The Importance of an Accounting Engagement Letter

What To Know About Accounting Engagement Letters

As an accountant, you provide essential services that most businesses and individuals need. After all, most people need to be better versed in the ins and outs of everything that accounting entails. Because accountants work with financial records and can be responsible for saving their clients a lot of money—or potentially costing them a lot of money—they are vulnerable to specific liability issues that may impact their professional accountants insurance coverage.

The best way to limit professional liability, avoid unpleasant disputes and ensure that your business relationship with your clients is positive and productive is to have both parties sign an accounting engagement letter before the work begins. But why are they so necessary? What should be included in an accounting engagement letter? The team of insurance brokers at Morison Insurance has the answer to those questions and other commonly asked questions about these letters.

What is an Accounting Engagement Letter?

An accounting engagement letter is a legally binding document outlining the scope, terms and conditions of a professional relationship between an accountant and a client. Both parties must sign and date the letter to be a binding arrangement. Along with accounting engagement letters, accountants may also need tax engagements, consulting services engagements and bookkeeping engagements, and each service provided should have its engagement letter outlining the specific scope, terms and conditions for that particular service.

Are Accounting Engagement Letters Mandatory?

While the government doesn't legally require accounting engagement letters, they are still mandatory. Canadian accounting firms are required by Chartered Professional Accountants of Canada (CPA Canada) to have signed accounting engagement letters on file for every corporate or personal client. These CPA firms provide resources such as sample engagement letters that are helpful to ensure accounting engagement letters meet their professional standards.

The other factor to consider is that the accountants insurance carrier who provides your professional liability insurance will typically require you to have signed accounting engagement letters for every client to keep your insurance coverage. They require it because these letters limit your liability by reducing the risk that you'll have legal action brought against you by a client and be forced to defend yourself in court. That reduces the likelihood that you'll need to file an insurance claim on your liability coverage to pay expenses such as legal defence fees and settlement costs. Since accounting engagement letters are a simple and effective way to limit professional liability, insurance companies would require them to provide professional liability insurance coverage.

How Do Accounting Engagement Letters Benefit Accountants?

Even if accountants and accounting firms were not in any way obliged to issue accounting engagement letters by CPA Canada or their accountant's insurance provider, it would still be in their best interests to do so. Here are some of the significant reasons why it's so important for accounting professionals to protect themselves with comprehensive accounting engagement letters:

  • Prevent "Scope Creep": The term scope creep describes a phenomenon that most professionals are familiar with in which they are hired to do specific tasks or functions. Still, the client's expectations increase over time, and the professional adds on "small" duties or responsibilities to satisfy them. Since those additional tasks and responsibilities were not factored into the payment agreement, it can add to much unpaid work over time. Accounting engagement letters clearly define the boundaries of the services that will be provided, which goes a long way toward preventing scope creep from occurring.
  • Clarify Fee and Billing Expectations: Everyone wants to feel like they are paying a fair price for products and services and receive fair compensation for their work. Accounting engagement letters help ensure that both parties get what they want by clarifying how much will be paid when it will be paid, and how it will be paid.
  • Protect Against Liability Claims: One of the most critical roles of an accounting engagement letter is to protect accounting professionals against liability claims. If you had a verbal agreement about the work that would be done, a client could later try to claim you didn't deliver the promised services and sue you, even if you did what was verbally agreed on. With a letter of engagement in place, you can point to the part of the letter that defines the scope of work, therefore avoiding a potential lawsuit.

What Should Be Included in an Accounting Engagement Letter?

Since accounting engagement letters are needed for every client, individual accountants and accounting firms typically have their engagement letter templates that they modify for each client. Every letter will be different to reflect the agreement with that particular client. Accounting engagement letters are legally binding documents, so it's an excellent idea to consult an attorney for advice when creating a modifiable template to ensure you have the correct information included and it is worded in a legally comprehensive manner. Here are the key sections that are typically included in a letter of engagement.

Identification

This may seem obvious, but it sometimes needs to be included. Accounting engagement letters should always include the name and role of each person on your team who will be working on the project. They should also include your business name, the name of your client and the name of your client's business if it's relevant to the project. A generic letter that doesn't list this information will not hold up under legal scrutiny.

