An audit engagement letter is a formal document signed by the auditor and the client that outlines the scope of an audit engagement. It sets out the terms and conditions of the audit, including what work will be done, how it will be done, and who will do it. The letter also establishes the responsibilities of both parties during the audit process.

One important aspect of an audit engagement letter is that it helps to manage expectations. By clearly stating what services will be provided, clients can better understand what they can expect from their auditors. Additionally, this document defines any limits or restrictions on services, which ensures that clients are aware of any areas where auditors may not be able to provide assistance.

In this post, we will explain why having an audit engagement letter is important and what to include in them, so you never find yourself in a poor scenario where there are misconceptions about your clients due to a lack of documentation.

Why you must have an audit engagement letter drafted?

Some may see it as just another formality, but having an audit engagement letter is essential for several reasons. So, whenever your company is appointed to carry out an audit engagement, you must have an audit engagement letter prepared, and here’s why:

• It prevents scope creep: This document helps prevent scope creep, which refers to the tendency for projects to expand beyond their original boundaries. Without an engagement letter, it can be difficult to establish clear expectations and responsibilities. When both parties are clear about what is expected of them, it becomes easier to manage the project effectively.
• Provides clear expectations: It provides clear expectations of fee estimates. This ensures that there are no surprises for either party when it comes to billing.
• Increases the efficiency of the audit process: By clearly outlining all expectations upfront, an audit engagement letter increases efficiency in the audit process. Both parties know what they need to deliver and within what time frame. This allows for smooth communication and collaboration throughout the auditing process
• Sets the boundaries: By setting clear boundaries upfront, both parties can avoid confusion about what exactly the auditor is responsible for during their engagement. Additionally, this document outlines any limitations on liability or damages in case something goes wrong during the audit process.
• Outlines the client’s responsibilities: It ensures that the clients are aware of their roles or responsibilities such as providing accurate and complete financial records, access to any relevant documents or information necessary for a successful audit, responding promptly to requests from auditors and providing any additional information required during an audit engagement.
• Protects both auditor and clients: For auditors, an engagement letter provides essential legal protection by clearly stating their role in the audit process. It protects them from potential lawsuits or claims against them if something goes wrong during the audit.

While it’s important to ensure that all necessary legal provisions are included in the engagement letter, it’s equally critical not to fill it with legal jargon that could be confusing or intimidating for clients.

In fact, using plain language in the engagement letter can help improve communication and build trust between you and your clients. By avoiding complex legal terms and explaining key concepts clearly, you can ensure that your clients understand exactly what they are agreeing to. This will help prevent misunderstandings down the line and minimize disputes or disagreements over expectations or deliverables.

To make it easier for you we have created a sample audit engagement letter template that strikes the right balance between legal language and plain English.

When should the engagement letter be sent and signed?

The ideal time to send the engagement letter is immediately after you have been engaged by the client. This provides clarity on what services will be delivered and how they will be executed. 

Additionally, it ensures that there is no confusion regarding responsibilities or expectations between both parties. Once received by your client, they should review all its contents before signing to indicate their acceptance of your proposal.

It’s important not to delay sending out an engagement letter since it can lead to misunderstandings or disputes later on when you begin providing services.

What makes an audit engagement letter legally binding?

Below are the key sections that should be included in an audit engagement letter to make your letter legally binding:

The auditor’s responsibilities 

The responsibilities of the auditor should be outlined in an audit engagement letter, that includes:

• conducting an independent examination of the financial statements
• assessing internal controls
• identifying areas of risk or fraud, gathering sufficient evidence to support their findings
• preparing a report on their findings
• assess the risks associated with significant transactions or events impacting an organization’s financial statements

It’s important to acknowledge that audits are not foolproof and have inherent limitations. Auditors cannot guarantee that financial statements are completely free from error or fraud, but rather provide reasonable assurance based on their professional judgment. 

In addition, they may encounter difficulties in obtaining sufficient evidence due to factors such as time constraints or incomplete records. These limitations should be discussed in detail in this section of the engagement letter so that clients understand what can and cannot be expected from an audit.

The management’s responsibilities

Management plays a critical role in ensuring that the audit process runs smoothly and effectively. Therefore, the audit engagement letter should also list management’s responsibilities, such as

• Providing access to all relevant documents and information necessary for the auditor to perform their work. This includes financial statements, supporting schedules, and any other relevant data required by auditing standards. 
• Ensuring that there are no material misstatements in the financial statements or fraud in the company’s operations.
• Maintaining effective internal control systems. These controls are designed to prevent or detect errors or fraud in financial reporting, making them essential for accurate financial reporting.
• Another responsibility that management should take into consideration during an audit engagement is providing adequate explanations for any discrepancies found by auditors in their reports.

Outline the financial reporting structure

It should outline the financial reporting structure used to prepare financial statements.

The financial reporting structure refers to the principles, rules, and regulations governing how financial information should be recorded, classified, summarised, and presented in a company’s financial statements. 

The engagement letter should specify which reporting framework will be used for preparing financial statements. Typically this may include GAAS, International Financial Reporting Standards (IFRS), or another applicable framework.

Define the objective and scope of the audit engagement

This information is essential because different frameworks have different requirements for what needs to be included in a company’s financial statements.

The objectives and limitations of the audit engagements must be specified in the audit engagement letter. This provision in the agreement is crucial because it protects against scope creep.

This section should include information regarding the tests, processes, and analyses that will be carried out as well as a timeframe and any associated deliverables.

A detailed breakdown of all costs and billing schedules

A comprehensive audit engagement letter should include a detailed breakdown of all costs associated with the financial audit services.

The cost estimate in an audit engagement letter should not only reflect the fees charged by the auditing firm but also any other expenses such as travel, accommodation, or subcontracted services that may arise during the course of conducting the audit. The calculation of these costs should be transparently explained so that clients have clarity on what they are paying for.

Additionally, it is essential for an audit engagement letter to outline when clients will be billed throughout the course of their project.

Other relevant terms and conditions

Depending on your company, the client, and the circumstance, these can vary. Still, you can include terms like “confidentiality,” “dispute resolution,” and “electronic data management”.

Confirmation and Signature

At the end of an audit engagement letter, it’s essential to include a statement requesting confirmation from the client that they have reviewed and agreed to all terms outlined in the document. This confirmation process ensures that both parties are on the same page regarding expectations and obligations. Also, include both the client’s and auditor’s electronic signatures with the date.

Bottom line

In conclusion, an audit engagement letter is an important document that outlines the scope, responsibilities, and terms of the audit. It ensures that both parties are on the same page and makes sure expectations are clear and understood. Therefore, it is essential to ensure that all necessary information is included in the letter. 

Additionally, all terms should be discussed between the client and auditor prior to signing in order to avoid any potential disputes or misunderstandings.