An engagement letter is a legal agreement that describes a business relationship to be entered into by a client and a company. An engagement letter is a contract of the performance of service by the auditor or an accountant and the payment of those services by the client. The letter defines the terms and conditions of the engagement, the obligations of both parties, services to be rendered, the duration of the engagement, and the fee structure, etc.
An Engagement letter limits the duties and responsibilities of the company, directly or by inference. A well-formatted engagement letter establishes the framework in which the client relationship is managed.
Most general practitioners limit their liability for work done by an appropriately drafted clause in the engagement letter. The liability clause should be discussed and agreed with the client at the start of the assignment. A properly drafted engagement letter makes the legalities of entering into a business relationship less intimidating, especially when working with small businesses.
Benefits of Using an Engagement Letter
Having an engagement letter is a matter of good business practice. The letter offers an opportunity to limit and define the nature of the specific services being rendered in unusual and out-of-the-ordinary engagements. An engagement letter is, however, not a panacea for all disputes and disagreements, and they do not offer the practitioner immunization from litigation. Some of the benefits of using an engagement letter include:
- An engagement letter helps prevent any misunderstanding between the client and the auditor/accountant by describing in writing, the mutual understanding of the terms and conditions of the agreement.
- An engagement letter also eliminates any misunderstanding between the auditor or accountant and the client by describing the mutual understanding of the terms and conditions of the engagement in writing.
- An engagement letter helps you mitigate risks: by using an engagement letter, you reduce professional liability insurance premiums, and many insurers require it.
How an Engagement Letter Works
An Engagement Letter functions the same as an agreement between two parties. The format of the letter is less formal compared to that of an agreement and generally avoids any legal jargon. An Engagement Letter is a legal document and binding in a business deal.
The letter also limits the scope of the company’s services. For instance, when an individual or an organization secures the service of an attorney, the engagement letter might describe the specific purpose or area of expertise in which their services can be used. For example, a service provider who hires an attorney to draw up a business purchase cannot call the attorney for advice about his divorce. The engagement letter will clearly state the fact, but the meaning will be clear.
Advantages of an Engagement Letter
Making clear what you expect out of a contract is important. An engagement letter offers the client reassurance of knowing what, when, and how a service will be completed. The engagement letter also informs the client of the total cost of the service and any other costs not included in the agreement that might be incurred.
The letter also defines the set boundaries on the work that is expected to be performed by a business. This is meant to prevent “scope creep,” a situation that every tax accountant and attorney dreads. The engagement letter also lists any services that may be needed in the future but are not in the current agreement.
The letter may also include a clause on the subject of mediation or any binding arbitration for the relationship. The provision provides guidance for managing any disputes arising between the parties.
When and How Often Should you Use an Engagement Letter?
It is recommended to use engagement letters for all engagements. One engagement letter can be used for different types of services to be rendered, or you can use separate engagement letters for each type of service to be rendered. You can download an engagement letter template from here to make your work easier.
Typically, you don’t need to obtain an engagement letter more often than annually. Nevertheless, as a practical matter, if the services rendered are recurring, the accountant or the auditor might consider drafting an engagement letter that will extend beyond one year. Since an engagement letter is a legal agreement, in cases where it is protracted to cover more than one fiscal period, it should contain a clause that either party has the right to terminate the agreement upon written notice to the other party.
Regardless of the duration of the agreement, the content of an engagement letter should be reviewed annually to determine if there are any changes in the service to be rendered. If there are changes to be made in the initial agreement, then a new engagement letter or a supplement letter should be obtained.
Contents of an Engagement Letter
There are standard services that are usually included in an engagement letter including but not limited to;
- Write-up services;
- A review of financial data related to the acquisition of a business; and
- All tax services including tax return reviews, proposed tax transactions, and tax review preparation
- The engagement letter should be addressed to the person retaining the firm and approving the engagement
- An expression of gratitude for the opportunity to offer professional services to the client
- Identification of the entity (its name, and fiscal year-end) with reference to the financial statement to be audited and reviewed
- A detailed description of the scope of services to be rendered
- A clause limiting the auditor’s responsibility for the discovery of fraud and any other irregularities
- Amount to be paid for the services and how the amount shall be paid
After drafting your engagement letter, make sure to go through it to ensure that it has covered all the things that must be included in the letter. Generally, the engagement letter must cover the following topics:
- The objective of the engagement
- The duties and responsibilities of management
- Responsibilities of the auditor
- Limitations of the auditor
- Hiring restrictions
Sample Engagement Letter
June 20, 20XX
Plymouth Drug store company,
Oak Street, MA 1534
Dear Crestview High school,
RE: Health Care Services for Crestview High school
This letter acts as a verification of the terms of our signed contract (requested services), the scope of our service, the cost to be paid, and also, it details the duties of both parties. The engagement letter was recorded on September 9, 2014, whereby the school called for Plymouth drugstore services.
Following the engagement letter, the services to be provided by Plymouth drug store include: distribute adequate drugs to the school and also availing our doctors and nurses to take care of your ailing students and staff.
The amount to be paid for these services are in the following conditions: (select one)
$ 60 per hour for the medics
$ 5,000 weekly payments for the distributed drugs
$ 250,000 monthly payments for the medics
$ 400,000 monthly payments for the drugs
Terms of the engagement:
• Unless otherwise, the drugs will be delivered to the school every week.
• In case some of the drugs expire before being used, the school management is allowed to return the drugs to the store.
• Any risk befalling the doctors and nurses while on the school premises, the school management will be held responsible.
After signing the letter, the school management is allowed to have: (pick one)
A doctor/nurse retainer for a fee of $ 3000
No retainer needed
An alternative contact person on behalf of the school regarding the services mentioned earlier can be reached on the following address:
Principal, Crestview High school
Russell road, SA 1438
According to this letter, the services provided can only be terminated under the following circumstance: (choose one)
Formal termination letter from one of the involved parties
Upon the last day of the contract
Poor quality of the services rendered
- MS Word