Letters of engagement in auditing

Before commencing any professional work, an
accountant should agree, in writing, the precise scope and nature of the work
to be undertaken. This is done through the medium of an engagement letter.

The engagement letter forms the basis of a legally
binding contract between the

auditors and their client. If the auditors carry
out their work in a negligent manner it is on the basis of this letter that the
client may well sue them.

There is an international standard on auditing
(ISA210) ‘terms audit engagements’ which governs the form and content of such
letters.

This states:

The auditor and the client should agree on the
engagement. The agreed terms should be recorded in an audit engagements letter
or other suitable form of contract.

Purposes

The purpose of the engagement letter is:

·
To set
out the basis on which the firm is to act as auditors and the respective
responsibilities of the auditors and the directors;

·
To
minimize misunderstandings between auditor firm and client;

·
To set
out the scope of the work to be carried out and the nature and extent of the
audit procedures to be carried out;

·
To set
out details of any other services the audit firm is to carry out, e.g.
preparation of tax computations;

·
To set
out the basis on which fees will be charged;

·
To set
out which legal jurisdiction the agreement is made under and the process of
arbitration of any disputes;

·
To
confirm acceptance by both the client and the auditor of the terms of the
engagement.

When
to send an engagement letter

Engagement letters should be sent:

·
To all
new clients before any professional work has been started.

·
To all
existing clients who have not previously had such a letter.

·
Whenever
there is a change of circumstances (e.g. extra duties to be performed or a
major change in ownership or management of the client) or any change in the
audit firm (e.g. merger, change of name). The engagement letter should be
reviewed every year to see if there is a need for a revised letter.

·
In the
case of groups an engagement letter should be sent to each member company of
the group that is to be audited by the firm. If a standard letter is
satisfactory, then a letter can be sent to the group board requesting that it
be copied to all group members to be audited by the firm and that
acknowledgement be received from all of them.

This should be carried out before any audit work is
commenced in the case of a new client or before the current audit starts in the
case of an existing client.

Auditors must:

·
On or
before acceptance of a new client, discuss the precise terms with the directors
and review the draft of the letter with the client.

·
Sign the
letter before commencing any part of the assignment and send two copies to the
client. One copy has an acceptance confirmation which the client is required to
sign and return to the auditors.

·
Acceptance
of the audit appointment should be confirmed by the directors at a formal
meeting and the signing of the acceptance of the terms of the engagement letter
should be minute.

·
When the
signed letter is returned by the client the auditor should keep it safely and
place a copy of it on the permanent file.

·
Every
year review the letter and consider if revision is necessary.

Principal
contents

The letter should outline the client’s statutory
duties (e.g. on accounting records) and the auditors’ statutory (e.g. to
report) and professional responsibilities (e.g. to follow the auditing
standards).

The section may include:

·
The
board’s responsibilities regarding proper accounting records and for financial
statements to show a true and fair view and comply with the act. Also the
board’s responsibility to make available to the auditors all the accounting
records, other relevant records and related information and minutes of
meetings.

·
The
auditor’s responsibility to report on the financial statements and on the
consistency of the directors’ report.

·
The
auditors’ planning of the audit to have a reasonable expectation of discovering
fraud or material misstatements in the accounts, including a statement in
respect of non-reliance on the auditor to uncover irregularities and frauds.

·
The scope
of the auditor’s work including reference to:

·
Auditing
standards;

·
Accounting
systems review;

·
Collection
of audit evidence;

·
Tests and
reliance on internal controls;

·
The
sending of a letter of weakness to the management

·
Any
special factors:

·
Relations
with the internal auditors; if any

·
Audit of
divisions or branches;

·
Any
overseas location problems;

·
Relationships
with other auditors if any.

·
Significant
reliance on supervision of the directors in small proprietary companies