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 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:

  1. To define precisely the extent of the auditor’s responsibilities
  2. To minimize the possibility of misunderstanding between the auditor and the client
  3. To accept formally any verbal arrangements and agreements
  4. To inform and educate the client regarding each parties responsibilities and duties
  5. 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 a client that has subsidiary companies, a separate letter should be sent 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 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 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.

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