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How to write an effective audit engagement letter

As with all accounting procedures, there are strict procedures to follow in an audit. This begins with an audit engagement letter, which clarifies expectations for a smoother audit process.

What is an audit engagement letter?

Accounting standards require that both the client and auditor must agree on terms and conditions. Therefore, before a company begins its auditing process, an audit engagement letter lays out the scope of the agreement. This includes general details such as the terms, costs, and processes of the audit, described in brief but accurate terms.

Although it contains many of the same elements as a written contract, an audit engagement letter is less formal. It's written in an easily understandable style without the legal jargon of a contract. However, it's still considered legally binding and can be used as evidence in a court of law.

Audit engagement letter purpose

The purpose of any engagement letter is to clearly state expectations from both sides at the start of any business relationship. It details important factors like the audit's timeline, its costs, and what processes will be involved so that there are no surprises.

The audit engagement letter's purpose is also to limit the company's services by defining the scope. An audit won't go beyond these predefined limits of scrutiny. For example, if the audit is meant to only look at compliance, it won't stray from this to inventory management.

Benefits of an engagement letter

So, why is it important to set and manage expectations? There are benefits of audit engagement letters on both sides. The client receives reassurance of what the audit will entail, how long it will take, and how much it will cost. If additional costs outside of the agreement are required later, they must be approved individually.

From the auditor's end, an engagement letter prevents scope creep. This means that boundaries are set on the work that is due to be performed. When additional services are required outside of this agreement, they must be added in the future with the corresponding cost estimates.

An audit engagement letter should normally include guidance for managing disputes. While all parties hope this won't be needed, it's useful to have mediation or arbitration clauses built in from the start.

Audit engagement letter examples: reasons to engage

There are many circumstances in which an engagement letter is needed. Some audit engagement letter examples include:

  • Engagement letter for any new clients, before the first audit engagement is performed

  • Letters for existing clients who may not have received an engagement letter in the past

  • If an auditor of a parent company is auditing its subsidiaries, separate engagement letters are required for each branch

  • When an assignment changes in scope or size, a new engagement letter must be issued

Elements of an audit engagement letter

Keeping these purposes and benefits in mind, an audit engagement letter should normally include the following elements.

  • Auditor's Responsibilities: Any engagement letter should clearly state the auditor's professional duties, as well as the reporting responsibilities.

  • Client's Responsibilities: It will also state what is expected from the client's end. For auditing purposes, this usually includes preparing financial statements, applying accounting policies, and instituting internal controls.

  • Scope: This is one of the most critical elements of an audit engagement letter, as it helps prevent the common issue of scope creep. The scope will include information about what tests and procedures will be performed by the auditor. It should also outline the international auditing standards that the auditor will adhere to and which evaluations of controls will be used.

  • Irregularities: It's common for irregularities to be detected during a standard audit process, but this isn't the auditor's primary goal. The engagement letter should make clear that fraud prevention is up to the client or management.

  • Additional Services: Most of the services to be performed are included in the engagement letter's scope portion. If additional services are needed, these should be outlined as well.

  • Costs: This section of the letter should include a breakdown of all fees for services and supplies, along with any necessary explanation of how costs are calculated.

  • Confirmation: Finally, an audit engagement letter will finish by requesting confirmation, in writing, that the client has read all of these terms and conditions.

By incorporating all these elements, you can write more effective audit engagement letters that satisfy both parties.

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