Engagement Letters Notes
Introduction
This topic attempts at explaining the procedure and require of engaging
auditor. Before starting any professional engagement, it is important
that the professional agree in writing, the precise scope and the nature
of the work to be done. This is to make sure that both the client and
the professional are properly. The accountant is required to agree with
the client in writing, the scope and nature of the auditing work to be
done. This is usually done an engagement letter. There exists an
auditing guideline on engagement letters. This is auditing guideline is
Kenyan Auditing Guideline number Twelve.
Purpose of Engagement Letters
Paragraph 2 of Kenyan Auditing Standard 1 states “The auditor should
adequately plan, control and record his work”. The auditing guideline
gives guidance on one of the procedures to be followed before
commencement of audit. The purpose of an engagement letter is to define
clearly the extent of the auditor’s responsibilities and to minimize the
possibility of any misunderstanding between the client and the auditor.
The engagement letter provides a written confirmation of the auditor’s
acceptance of his/her appointment, the scope of the audit work and the
form of his/her report. If an engagement letter is not sent to clients,
both new and existing, there is scope for argument about precise extent
of the respective obligation of the client and its directors and the
auditors. Furthermore, the auditor may find that he has entered into an
implied contract arising either from article of association or by virtue
of conduct arising from practices that he has adopted over a period of time.
Specifically the purposes of an engagement letter can be simplified as
under:
- To define precisely the extent of the auditor’s responsibilities
- To minimize the possibility of misunderstanding between the auditor
and the client - To accept formally any verbal arrangements and agreements
https://masomomsingi.com/nature-and-purpose-of-financial-statements/ - To inform and educate the client regarding each parties
responsibilities and duties - If the terms of engagement are agreed in writing, there may be an
implied contract arising out of the Article of Association of
previous engagement
Procedures
The agreement of an engagement letter is in the interest of both the
auditor and the client. Therefore the contents of an engagement letter
should be discussed and agreed with the management before it is sent and
preferably prior to the audit appointment. In case of a company
incorporated under the companies Act Cap 486, the term management should
be taken to mean the directors of the company and persons acting with
similar authority.
The auditor should send an engagement letter to all new clients soon
after his appointment as auditor and, in any event, before the
commencement of the first audit assignment. He should also consider
sending an engagement letter to existing clients to whom no letter has
previously been sent as soon as suitable opportunity presents itself.
Where an auditor is engaged by a client that has subsidiary companies, a
separate letter should be sent by the auditor to the board of directors
of each company which he is auditing. However, if the terms of the
engagements are common, one letter may be sent relating to group as a
whole. In the later case, the auditor’s letter should identify the group
companies for which he is appointed as auditor, and the directors of the
holding or parent company should be requested to forward the letter to
the board of director of the subsidiary companies concerned. The
auditing should request confirmation from each board that the terms of
engagement letter are accepted. Where more than one firm of auditors is
involved in the audit of the group, the respective responsibilities of
the parent or holding company auditor and the subsidiary auditors should
be clearly defined.
Where there are joint auditors, the audit engagement should be explained
in similar terms by each auditor. The auditors should agree whether
joint or separate letters should be sent to the client. Separate letters
would normally need to be sent where other services are provided. Once
it has been agreed by the client, an engagement letter will, if it so
provides, remain effective, from one audit appointment to another, until
it is replaced. However, the engagement letter should be reviewed
annually to ensure that it continues to reflect the client’s
circumstances. If a change has taken place, including a significant
change in management which materially affects the scope or understanding
of the audit, the auditor should discuss the matter with the management
and where
appropriate send a revised engagement letter.
Contents of an Engagement Letter
The engagement should outline clear the client’s statutory duties and
the auditor’s statutory and professional responsibilities and duties.
The client’s statutory responsibilities include keeping proper books of
accounts as stipulated by Companies Act Cap 486 section 147. The
auditor’s statutory responsibilities include preparing audit reports as
stipulated in the Companies Act Cap 486 section 156 and 162 and other
provisions. The auditor’s professional responsibilities include
accounting and advising the client on compliance to standards,
regulation and the necessary legislation. The actual contents are
explained here below.
- Responsibilities and scope of the Audit
The letter should explain the principal statutory responsibility of the
client and the statutory and professional responsibility of the auditor.
