AUDITING THEORY REPORT: [ INTRODUCTION ] When taking a new client, an auditor creates an engagement letter to solidify audit arrangements

s between the audit firm and the client. The letter serves as the contract, detailing the duties and obligations on either side of the table. Your CPA firm prepares the engagement letter. According to ISA 210 (Terms of Audit engagements) It is in the interest of both client and auditor that the auditor sends an engagement letter, preferably before the commencement of the engagement, to help in avoiding misunderstandings with respect to the engagement. The engagement letter documents and confirms the auditors acceptance of the appointment, the objective and scope of the audit, the extent of the auditors responsibilities to the client and the form of any reports Although you arent required to have a written agreement with an audit client (per SAS No. 108), it is unwise to undertake an audit with only a verbal agreement

[ CLIENT/ADDRESSEE ]
Who you address the engagement letter to depends on the type of business entity. If youre working with a corporation, address the letter to the board of directors. If your client is a small corporation that doesnt have a board of directors, address the letter to the chief executive officer. If youre auditing a sole proprietorship, address it to the owner. For a partnership entity, address it to the partners.

[ OBJECTIVES AND SCOPE ]

The first part of engagement letters always deals with the services being provided to the client. Depending on the issuer of the letter, it can prescribe anything from an accountant performing an audit of a client's specific accounts to something more open-ended, such as anattorney's legal retainer agreement. This part of the letter normally also breaks down the specific responsibilities, such as what tasks the auditor will be performing and what results or reports will be provided to the client, if any. Addressee: Typically addressed to the senior management (e.g. CEO) of the client. Identification of the service to be rendered: One type of service is a financial statement audit. Provided in this section is a brief description of the nature of the particular service. Other services that are planned for the audit (e.g. evaluation of internal control, preparation of regulatory reports) are also identified in this section. eir responsibility concerning the financial statements. pronouncements of professional bodies to which the auditor adheres;

[RESPONSIBILITIES OF THE AUDITOR] The second portion of engagement letters usually deals with any specific caveats (warnings) to the responsibilities and services being provided. This is where the issuer of the letter explains any possible constraints of performing work and what the possible consequences will be. One example is an accounting firm stating that it needs access to records for a specific amount of time or it cannot guarantee delivery of its audit. The delivery time of these services, known as the deadline, also is covered in this section. It makes the time expectations clear for both parties and acknowledges that failure to meet this deadline is a breach of the contract.
Specification of the responsibilities of the auditor of the company: This section refers to the specific professional standards and responsibilities of the auditor. Constraints on the accounting firm: For example, timing of access to client facilities and accounting records may delay the engagement. Deadlines: This section lays out the estimated date of completion and release of the financial statements, as well as the general guidelines for the timing of the audit work.

The fact that because of the test nature and other inherent limitations of an audit, together with the inherent limitations of internal control, there is an unavoidable risk that even some material misstatement may remain undiscovered; and

in connection with the audit

[ RESPONSIBILITY OF THE MANAGEMENT]

Client assistance is firmly listed in the third section of most engagement letters. This section intends to state what assistance, if any, the client is expected to provide the issuer of the letter. This encompasses a lot of tasks but usually refers to filling out paperwork or opening accounts. This section usually states that a fee will be added if the client fails to handle these responsibilities. This also is the portion of the letter that addresses any outside contractors who will be needed, such as an appraiser who will determine the value of the client's assets for a law firm that is handling the client's divorce.
Description of any assistance to be provided by the client: Typically, the clients personnel will prepare some schedules (e.g. bank reconciliations) and retrieve documents from files. The letter should describe the assistance of client personnel. If the assistance is not provided and the auditors must complete the work themselves, this section of the letter would provide justification for additional fees to the client.

[ FORM OF ANY REPORT ]

The form of any reports or other communication of results of the engagement. This includes the provision for the management to provide the Management Representation Letter especially concerning the balances in the financial statements that cannot be verified. It also includes the provision for the auditor to provide a Management letter.

[LIMITATTIONS]
A disclaimer: Describing the limits of the audit. Typically this expresses that an audit is not designed to detect all forms of fraud or illegal acts; rather, an audit checks the financial position of a client with reference to generally accepted accounting principles. A description of the basis for fees: This may include a fixed fee or an estimate of fees based on expected completion time and billing rates of firm employees assigned to the engagement.

Finally, a disclaimer stating the issuer's intent to perform its duties to the best of abilities is a standard part of the fourth section. The fee for this service also is listed. At the end of the engagement letter, all of the parties involved will sign and date the paperwork to complete the contract.

[OTHER ITEMS] Other items you should clear up through the engagement letter are your fees and when you expect the company to pay them. If you plan on using specialists in the companys field to assist you, include that fact as well. Its wise to spell out the conditions under which youll terminate the engagement for example, if the clients books render you unable to express an opinion.
Interactions with specialists, internal auditors, and the predecessor auditor needed to conduct the audit: Some specialists needed on an audit may include engineers to verify the stage of completion of electronic components, real estate appraisers to appraise realizable value of real estate used as collateral for loans, actuaries to evaluate the funding requirements and future cash flows associated with pensions or post-retirement health costs, and attorneys to evaluate the likely disposition of contingent losses arising from litigation

[ NOT TO INCLUDE ]

What not to include in the engagement letter? Dont use jargon that only CPAs understand. Doing so will make your client uncomfortable and may cause the client to refuse to sign the letter. Also, dont overstate what you can do. And certainly dont include any promotional or marketing information.

The engagement letter is signed by your CPA firm for example, Smith and Jones. It can also be signed by the firms contact person, such as Joe Smith, Partner. The engagement letter also has a place for the client to sign, acknowledging that it accepts the letters terms.