Helping Accountants Develop More Effective Engagement Letters

By Reinstein, Alan; Bayou, Mohamed E. | The National Public Accountant, January-February 1999 | Go to article overview

Helping Accountants Develop More Effective Engagement Letters


Reinstein, Alan, Bayou, Mohamed E., The National Public Accountant


INTRODUCTION

The American Institute of Certified Public Accountants' (AICPA) Auditing Standards Board recently issued a new Standard to help accountants clarify their client services. SAS #83, Establishing an Understanding with the Client, should clarify the engagement's objectives, and management's and the auditor's responsibilities. The purpose of this article is to show how accountants can adopt the provisions of this new Standard to help avoid potential "trouble" when misunderstandings arise.

In today's competitive environment, accountants, physicians, lawyers, engineers and other professionals face ever-increasing competition for their services and growing legal liability from their clients. For example, McCarroll (1992) notes that in 1991 U.S. accountants faced 4,000 liability suits - double the number in 1985 - and more than $15 billion in damages. This perilous litigation environment also affects non-CPA accountants and bookkeepers, as Spalding and Reinstein (1992) show. Accountants can face breach of contract or tort liability claims for audits, and claims for such non-audit services as:

* Bookkeeping services, such as financial statement preparation;

* Divorce and other types of property evaluations;

* Forensic accounting (e.g., litigation support and expert witness work);

* Personal financial planning;

* Tax return preparation and tax planning assistance; and

* Computer consulting services.

These claims often involve accountant and client misunderstandings regarding the nature, extent and timing of the services and the fees due. To minimize such perils, accountants should select clients carefully and ask them to sign carefully drafted engagement letters before commencing services. For example, the Court ruled that a proper engagement letter would have minimized the CPA's legal exposure when performing bookkeeping services in the 1136 Tenants (1971) case; and, a poorly drafted engagement letter provided much of the rationale against a CPA in the Maryland Casualty Company v. Jonathan Cook (1939) case.

To help accountants clarify potential misunderstanding regarding performed client services, the AICPA (1997) issued SAS #83, Establishing an Understanding with the Client, which requires auditors to: (1) set an understanding with the client of the engagement's objectives, management's and the auditor's responsibilities - including any limitations of the engagement; and (2) document this understanding in an engagement letter. Such understandings reduce the risk that the parties misinterpret their expectations, e.g., clients relying improperly on auditors to protect them from actions that are their own responsibility - such as ascertaining the viability of new client software.

The engagement letter should cover four specific areas: (1) the objective of the engagement (i.e., to express an opinion on the financial statements); (2) management's responsibilities; (3) auditor's responsibilities; and (4) limitations of the engagement. Moreover, the letter should also clarify the accountant's responsibilities for such "special"areas as; (1) reviews of interim financial information; (2) audits of recipients of governmental financial assistance; and (c) applications of agreed-upon procedures to specified elements, accounts or items of a financial statement.

The letters should also document that management is responsible to: (1) establish and maintain effective internal control over financial reporting; (2) ascertain that the entity complies with applicable laws and regulations; (3) make all financial records and related information available to the auditor; and (4) provide (at the end of the engagement) the auditor with a letter that confirms certain representations made during the audit.

The letters can also include such other matters as arrangements regarding the conduct of the engagement (e.g., client assistance regarding the preparation of schedules and availability of documents); use of specialists or internal auditors; communications with predecessor auditors; audit fees and billing arrangements; limitations of auditor or client liability (e. …

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