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Always Use an Engagement Letter

By Suzanne M. Holl

Every engagement—routine engagements, new engagements, repeat engagements and especially changed engagements—deserves an engagement letter.

An engagement letter is in many respects a written contract between the CPA and the client, stating both parties’ understanding of the professional relationship. The letter allocates, in limiting language, the responsibilities of the engagement for the CPA and the client, and it’s an excellent communication link, providing both parties with a focus and an opportunity to identify additional services needed.

Unless the letter states what the engagement entails, the CPA and the client might be entertaining completely different points of view. The CPA’s concept of the engagement might be to write up the client’s books and prepare federal and state income tax returns. The client’s concept of the engagement might be to prepare income tax returns and advise about compliance for property tax returns, business licenses, sales tax, fidelity bonds, workers’ compensation insurance coverage and other insurance needs.

Courts and clients often do not understand the role of accountants. While an engagement letter will not make the CPA immune to lawsuits, the letter can be the “first line of defense” if a client makes a claim against the CPA.

The engagement letter should cover:

  • the purpose of the engagement;
  • specifically what the CPA “will and won’t do” (the scope);
  • client instructions and responsibilities;
  • reliance on facts the client gives the CPA;
  • known adverse or negative conditions or circumstances;
  • billing rates and estimates;
  • request for the client’s signature; and
  • instructions to return the signed engagement letter.

In addition, engagement letters can include:

  • warnings about inadequate internal control;
  • limitations on distribution of financial statements (what the client intends to do with them);
  • arbitration clause; and
  • record retention policy.

The engagement letter should not market the firm’s services. An engagement letter limits services rather than sells them. Wording such as “We are particularly suited for this type of work” is appropriate for a proposal letter but not an engagement letter. If work is accepted as the result of a proposal letter, the engagement letter for that work shouldn’t deviate from the terms in the proposal letter. The proposal letter can be written so that the engagement letter has the final word; e.g., “The terms of the engagement will be defined in more detail in an engagement letter.”

An engagement letter limits the scope of your work, so avoid superlatives, absolutes and all-encompassing language. Avoid words that expand rather than contract the CPA’s responsibility.

Some words to avoid include: audit (never use the word “audit” on nonaudit engagements unless it’s used to say: “This engagement is not an audit.”), all, conclude, any, rule, decide, every, judge, define, everything, settle, whenever, each, rule, confirm, validate, verify, totally, authenticate, comprehensive, complete, entire, absolute, whole, certain, unlimited, definite, thorough, conclusive, exhaustive, ascertain, analysis, discover, scrutinize, settle, and determine.

Some words to use include: look at, examine, study, comment on, survey, observe, investigate, notice, follow, watch, and test.

Simple, Clear Language

Any ambiguity in the engagement letter would most likely be decided in the client’s favor in a court of law, so the language should be simple, clear and free of legal jargon. Also, clear, simple language generally will be less intimidating and afford the client a better opportunity to understand the terms of the engagement letter.

Signed or Unsigned?

Review the letter with the client and get a signature before beginning any work. If the work is done without a signature, a judge in a court of law might decide that the client did not agree to the terms of the letter. The fact that the work was completed might also suggest that the engagement was different from the terms contained in the unsigned letter.

Review the Engagement Letter Regularly

Some guidelines for reviewing engagement letters include:

  • Review letters at least once a year.
  • Review letters whenever engagements change.
  • Establish a procedure to follow up on unsigned or unreturned letters.

Ongoing Engagements

The “evergreen” engagement letter is a thing of the past. No engagement is so static that the same engagement letter will work year after year. Ongoing engagements that extend into a new fiscal or calendar year need to have new engagement letters annually.

Disengaging

While the engagement letter is a bilateral agreement, disengagement is a unilateral cancellation of an agreement. It is usually not feasible to include a disengagement clause in an initial engagement letter, unless it refers specifically to nonpayment of fees.

If a problem arises at the outset of an engagement, think it through, discuss it with partners and attorneys, and decide whether to propose disengagement terms to the client before finalizing the engagement letter. Doing this may help the CPA decide whether the engagement should be accepted.

If a problem arises mid-engagement, the CPA might be in a position to notify the client that his or her agreement of certain terms is required for the engagement as a condition of the CPA’s continued performance of services.

  • Termination of an engagement by an accountant, as a legal right, is available on limited grounds, such as:
  • client failure to pay;
  • noncooperation from the client;
  • conflict between performance and ethical obligations; and
  • client agreement to disengage.

When the CPA disengages before completing work for a client, liability exposure can result from the successor CPA’s inability to complete the work by its deadline. A delay can cause missed opportunities or serious damages to the client’s business. Don’t wait until the last minute if disengaging. Contact your attorney or risk advisor, and cooperate with the client and the successor accountant. Do not turn over work papers without first consulting with your attorney or risk advisor.

An excellent resource for engagement letters is the CPA’s Guide to Effective Engagement Letters. For an order form, visit www.camico.com, click on “Services,” scroll down to click on “Practice Management Tools,” and scroll down to the form.


Suzanne M. Holl, CPA, is director of loss prevention services with Camico Mutual Insurance Company. With more than 14 years of experience in accounting, she provides Camico policyholders with information on a wide variety of loss-prevention and accounting issues. Holl is a co-author of the CCH-published book CPA’s Guide to Effective Engagement Letters.

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