Defining the Scope of the Audit with an Engagement Letter

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Creating a Strong Foundation: Importance of an Audit Engagement Letter

Format of audit engagement letter

An effective audit engagement letter is a critical component of a successful audit. It establishes the terms of the audit, outlines the responsibilities of both the auditor and client, and serves as a reference point throughout the audit process. In this article we will discuss importance, contents and other aspects of an audit engagement letter.

Before proceed further you must be aware of Standard on Auditing issued by the ICAI  SA 210* Agreeing the Terms of Audit Engagements. Which is soul of this article, but we will discuss only about Engagement letter. 

What is an audit engagement letter?

An audit engagement letter is a document that outlines the scope and objectives of an audit engagement and serves as a contract (along with your mandate) between the auditor and the client, which also defines services to be provided by the auditor, timeline, cost involved, limitations if any.

Why is an audit engagement letter is important?

One of the prime purposes of engagement letter is to avoid misunderstanding about the responsibilities of management and auditor. Following are some of the reasons for importance:

  • Defines scope of work: The audit engagement letter sets out the scope of work to be performed by the auditor, including the objectives of the audit, the areas that will be audited, and the time frame for the audit. This helps both the auditor and the client to have a clear understanding of what is expected from the audit engagement.

  • Sets expectations: The audit engagement letter sets expectations for both the auditor and the client, and helps to ensure that both parties understand their respective responsibilities. This can help to reduce misunderstandings and conflicts during the audit process.

  • Establishes professional relationship: The audit engagement letter creates first impression and  establishes a professional relationship between the auditor and the client and lays the foundation for a productive and successful audit engagement. 

  • Legal protection: If you remember the very popular tv series SUIT, you must recall importance of engagement letter as emphasised by actor Harvey.  The audit engagement letter serves as a legal contract between the auditor and the client, and provides the auditor with legal protection in the event of future disputes or disagreements. During the disciplinary proceedings members of ICAI fails to produce engagement letters before the authority.

  • Facilitates communication: The audit engagement letter provides a clear and concise summary of the audit engagement, and can serve as a reference point for both the auditor and the client throughout the audit process.
Now we are clear about importance of audit engagement letter. will discuss:

How to write audit engagement letter with reference to SA 210.

Though writing an effective audit engagement letter requires a clear understanding of the audit engagement, the responsibilities of the auditor and the client, and the legal requirements that may apply to the engagement, here are few aspects that should be considered:

  • Start with a greeting: Start the letter with a formal greeting, addressing the client/team.

  • Introduction: Provide a brief introduction of your company and your role as the auditor. (😎Kind of advertisement)

  • Purpose of the audit: Based on type of audit, clearly state the purpose of the audit, including the specific objectives, the areas to be audited, and the time frame for the audit. 

  • Scope of work: Outline the scope of work to be performed by the auditor, including the types of procedures to be performed, the records to be examined, and any other relevant information. It is also useful to share your audit plan with client. Also don't forget to give reference to applicable legislation, regulations, SAs, and ethical and other pronouncements by ICAI.

  • Responsibilities of the client: Clearly state the responsibilities of the client, including the preparation of financial statements, provision of access to records and information, and the timely delivery of any requested data. You must create awareness that, maintenance of accounting records is responsibility of the management and not of the auditor.

  • Representation letters: Discussion specifically that management will give representation letters wherever required as required by "SA 580 Written Representations." Read more about it.

  • Confidentiality: Discuss the confidentiality of the audit engagement and any restrictions on the use or dissemination of information obtained during the audit. Also specifically write down a clause which will highlight your obligation to share data with government agencies if asked by the respective departments. Nowadays CBI, ED, Courts, tax departments summon specifically to auditors.

  • Data security: In this cyber word do not forget to define stand about data theft etc. from your side in situations like phishing, hacking etc.

  • Fees and expenses: Most crucial is discuss the fee structure for the audit, including estimated expenses, and payment terms, out-of pocket expenses, reimbursement etc. prior to start of your work, rather bargaining after completing work. Like we do with vegetable vendors. First fix price and then move forward.

  • Termination of engagement: Outline the conditions under which the audit engagement may be terminated, and the procedures to be followed in the event of termination. SA 210 highlights in case of limitation by management on audit scope , auditor should not accept the engagement unless required by laws.

  • Legal compliance: Discuss any legal requirements that may apply to the audit engagement like Peer Review under Chartered Accountants Act, 1949, including the compliance with applicable laws, regulations, and standards.

  • The Fact: The fact that because of the inherent limitations of an audit, together with the inherent limitations of internal control, there is an unavoidable risk that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with SAs.

  • Future events: Define your & client's responsibility that may arise out of your engagement. Like who will bear the cost of litigations if any arising out of your audit / work etc. 

  • Audit working papers: Write brief about ownership of working papers. SA 230 Audit Documentation also states "unless otherwise specified by law or regulation, audit documentation is the property of the auditor." (Para A25)

  • Conclusion: Close the letter with a brief conclusion, thanking the client for the opportunity to perform the audit, reiterating your commitment to providing a high-quality audit service and request to return signed copy of engagement letter.
Though the above article pointing towards engagement letter for Audit, make it habit- part of client onboarding process of taking engagement letters for every professional work irrespective size and cost of the work.
You can refer SA 210 for examples of an Audit Engagement Letter. #Audit engagement letter

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