8 Critical Elements of an Effective Engagement Letter

One of the best tools a CPA can (and should) consistently employ to help manage their professional liability risk is an engagement letter—a document that defines the contractual obligations between the CPA and their client.

Of course, it can’t just be any engagement letter—it needs to be an effective one. An effective engagement letter identifies the services to be performed, each party’s responsibilities, and the terms and conditions of the engagement. Ineffective engagement letters are overly brief, absent of key elements, and are poorly written.

While most CPAs understand the significance of engagement letters, there’s evidence that supports the need for practice improvement throughout the accounting profession. According to CNA, the endorsed insurer of the AICPA Professional Liability Insurance Program, only 50% of tax claims asserted against CPA firms in the program in 2022 had an engagement letter related to the underlying service. For consulting services claims in the same year, only 68% had an engagement letter (better but not where it should be).

To help you protect yourself and mitigate risk, these eight critical elements should be included in every engagement letter.

1. CLIENT NAME

The first critical element may seem obvious—the identities of the parties involved in the engagement. However, it’s important to remember that identifying all engaged parties provides a defense to third parties asserting that the engagement was performed for their benefit.

In your engagement letter, ensure that the client’s proper legal name is used, including subsidiaries and other related parties (if services are to be delivered to those parties). Within the body of the letter, consider identifying a specific point of contact you’ll take direction from and to whom questions and requests should be directed. Identifying a singular client point of contact has proven to be beneficial, particularly when business owners are in conflict with one another or if a request is made of you by an owner who’s not the primary contact.

2. SCOPE OF SERVICES

Often, disputes arise when the client’s understanding of the services to be rendered differs from yours. To reduce the likelihood of an expectation gap and avoid misunderstanding or misinterpretation, your engagement letter should clearly delineate the services to be provided with sufficient detail.

Although such detail may be fairly straightforward for an attest or tax compliance engagement, it’s commonly less so for consulting and tax services other than tax compliance. Work with your client to articulate the specific scope of the service they require and include such details in your engagement letter.

For example, “Consult regarding the individual income tax implications of the current year sale, installment sale, or like-kind exchange of the real property located at 123 Main Street, City, State, based upon a sale price of $X,” is preferable to a brief summary. For instance, “Minimize the tax on the sale of the rental property,” is far too brief and may raise questions regarding which rental property or if tax was truly minimized if another planning strategy resulted in less tax.

After the scope of services is drafted, consider asking a colleague or an impartial party to read your engagement letter to help evaluate whether it’s sufficiently specific.

3. CPA FIRM RESPONSIBILITIES

Your CPA firm’s responsibilities are generally limited to performing the services identified in the engagement letter in accordance with the professional standards outlined in the letter. Why include relevant professional standards? Doing so helps identify the specific duty of care to which you’ll be held to in the event of a dispute, and it provides a defense to the plaintiff’s counsel suggesting that a different standard applies.

This section of your engagement letter should also include limitations of the engagement which, for most services, includes no responsibility to detect theft, fraud, or weaknesses in your client’s internal controls.

4. CLIENT RESPONSIBILITIES

Experience demonstrates that clients who deflect their responsibilities related to your services are quick to blame you if problems arise. Therefore, clearly defining their responsibilities is an important element of every engagement letter for any service. Client responsibilities may include, but are not limited to:

• Providing requested information and responding to inquiries in a timely manner.
• Maintaining a system of internal controls.
• Making management decisions.
• Accepting responsibility for the results of your firm’s services.
• Providing certain representations when requested.

5. DELIVERABLES

The deliverable is the result or work product of the service you’ve been engaged to perform for your client (e.g., an audit report, a tax return, or a written memo summarizing recommended process improvements). Written deliverables are preferred to oral ones since they provide evidence of the work you’re expected to perform. However, if oral advice is provided, the deliverable could be an email to your client summarizing the oral advice you provided. Of course, like the scope of services, it’s important to be specific in your engagement letter. Be sure to:

• Describe the anticipated deliverable and its format.
• Identify tax form names and numbers to be prepared (if applicable).
• Attach a template of the deliverable (if additional clarity is needed).
• Note any restrictions or limitations on the use and distribution of the deliverable. With the exception of attest engagements, most CPA firm deliverables are solely for client use, not for third parties, which should be clearly stated in the engagement letter.

6. ENGAGEMENT TIMING

Identify when services will begin and any contingencies, such as receipt of client documentation, engagement letter, or retainer, that may affect the start date. This clarification helps reduce the risk of a misunderstanding with your client regarding timing.

The same is true for the service’s end date. Identify when the services are expected to conclude, whether it’s a milestone, such as delivery of the engagement work product, or a specific date or length of time. This clarification helps determine when the statute of limitations begins, which can aid in your defense in the event of a professional liability claim.

7. TERMINATION AND WITHDRAWAL

While nobody likes to contemplate ending an engagement before work is complete, it can and does occur. You may wish to terminate an engagement if your client insists that you take an unreasonable tax position or if your client hasn’t paid you for your services. So, make sure to include a statement in your engagement letter that notes you may withdraw from the engagement at any time without completing the services. If you feel providing examples is necessary, be sure to include the phrase, “including but not limited to,” to convey that other circumstances may result in termination or withdrawal.

8. BILLING AND FEES

Including the fees or fee estimate in your engagement letter helps clarify, in writing, the anticipated cost to your client. This specificity increases the likelihood of being paid and reduces the likelihood of a fee dispute. You should also identify contingencies that may result in fees that differ from the estimate provided.

Simply put, engagement letters often serve as written records of discussions or mutual understandings that’ve already transpired. What’s important to take away is that engagement letters help protect you and your firm from disputes and offer clients clarity of what they can expect while working with you. If a client balks at signing an engagement letter, consider drawing a parallel to their business or everyday life. Would an architect start designing a home without an understanding of what the homeowner wanted? Would an individual turn a car over to a mechanic without first approving what is to be repaired and at what cost? Obviously not. The same should be true for CPAs—engagement letters should be the foundation of our business.

Related Content:

• 5 Risk Management Tips for CPA Firms Contemplating Outsourcing: Due diligence is critical for CPA firms who are considering outsourcing their work to a third party. Before signing any contracts or agreements, consider these five risk management tips.
• The Dos and Don’ts of Disengaging: Terminating a client relationship can be a difficult, emotional process for all involved. But with the proper blueprint, it doesn’t have to be.