## **Learning Outcomes**

After studying this article, you will be able to explain the purpose of an audit engagement letter, describe its typical contents, and understand the legal role of engagement letters in defining auditors’ and clients’ responsibilities. You will also be able to discuss why having a clear engagement letter reduces risk for both auditors and clients, and identify key requirements relating to engagement letters under international audit standards.

## **ACCA Foundations in Audit (FAU) Syllabus**

For ACCA Foundations in Audit (FAU), you are required to understand the fundamentals surrounding auditor engagement and legal responsibility. Review these key syllabus points:

- The factors an auditor must consider before accepting an audit engagement
- The purpose and nature of an audit engagement letter, including required contents
- The contractual significance of engagement letters for clarifying rights, responsibilities, and reducing liability
- The legal liability of auditors to clients under contract (including engagement letters)
- The requirements of ISA 210 in agreeing audit engagement terms

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What are three typical contents of an audit engagement letter?
2. Why is it important for both auditor and client to agree the terms of an engagement in writing before audit work begins?
3. True or false? An engagement letter provides the auditor with legal protection in disputes regarding the extent of work agreed.
4. Which International Standard on Auditing (ISA) covers agreeing the terms of audit engagements?
5. Under what circumstances should an auditor revise or resend an engagement letter for a recurring audit client?

## **Introduction**

Before accepting or beginning an audit, auditors must establish a clear agreement with the client about the nature and scope of the work. This is achieved through an engagement letter, which acts as a formal contract between the auditor and the entity. The engagement letter plays a central role in reducing the risk of misunderstandings, setting expectations, and providing a legal framework for the auditor's work.

A well-drafted engagement letter protects both parties by specifying responsibilities, limits of liability, and key terms. It helps ensure that both the auditor and the client understand their roles, reduces disputes, and underpins the auditor’s professional obligations.

## **PURPOSE OF THE AUDIT ENGAGEMENT LETTER**

The main aim of an audit engagement letter is to clearly define in writing:

- The objective and scope of the audit
- Responsibilities of the auditor and management
- The applicable financial reporting framework
- The expected form and content of the audit report
- Any other terms, including access to records and fees

By doing so, the letter minimizes the risk of misunderstandings and sets a solid contractual basis for the engagement. This benefits both the firm and the client by clarifying what is and isn't covered by the auditor’s work.

> **Key Term: engagement letter**
> A formal written agreement between the auditor and the client that details the terms, scope, and key responsibilities of both parties for an audit assignment.

## **WHY AN ENGAGEMENT LETTER IS ESSENTIAL**

An engagement letter is not just administrative. It serves several critical purposes:

- Confirms acceptance by the auditor of the engagement
- Documents the agreed terms and scope of the assignment
- Legally protects both parties by setting clear obligations and limitations
- Demonstrates professional conduct, meeting standards such as ISA 210
- Prevents future disputes by giving reference to agreed terms if disagreements arise

Without a formal engagement letter, auditors can be exposed to claims that additional work, advice, or assurances were expected by the client.

> **Key Term: liability**
> Legal responsibility for acts or omissions arising from failure to meet contractual or professional obligations, such as those set out in the audit engagement letter.

## **CONTENTS OF AN ENGAGEMENT LETTER**

While the detail may differ between firms and jurisdictions, the following are usually included:

- The overall objective and scope of the audit engagement
- Auditor’s responsibilities (including following ISAs)
- Management’s responsibilities (e.g., preparing financial statements, internal controls, giving access to information)
- Identification of the financial reporting framework
- The nature and expected form of the auditor’s report
- Reference to access to records and explanation of limitations if any
- The basis of fees and billing arrangements
- Arrangements for the use of experts or other auditors, if relevant
- Clarification of confidentiality and communication of significant matters

These elements align with guidance in ISA 210.

### **Worked Example 1.1**

**A firm is appointed to audit Beta Ltd for the first time. Before starting work, what steps should the auditor take relating to the engagement letter, and why?**

> **Answer:**
>
> - The auditor should prepare and send an engagement letter to Beta Ltd’s management (or those charged with governance) detailing the objective, scope, and key terms of the audit, responsibilities of each party, applicable standards, and fee arrangements.
> - This confirms in writing the terms of the engagement, establishes a legal contract, and ensures that both parties are aware of their obligations, reducing the risk of disagreement or legal claims later.

## **CONTRACTUAL NATURE AND LEGAL SIGNIFICANCE**

Once signed (or accepted in writing) by the client, the engagement letter forms a binding contract. If disputes arise—such as over the scope of the audit or liability for omissions—the engagement letter’s contents provide the main evidence of what was agreed.

A clear engagement letter reduces the chance that a client can claim for additional work or services not originally covered. For example, in legal proceedings regarding auditor negligence, courts will examine whether the auditor performed only those tasks set out in the agreed engagement letter.

### **Worked Example 1.2**

**A client later claims the auditor should have detected fraud outside the agreed scope of audit. The auditor completed all work outlined in the signed engagement letter. What defence does the auditor have?**

> **Answer:**
>
> - If the engagement letter explicitly limited the scope to a statutory audit, and the auditor followed all required standards, the letter can be used as evidence that extra investigative work was not part of the agreement, reducing the auditor’s liability for undetected fraud outside the written scope.

## **WHEN TO ISSUE OR RENEW AN ENGAGEMENT LETTER**

A new engagement letter is always required before a first audit for a client. For recurring audits, it is best practice (and often required by firm policy) to resend or revise the letter if there are:

- Changes in senior management or ownership
- Significant changes in the client's business or structure
- Updated auditing or accounting standards affecting the engagement
- Any indication of misunderstanding between auditor and client
- Changes in fees, the applicable financial reporting framework, or scope

Regularly reviewing and updating the letter strengthens the contractual clarity and professional relationship.

### **Worked Example 1.3**

**A recurring audit client moves to new accounting standards partway through a multi-year engagement. What should the auditor do regarding the engagement letter?**

> **Answer:**
>
> - The auditor should issue a revised engagement letter highlighting the change in the applicable financial reporting framework and any new responsibilities. This ensures all parties remain clear about the terms of the engagement and the basis of reporting.

### **Exam Warning**

> A common exam error is to treat an engagement letter as a mere formality. In fact, it is a key contract that underpins the entire auditor-client relationship, and its precise contents can determine the extent of the auditor’s liability if a dispute arises.

### **Revision Tip**

> Always review the required components of an engagement letter for exam questions, especially any risks or situations where a revised letter is needed.

## **Summary**

The audit engagement letter is a core tool for managing both the auditor’s liability and the client’s expectations. It specifies the purpose, responsibilities, required standards, and scope of the audit. The engagement letter’s contractual status means it is essential both at the start of the engagement and in the event of legal disputes, protecting both auditor and client from misunderstandings or unfounded claims.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- What an audit engagement letter is and why it is necessary
- Typical contents of an engagement letter, as required by ISAs
- How engagement letters define and limit auditor liability by setting clear responsibilities
- The contractual status and legal enforceability of engagement letters
- When a new or updated engagement letter should be issued

## **Key Terms and Concepts**

- engagement letter
- liability

Auditor engagement and liability - Purpose and nature of engagement letter