avoid any confusion related to their duties in fulfilling the contract. Engagement letters are usually common for relationships that last over a long time.
There are various examples of engagement letters. One of these includes the audit engagement letter that auditors use before entering a new audit engagement.
What is an Audit Engagement Letter?
An audit engagement letter is a written agreement used by auditors when signing a new client. This letter serves as a legal contract between both parties. It also defines their rights and responsibilities for their business relationship. The requirement for these letters comes from auditing and accounting standards. These require both the client and auditors to agree on the terms and conditions of an audit engagement.
For each client with which an audit firm enters into a business relationship, it must sign an audit engagement letter. Each letter defines the audit’s scope and other terms, such as the costs, processes involved, and outcomes. In short, the audit engagement letter describes the business relationship that each party will have and what both of them will get from it.
Essentially, audit engagement letters are written contracts. However, these are less formal in nature. These letters don’t contain any legal jargons that may be confusing to some clients. Despite that, these letters serve as legally binding contracts between an auditor and their client. Audit engagement letters have various elements or components that define the auditor-client business relationship.
What are the elements of the Audit Engagement Letter?
There are several elements that each audit engagement letter must include. This requirement comes from ISA 210 Agreeing with the Terms of Audit Engagements. These include the following.
1. The objectives and scopes of the audit engagement
One of the primary objectives of the audit engagement letter is to define the objectives and scope of an audit engagement. These objectives may differ according to the jurisdiction in which auditors and their clients operate. Auditors can reference the rules and regulations in the letter that define the engagement’s objective and scope.
2. The responsibilities of the auditor
An audit engagement letter also specifies the auditor’s responsibilities related to the audit. This section allows the client’s management to understand the expectations of the auditor during the engagement. Similarly, it also helps clarify any confusion in case of future disputes.
3. The responsibilities of the management
An audit engagement letter also includes the management’s responsibilities in ensuring the audit completes properly. As with the auditor’s responsibilities, it also acts as a reference when there are disputes between both parties.
4. Identification of the applicable financial reporting framework that the entity uses in order to prepare the financial statements
An audit requires auditors to establish suitable criteria against which they can check the financial statements. This section of the audit engagement letter allows auditors to specify those suitable criteria. It mentions the applicable financial reporting framework that the auditor will expect the financial statements to follow.
5. Reference to the expected form and content of any applicable reports to be issued by the auditor
The audit engagement letter also clarifies the scope of the audit report provided by the auditor. It also mentions which statements the auditors will examine. Lastly, it specifies that the audit report may change according to the auditor’s findings during the audit engagement.
6. Others
The above sections are compulsory to any audit engagement letter. Apart from the above, this letter also includes other elements. These requirements come from ISA 210. The additional sections include the following.
- Reference to relevant professional standards, regulations as well as legislation that are applicable to the audit engagement.
- Limitations of an audit engagement
- Expectations that management will provide written representations
- The basis on which the fees are calculated
- Agreement of management to notify the auditor of subsequent events after the auditor’s report is signed
- Agreement of management indicating the provision of the draft financial statements in time to allow the audit to be completed by the deadline
- Form (and timing) of any other mean of communication during the course of the audit
The audit engagement letter may also cover other matters. These include the following.
- Any arrangements that concern the involvement of internal auditors and other staff of the entity
- Limitations to the auditor’s liability
Conclusion
Engagement letters are written contracts between two businesses. It is an agreement between an auditor and their client. Similarly, it does not include legal jargon like other contracts. Audit engagement letters have various key elements that define the audit’s scope, each party’s responsibilities, and other fundamental terms.
Reference
ACCA F8- Audit and Assurance Study Text by BPP
