Audit Engagement Letter
An audit engagement letter is a written agreement used by auditors when signing a new client. This engagement establishes a legal relationship (or engagement) between both parties. It also defines their rights and responsibilities for their business relationship. These require both the client and auditor to agree on the terms and conditions of an audit engagement. It is in the interest of both client and auditor that the auditor sends an engagement letter, preferably before the commencement of the engagement, to help in avoiding misunderstandings with respect to the engagement.
The engagement letter documents and confirms the auditor’s acceptance of the appointment, the objective and scope of the audit, the extent of the auditor’s responsibilities to the client and the form of any reports.
Engagement also covers whether the nature and scope of the engagement as related to performing an audit for a single period or multiple period, or whether a review, compilation or preparation or the select of financial statement audit only or integrated audit. There are several elements that each audit engagement letter must include and varies depending on some standards such as ISA210 or GAAS, we will proceed here based on the criteria of Terms of Engagement in AU-C Section 210 set by the AICPA.
Agreement on Audit Engagement Terms
The auditor should agree upon the terms of the audit engagement with management or those charged with governance, as appropriate. The agreed-upon terms of the audit engagement should be documented in an audit engagement letter or other suitable form of written agreement and should include the following
- The objective and scope of the audit of the financial statements
- Scope of the audit per issuer/nonissuer, period, relevant legislations
- Objectives of the Financial Statement Audit
- Objectives of the Audit of Internal Control over Financial Reporting
- The responsibilities of the auditor
- Professional skepticism; Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence.
- Ethical requirements; establishing fundamental principles of professional ethics, which include: integrity, objectivity, Professional competence and due care, confidentiality, professional behavior.
- Professional judgment; many factors such as materiality, audit risk, the nature , extent and timing of audit procedures, evaluating sufficient and appropriate evidence, evaluating management’s judgement and including drawing a conclusion are evaluated in the light of professional judgement.
- Obtaining sufficient appropriate audit evidence.
- Compliance with GAAS, in certain audit engagements, the auditor may be required to comply with other auditing requirements in addition to GAAS.
- Auditing Standards issued by PCOAB
- International Standards on Auditing (ISAs)
- Government Auditing Standards (GAS/GAGAS, yellow book)
- Auditing standards of a specific jurisdiction of country
- The responsibilities of the management
- The preparation and fair presentation of the financial statements
- The design, implementation and maintenance of internal control
- Providing the auditor with access to information and persons within the entity
- A statement that because of the inherent limitations of an audit, together with the inherent limitations of internal control, an unavoidable risk exists that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with GAAS.
- Identification of the applicable financial reporting framework for the preparation of the financial statements
- Reference to the expected form and content of any reports to be issued by the auditor and a statement that circumstances may arise in which a report may differ from its expected form and content.
Please find the example of an Audit Engagement Letter (Ref: par. .A27) under Terms of Engagement in AU-C Section 210 set by the AICPA;
Audit Engagement Letter
Date
ABC Company
Address
To the appropriate representative of those charged with governance of ABC
The following represents our understanding of the services we will provide ABC Company
[The objective and scope of the audit]
You have requested that we audit the financial statements of ABC Company, which comprise the balance sheet as of December 31, 20XX, and the related statements of income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes to the financial statements. We are pleased to confirm our acceptance and our understanding of this audit engagement by means of this letter. The objectives of our audit are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not absolute assurance and therefore is not a guarantee that an audit conducted in accordance with auditing standards generally accepted in the United States of America (GAAS) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if there is a substantial likelihood that, individually or in the aggregate, they would influence the judgment made by a reasonable user based on the financial statements.
[The responsibilities of the auditor]
We will conduct our audit in accordance with GAAS. As part of an audit in accordance with GAAS, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:
- Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
- Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control.3 However, we will communicate to you in writing concerning any significant deficiencies or material weaknesses in internal control relevant to the audit of the financial statements that we have identified during the audit.
- Evaluate the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluate the overall presentation of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation.
- Conclude, based on the audit evidence obtained, whether there are conditions or events, considered in the aggregate, that raise substantial doubt about ABC Company’s ability to continue as a going concern for a reasonable period of time.
Because of the inherent limitations of an audit, together with the inherent limitations of internal control, an unavoidable risk that some material misstatements may not be detected exists, even though the audit is properly planned and performed in accordance with GAAS.
[The responsibilities of management and identification of the applicable financial reporting framework]
Our audit will be conducted on the basis that [management and, when appropriate, those charged with governance] acknowledge and understand that they have responsibility,
- for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America;
- for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; and
- to provide us with
-
- access to all information of which [management] is aware that is relevant to the preparation and fair presentation of the financial statements such as records, documentation, and other matters;
- additional information that we may request from [management] for the purpose of the audit; and
- unrestricted access to persons within the entity from whom we determine it necessary to obtain audit evidence.
As part of our audit process, we will request from [management and, when appropriate, those charged with governance], written confirmation concerning representations made to us in connection with the audit.
[Other relevant information]
[Insert other information, such as fee arrangements, billings, and other specific terms, as appropriate.]
[Reporting]
[Insert appropriate reference to the expected form and content of the auditor’s report, including, when applicable, the reporting on other information in accordance with section 720, The Auditor’s Responsibilities Relating to Other Information Included in Annual Reports.]
We will issue a written report upon completion of our audit of ABC Company’s financial statements. Our report will be addressed to the board of directors of ABC Company. Circumstances may arise in which our report may differ from its expected form and content based on the results of our audit. Depending on the nature of these circumstances, it may be necessary for us to modify our opinion, add an emphasis-of-matter paragraph or other-matter paragraph to our auditor’s report, or if necessary, withdraw from the engagement.
We also will issue a written report on [insert appropriate reference to other auditor’s reports expected to be issued] upon completion of our audit. Please sign and return the attached copy of this letter to indicate your acknowledgment of, and agreement with, the arrangements for our audit of the financial statements including our respective responsibilities.
XYZ & Co.
Acknowledged and agreed on behalf of ABC Company by
[Signed]
[Name and Title]
[Date]
