Auditing Engagement Letters Overview

Pre-engagement

The auditor and client must agree on the terms of the engagement, documented in an engagement letter or contract.
The engagement letter aims to prevent misunderstandings regarding the engagement.
The engagement letter should confirm:
- The auditor's acceptance of the engagement
- The audit's objective and scope
- The auditor's responsibilities to the client
- The form of any reports
The engagement letter may vary per client but generally includes:
- The audit's objective
- Management's responsibility for the financial statements
- The audit scope, referencing relevant legislation, regulations, or professional body pronouncements
- The form of reports or communication of engagement results
- Acknowledgement of inherent audit risks, including the potential for undiscovered material misstatements
- Unrestricted access to records, documentation, and information for the audit
The engagement letter may also include:
- Arrangements regarding the planning of the audit
- Request for management's written confirmation regarding representations made during the audit
- Confirmation of the engagement terms by the client acknowledging receipt of the engagement letter
- Description of expected letters or reports to the client
- Basis for fees and billing arrangements
The engagement letter may additionally include:
- Arrangements for other auditor and expert involvement in specific audit aspects
- Arrangements concerning the involvement of internal auditors and client staff
- Arrangements with the predecessor auditor in case of an initial audit
- Any restrictions on the auditor's liability
- Reference to further agreements between the auditor and the client

Audit of Components

The decision to send a separate engagement letter to a component (subsidiary, branch, or division) depends on:
- Who appoints the auditor of the component
- Whether a separate audit report is issued for the component
- Legal requirements
- The extent of work performed by other auditors
- The degree of ownership by the parent
- The component's management independence.

Recurring Audits

The auditor should consider revising engagement terms and reminding the client of existing terms for recurring audits.
Factors that may necessitate a new engagement letter include:
- Client misunderstanding of the audit's objective and scope
- Revised or special engagement terms
- Recent changes in senior management, board of directors, or ownership
- Significant changes in the client's business nature or size
- Legal requirements

Acceptance of Change in Engagement

A client's request to change the engagement may result from:
- Changes in circumstances affecting the need for the service
- Misunderstanding of the audit or related service initially requested
- Restrictions on the engagement scope, imposed by management or circumstances
- Items 1 and 2 are typically considered reasonable grounds for requesting a change in the engagement.

Terms of Audit Engagements

The auditor and client must agree on the terms of the engagement and document these in an audit engagement letter, which is a formal contract outlining the scope, responsibilities, and objectives of the audit.
The engagement letter is essential for avoiding misunderstandings and ensuring both parties understand their roles and obligations.
Auditors should send an engagement letter, preferably before commencing the engagement.

Content of the Engagement Letter

The engagement letter commonly includes the following information:
- The objective of the audit of financial statements.
- Management’s responsibility for the financial statements.
- The scope of the audit, outlining applicable legislation, regulations, and professional standards adhered to.
- The form of any reports or communications of the audit results.
- Acknowledgment of the inherent limitations of an audit, stating there's a risk of material misstatements remaining undiscovered despite best efforts.
- Confirmation of the auditor's unrestricted right to access all relevant records, documentation, and information necessary for the audit.

Additional Points to Include

Besides the core elements, the engagement letter may also include provisions for:
- Planning arrangements for the audit.
- Requesting written confirmation from management regarding representations made during the audit.
- Seeking client acknowledgment of the engagement letter, confirming the terms are understood.
- Description of potential additional letters or reports the auditor anticipates issuing to the client.
- Basis for determining fees and any associated billing arrangements.

Handling Recurring Audits

When conducting recurring audits, the auditor should reassess the terms of the engagement annually to determine if revisions are needed.
Factors that necessitate sending a refreshed engagement letter may include:
- Client misunderstanding of the audit's objectives and scope.
- Revised or special engagement terms.
- Recent changes in senior management, board of directors, or ownership.
- Significant changes in the client's business nature or size.
- Legal requirements.

Managing Changes in the Engagement

Clients may request changes to the initial engagement for several reasons:
- Circumstances affecting the need for the service have altered.
- There was a misunderstanding regarding the nature of the audit or related service initially requested.
- Restrictions are imposed on the scope of the engagement, either by management or due to circumstances.
Changes in engagement resulting from the first two reasons are typically considered reasonable.

Audits of Components

When an auditor of a parent entity also audits subsidiaries, branches, or divisions (components), the decision regarding sending separate engagement letters is influenced by factors like:
- Who appoints the component's auditor.
- Whether a separate audit report is to be issued on the component.
- Legal requirements.
- Extent of the work performed by other auditors.
- Degree of ownership by the parent entity.
- Degree of independence of the component’s management.