Scope of Services

It's critically important to define the scope of the professional services you intend to provide so everything is clear. For example, will you be providing auditing services? Storing documents? Preparing tax returns? Whether you are or not, that should be clearly stated in the accounting engagement letter and other essential information, such as delivery dates. Remember that many clients may need to learn exactly what to expect and what is typically included with an accounting service provider. They may assume, for example, that if you prepare their business tax returns for Ontario, you'll also be doing it for other provinces that they operate in, but that's not going to be the case if you calculated the payment terms based on preparing their Ontario tax returns only. If that's clearly defined in the accounting engagement letter, everyone will be on the same page about what exactly will be done and when. It also prevents scope creep, in which accountants take on additional responsibilities that didn't factor into the original agreement. 

Fees and Billing Practices

Next, the fee arrangement and payment terms should be fully outlined in the accounting engagement letter. That includes approximate information about how much the client will be billed and when. If it's not a fixed fee, it's a good idea to have an estimated range of the fees. Whether a fixed fee or an hourly rate, the overall cost is calculated based on the project's time and the staff required to fulfill the agreed-upon services. Accounting engagement letters should also include payment terms, such as billing practices and what will happen in the event of late payment. Finally, it should explain how payment will work if unanticipated services are required that are outside the original terms laid out in the engagement letter.

Responsibilities of Client

There needs to be a section in an accounting engagement letter that delineates the responsibilities and requirements of the client. For example, the client may be responsible for providing certain documents and verifying their accuracy, and the deadline to provide that information should also be part of the letter.

Limitation of Liability

Accounting engagement letters should always include terms that help to limit liability, and this is where legal advice can come in handy, especially for high-risk clients. This will likely not be its unique section like some of the other components listed above, but rather liability limiting statements throughout the legal document, where appropriate. For example, an accounting engagement letter may state in the scope of work section that the information provided by the client will not be verified or audited by the accounting firm.

Dispute Resolution

No one wants to consider that they may become involved in a dispute with a client, but it does happen. A brief passage in any accounting engagement letter should explain how disputes will be handled should a future dispute arise. That could be through arbitration, mediation, reasonable negotiations or other ways of ensuring it is settled satisfactorily without involving a court of law.

Cancellation Terms

An accounting engagement letter should explain the cancellation terms should either party wish to end the engagement agreement before the official engagement period has ended. That includes standard terms such as a 30-day notice period before the agreement is dissolved so both parties have the reassurance that there will be time to wrap up loose ends before termination.

Acceptance

Finally, there needs to be an acceptance section at the bottom of an accounting engagement letter where both parties sign and date the document to acknowledge their agreement to its terms. A letter of engagement from an accountant is legally binding once both parties have signed.

Is There a Difference Between an Accounting Engagement Letter and a Contract?

Accounting engagement letters and a traditional contract are similar because they are both legally binding documents that delineate the terms of a business agreement to reduce the risk of liability. However, engagement letters are generally less formal and shorter than contracts, so they are different.

When Should Accounting Engagement Letters Be Signed?

Before beginning the work, an accounting engagement letter should be presented to and signed by the client and the accountant. Long-term engagements should be reissued and resigned periodically or whenever the scope of services changes from what is listed on the current engagement document. Annual engagement letters are a good idea, even if the terms and conditions on the original letter remain unaltered because it reinforces the document's legality and better reduces liability risks.

What Should Not Be Included in Accounting Engagement Letters?

Along with everything that needs to be included in an accounting engagement letter, it's worth noting that there are also a few things that should be excluded. Firstly, it's important not to include vague, generic terms or overly frilly, poetic phrases. The point of the document is to hold each party accountable for their role in a business agreement, so it should be as clear and to the point as possible, so everyone is perfectly understood.

Engagement letters should also be seen as something other than a marketing opportunity to upsell services or convince clients to sign on for additional services. Of course, sales efforts have their time and place, but they should be included in legally binding agreements. Keep it professional and delineate the boundaries of your working relationship to focus on providing the best possible service to your existing clients rather than using your accounting engagement letters to attract more business.

Where Can I Find Out More About How Accounting Engagement Letters Can Impact My Accountants Insurance?

Are you interested in knowing more about why engagement letters are essential to managing your liability risk and how they influence your accountants' insurance? Get in touch with the professional brokers at Morison Insurance by calling 1-800-463-8074. Our experienced brokers are happy to answer your questions and give you contact all the information necessary to ensure you have the proper insurance protection combined with reduced liability from properly executed accounting engagement letters.

This content is written by our Morison Insurance team. All information posted is merely for educational and informational purposes. It is not intended as a substitute for professional advice. Should you decide to act upon any information in this article, you do so at your own risk. While the information on this website has been verified to the best of our abilities, we cannot guarantee that there are no mistakes or errors.

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