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
  • 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.

1. 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.

2. 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.

3. 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.

4. 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.

5. Fees
Mention should normally be made of fees and of the basis on which they are computed, rendered and paid.

6. 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 486. 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. 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.

Yours faithfully

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