In case of a company, it should be indicated that it is the statutory
responsibilities of the client to main proper accounting records and to
prepare financial statements which a true and fair view and comply with
the Companies Act Cap 486 and other
relevant legislation and regulations. It should also indicated that the
auditor’s statutory responsibilities include making a report to the
members stating whether in his opinion the financial statements gives a
true and fair view and whether they comply with Companies Act Cap 486
and other regulations and legislation.
It should be explained that the auditor has an obligation to satisfy
himself whether or not the director’s report contains any matter that
are inconsistent with the audited financial statements. Furthermore, it
should be indicated that the auditor has a professional responsibility
to report if the financial statements do not comply with in any material
respect with Internal Accounting Standards.
The scope of the audit should be explained explicitly. In this
connection, it should be pointed out that the audit will be conduct in
accordance with approved Auditing Guidelines and regard to relevant
Auditing Guidelines. It should be indicated that:
- The auditor will receive an understanding of the accounting system
in order to assess its adequacy as a basis for the preparation of
the financial statements - The auditor will expect to obtain relevant and reliable evidence
sufficient enough to enable him draw reasonable conclusion therefrom. - The nature and extent of the tests will vary according to the
auditor’s assessment of the accounting system and where he wishes to
place reliance upon it, the system of internal system. - The auditor will report to the management any significant weakness
in, or observation on, the client’s system which come to his notice
and which he thinks should be brought to the management’s attention.
Where appropriate, reference should be made to recurring special
arrangement concerning audit. These could include arrangements in
respect of internal auditors, divisions, overseas subsidiaries, other
auditors and (in the case of a small business managed by directors who
are the major shareholders) significant reliance of supervision by the
directors.
- Representation by Management
Where appropriate it should be indicated that prior to the completion of
the audit, the auditor may seek written representation from management
on matters having a material effect on the financial statements. - Irregularities and Fraud
The responsibility for the prevention and detection of irregularity and
fraud rests with the management and this responsibility is fulfilled
mainly through the implementation and continued operation of an adequate
system of internal control. The engagement letter should make this
clear. Furthermore, it should be explained that the auditor will
endeavour to plan his audit so that he has
reasonable expectation of detecting material misstatements in the
financial statements resulting from irregularities or fraud, but that
the examination should not be relied upon to disclose irregularities and
frauds which may exists. - Accounting and Taxation Services
The auditor may undertake, for the company, services in addition to
carrying out his responsibilities as an auditor. An engagement letter
should adequately describe the nature and scope of those services. In
this case of accounting services, the letter should distinguish the
accountant’s and the client’s responsibilities in relation to them and
the day to day book – keeping, the maintenance of all accounting records
and the preparation of financial statements. Preferably this should be
done in a separate letter but such services may form the subject to a
section in the audit engagement letter. In the case of the provision of
taxation services, the responsibilities for the various procedures such
as preparation of tax computations and submission of return to the
relevant authorities should be
clearly set out, either in a section of the main letter or in a separate
letter. Where accounting, taxation or other services are undertaken on
behalf of an audit client, information may be provided to members of the
audit firm other than those engaged on the audit. If
this is case, it may appropriate for the audit engagement letter to
indicate that the auditor is not to be treated as having notice, for the
purpose of his audit responsibilities, of the information given to such
people. - Fees
Mention should normally be made of fees and of the basis on which they
are computed, rendered and paid. - Agreement of Terms
The engagement letter should include a request to management that they
confirm in writing the agreement to terms of the engagement. It should
be clearly understood that, when agreed, the letter will give rise
contractual obligation and it precise content must therefore be
carefully considered. In the case of a company, the auditor
should request that the letter of
acknowledgement be signed on behalf of the board.
Example of Engagement Letter
This form of letter is generally appropriate for client companies. It is
not intended to be used in relation to every enterprise, as it must be
tailored to specific circumstances. To the directors of XYZ ltd The
purpose of this letter is to set out basis on which we (are to) act as
the auditors of the company (and its subsidiaries) and the respective
areas of responsibility of the company and of ourselves.
