When Are Engagement Letters Required?
An engagement letter is a form that describes the stipulations of an agreement between a firm and its clients. It helps to avoid misunderstandings, and it can also reduce the risk of legal issues in the future.
Having one of these in place is important for all types of businesses. It’s worth ensuring that it includes a cancellation clause, just in case the project is terminated for any reason.
Audit engagements
Audit engagements involve examining financial statements and providing an opinion on their reliability. Generally, auditors use a risk-based approach when designing their audit procedures, and they must be independent and objective in their work. In addition, they must maintain professional skepticism and exercise their own judgment, even if management’s decisions appear reasonable. Audit engagement letters help eliminate misunderstandings between the auditor and client, and they also make it easier for staff assigned to the engagement to understand the specifics of what will be requested of them.
During the planning stage of an audit, the auditor must meet with clients and gather information about the organization in order to assess the risks of material misstatement. During this phase, the audit plan is also developed. In some cases, an engagement letter can be prepared as one of the final steps in the planning process.
In general, the terms of an engagement letter can include the name and contact details of those assigned to the project, a statement about how and when fees will be billed, and any other pertinent information. It is recommended that an engagement letter be sent to all new audit clients, and ideally, the agreement will be signed before commencing any of the audit work. Additionally, existing audit clients who have not yet received an engagement letter should be sent one as soon as possible. This helps to minimise the risk of misunderstandings and may reduce the vulnerability of your firm to liability claims.
Tax preparation engagements
Whether you prepare individual tax returns or corporate ones, you need an engagement letter to clarify the scope of work. This document communicates to the client what the CPA will and won’t do, sets expectations for how payment will work and defines a process for either party to terminate the engagement.
The document should also identify the parties involved, include a disclaimer that the prepared return will rely on information provided by the client and set forth any contingencies that could result in a fee that differs from the estimate given to the client. It should also include a provision that states the firm cannot assume responsibility for discovering fraud or other illegal activity.
If your clients complain that you haven’t done everything they asked for, you can refer them to the engagement letter they signed that defined the scope of the work. This is a valuable tool that can help you maintain client trust and avoid costly disputes over billable hours.
You can find engagement letter templates through professional vendors or your insurance company. Practice Ignition, for example, offers industry-vetted accounting engagement letters that you can use as a starting point for your own documents. They’re available on demand and logged digitally, which streamlines the process and reduces risk. Even though the added work of implementing an engagement letter may seem daunting, the benefits far outweigh the extra effort.
Legal services engagements
An engagement letter clarifies the lawyer/client relationship in detail. It should be signed by both parties before or soon after any legal representation begins. Many lawyers use the same basic engagement letter for every client but change it to reflect the particular circumstances of each matter. For example, if the case involves a divorce, an engagement letter should identify that fact.
A well-drafted engagement letter can help prevent misunderstandings about the scope of work to be performed. It may also reduce malpractice claims and other risks that could result from a miscommunication about the nature of the representation. It can also be a useful tool in setting client expectations and providing an audit trail for attorneys in the event of future disputes.
An engagement letter should also identify the attorney or attorneys who will be primarily responsible for the matter, along with any other individuals who will assist. This allows clients to easily identify the lawyer responsible for each aspect of their case and can reduce misunderstandings that sometimes arise over who is doing what work and how it is being done.
An engagement letter is an important part of a law firm’s risk management protocol. It also helps law firms save money on legal malpractice insurance. When underwriters see that a law firm regularly uses engagement letters, they are more likely to believe that the firm is low-risk and keep premiums lower.
Other engagements
Although some accountants may resist using engagement letters because they can feel self-protective or like a “CYA” document, these documents are one of the best ways to limit risk from malpractice claims. They help define the scope of the work, which can cut down on misunderstandings that can lead to professional negligence.
Having clear fee provisions is also important. Many malpractice claims stem from the failure to collect fees, so having a specific formula for determining how much to charge can help reduce the number of claims and their associated costs. This can be accomplished by having clients sign off on the fee structure in an engagement letter or by requiring a deposit or staged payments before beginning work.
If an engagement includes more than one client, it’s a good idea to use separate engagement letters for each client. This helps limit the class of persons that could later assert a legal malpractice claim, as lawyers typically only owe duties to clients with whom they have an attorney-client relationship.
With the CPA’s insurer’s approval, it is possible to include provisions in an engagement letter that mandate alternative dispute resolution (ADRs) should a conflict arise. This can significantly decrease a firm’s exposure to litigation, which often results in thousands of dollars in liabilities. This can be particularly valuable for small firms and sole practitioners.