1.0 Audit
1.1 As directors of the above company, you are responsible for
maintaining proper accounting record and preparing financial statements
which give a true and fair view and comply with the companies Act Cap
- You are also responsible for making available to us, as and when
required, all the company’s accounting records and all other records and
related information, including minutes of all management and
shareholders’ meeting
1.2 We have statutory responsibility to report to the members whether in
our opinion the financial statements give a true and fair view of the
state of the company’s affairs and of the profit and loss for the year
and whether they comply with the companies Act cap 486.in
arriving at our opinion, we are required to consider matters, and to
report on any in respect of which we are not satisfied.
- Whether proper accounting records have been kept by the company
- Whether the company’s statement of financial position and income
statement are in agreement with the accounting records - Whether we have obtained all the information and explanation which
we think necessary for the purpose of our audit
1.3 We have professional responsibility to report if the financial
statements do not in any material respect with International Auditing
Standards and Kenyan Auditing Standards
1.4 Our audit will be conducted in accordance with Auditing Guidelines
issued by Institute of Certified Public Accountants of Kenya (ICPAK) and
will have regard to relevant Auditing Guidelines. Furthermore, it will
be conducted in such tests of transactions and of the existence,
ownership and valuation of assets and liabilities as we consider
necessary. We shall obtain an understanding of the accounting system in
order to assess the adequacy as a basis of the preparation of the
financial statements and to establish whether proper records have been
maintained. We shall expect to obtain such relevant and reliable
evidence as we consider sufficient to enable us to draw reasonable
conclusions therefrom. The nature and the extent of our tests will vary
according to our assessment of the company’s accounting systems, and
where we wish to place reliance on it the system of internal control,
and may cover any aspect of the business operations. We shall report to
you any significant weaknesses in, or observations on, the company’s
systems which come to our notice and which we think should be brought to
your attention. Our tests should not, however, be expected to identify
all weaknesses in the company’s systems.
1.5 As part of our normal audit procedures, we may request you to
provide written confirmation of oral representations which we have
received from you during the course of the audit.
1.6 In order to assist us with the examination of your financial
statements, we shall request sight of all documents or statements,
including the chairman’s statement and directors’ report, which are due
to be issued with the financial statements. We are also entitled to
attend all general meetings of the company and to receive notice of all
such meetings
1.7 (Where appropriate) we appreciate that the present size of your
business renders it uneconomical to create a system of internal control
based on the segregation of duties for different functions within each
area of business https://masomomsingi.co.ke/cpa-notes/. In the running
of your company we
understand that the directors are closely involved with the control of
the company’s transactions. In planning and performing our audit work we
shall take account of this supervision. Further, we may ask additionally
for confirmation in writing that all the
transactions undertaken by the company have been reflected and recorded
in the accounting records, and our audit report on your company’s
financial statements may refer to this confirmation.
1.8 The responsibility for the prevention and detection of
irregularities and fraud rests with you.
However, we shall endeavour to plan our audit so that we have a
reasonable expectation of detecting material misstatements in the
financial statements or accounting records resulting from irregularities
or fraud, but our examination should be relied upon to disclose
irregularities and fraud which may exist.
2.0 (Where appropriate) Accounting and other services – Either include
here or set out in a separate letter It was agreed that we should carry
out the following services as your agents and on the basis that you will
make full disclosure to us of all information.
We shall:
2.1 Prepare the financial statements based on accounting records
maintained by you
2.2 Provide assistance to the company secretary by preparing and lodging
returns with the registrar of companies.
2.3 investigate irregularities and fraud upon receiving specific
instructions
3.0 (Where appropriate) Taxation Services
3.1 Our engagement as tax advisors requires us to prepare and lodge with
the Income Tax department provisional and final income tax returns along
with their supporting computations and documents and financial
statements and to review and advise you on
correspondences or notices received from the tax authorizes.
3.2 We shall be pleased to advise you on matters relating to the
company’s tax liability, the implication of particular business
transactions and on other taxation matters you refer to us.
4.0 Fees
4.1 Our fees are computed on the basis of the time spent on your affairs
by the partners and our staff, and on the levels of skill and
responsibility involved. Unless otherwise agreed, our fees will be
charged separately for each of the main classes of work described above,
will be billed at appropriate intervals during the year and will be due
on presentation.
5.0 Agreement of Terms
5.1 Once it has been agreed, this letter will remain effective from one
audit appointment to another, until it is replaced. We shall be grateful
if you could confirm in writing your agreement to terms of this letter,
let us know if they are not in accordance with your
understanding of our terms of appointment.
