The Accountants Risk Control team at CNA, the endorsed underwriter of the AICPA Professional Liability Insurance Program, fields thousands of questions annually from CPAs seeking risk management advice. The top topic in any given year is usually engagement letters. We've summarized our frequently asked questions below so you can easily access resources to help manage professional liability risk in your practice.
Are engagement letters really that useful?
Ask any claim professional, defense counsel, or expert: Engagement letters are one of the best defensive tools a CPA can possess. In fact, in the event of a dispute, one of the first documents requested is the engagement letter. Engagement letters provide a host of benefits to an accounting firm, including:
- They can help prevent a disagreement from growing into a claim.
- If a claim should arise, the existence of an engagement letter generally leads to lower claim severity and a more expeditious resolution.
- Many professional liability insurers provide premium and/or deductible credits for using of engagement letters.
Despite these incentives and the well-known and widely-accepted benefits of engagement letters, CNA’s claim experience demonstrates there is still room for improvement, especially related to tax and consulting services. In fact, historically speaking, only around half of claims asserted against CPA firms had an engagement letter related to the underlying engagement.
How do engagement letters impact CPA practice management?
Engagement letters are legally binding documents that detail the terms set forth by a CPA firm when undertaking a new client engagement. The engagement letter outlines the scope of work, each party’s responsibilities, anticipated deliverables, start and end dates for services to be provided, billing arrangements, and other terms. An engagement letter memorializes the agreement between the client and the accounting services provider and plays a key role in the event of a dispute.
What are the different types of engagement letters?
Forms of engagement letters used by accounting professionals include:
Annual engagement letters
Annual engagement letters are engagement agreements that are updated and issued for every engagement and are signed by both the client and the accounting firm. These contracts are reviewed at regular intervals to help ensure both client and provider expectations are aligned.
Unilateral engagement letters
Unilateral engagement letters are the same as annual engagement letters except they are only signed by the service provider. They include a statement that, through the client's provision of information to the CPA, the client and CPA agree to and accept the scope of the engagement and the firm's terms as set forth in the engagement letter provided to the client.
Evergreen or self-renewing engagement letters
This is an open-ended agreement that states the contracted accounting services will be provided until either party terminates the agreement.
Should I use unilateral engagement letters or evergreen engagement letters?
Annual engagement letters, signed by both the CPA firm and the client and updated regularly to reflected the scope of services, are considered best and are recommended for the vast majority of engagements.
However, annual engagement letters are not always practical to implement on high-volume, small-dollar engagements, such as 1040 return preparation. For these engagements, unilateral engagement letters may be appropriate.
Evergreen engagement letters are not recommended. While seemingly convenient, the use of evergreen letters potentially removes an important statute-of-limitation defense, thus permitting a claim to be asserted several years after the services were rendered.
For more on the different types of engagement letters, read CPAs, Don’t Get TKO’d in a Liability Claim by an Evergreen Engagement Letter.
What should be included in an effective engagement letter?
There are several key components that, together, help increase the effectiveness of an engagement letter for services provided by accounting and bookkeeping firms.
- Identification of parties: Clearly identify the client to whom the services will be provided to help keep unrelated third parties from asserting reliance on the services.
- Scope of service: This should detail the specific work to be performed, including services that are not included in the scope of the engagement, where appropriate. A detailed scope of service at the onset of an engagement can also help identify and avoid scope creep later.
- Professional standards: Identify the professional standards that apply to the service to help establish the appropriate standard of care.
- Responsibilities: Clearly describe both the firm’s and client’s responsibilities. The firm’s responsibilities should be limited to the services outlined in the engagement letter. Client responsibilities could include making management decisions and providing information in a timely manner, for example.
- Deliverable or work product: Describe the work product to be delivered to the client, including any limitations on its use and distribution.
- Timing: Identify when the engagement is considered complete to help establish the start of the statute of limitations period.
- Termination and withdrawal: This lays out the terms under which the engagement can be terminated by either party.
- Payment terms and fees: Include details on what the in-scope accounting services will cost, how fees will be billed, and what can happen if payments are delinquent.
- Signatures: Include signatures and dates to help demonstrate acceptance of the engagement letter’s terms. Signatures can be wet or electronic. For more on electronic signatures, read Use of E-signatures for Engagement Documentation.
- Other terms and conditions: Other business and legal terms, such as governing law, limitation of liability, and confidentiality may be added to the engagement letter or included in a separate addendum that is attached to the engagement letter and incorporated by reference.
What are standard terms and conditions, and why should I use them?
Another way to help implement engagement letters more efficiently is by using a standard terms-and-conditions addendum. This is a set of standard, firmwide terms and conditions that are updated periodically and attached as an addendum to every engagement letter issued by the firm. Example terms in a terms and conditions addendum may include, but are not limited to, dispute resolution, limitation of liability, indemnification of the CPA firm, confidentiality, and designation of venue and jurisdiction. Standard terms and conditions apply to all engagements and give the firm and the client the benefit of a single understanding addressing the key contractual elements of the relationship. In addition to helping a firm manage its risk consistently across the firm, a standard terms and conditions addendum reduces the amount of language that is required to be updated for each engagement. Read more about how standard terms can help CPA firms in Build a Better Engagement Letter: Standard Terms and Conditions.
I've been working with my clients for years; why would I start using engagement letters now?
As one CPA in the Program notes, "They're called clients, not friends, for a reason." And another notes, "When people lose money, CPAs get sued." Both sentiments have proved to be true based on CNA's claims experience. Unfortunately, even long-term, loyal clients sue. If a client balks at the introduction of an engagement letter, rationally draw comparisons to the client's business or life. Would a contractor client ever start a project without a signed proposal in hand? Would an individual client ever agree to have their car fixed without first understanding and approving the work to be done? In today's business climate, having a mutual understanding between the parties to a service is expected. An engagement letter just puts that understanding in writing.
How can I efficiently implement engagement letters in my accounting firm?
Going from zero to 100% is a daunting task. To help implement engagement letters in your accounting firm, consider these tips:
- View engagement letters as a value-added tool to help the client relationship, not an administrative burden.
- Create standard templates. While there is no one-size-fits-all engagement letter, it’s likely that a significant portion of engagement letter content will apply to all clients in a specific service line. Streamline the process by creating a template for each service offered by your firm. Review and update templates annually.
- Customize the scope of services. Customize the scope of services and other content in the standard template with the specific engagement.
- Triage clients and engagements and implement engagement letters over time. For example, prioritize high-risk clients and services and services that require engagement letters, such as attest services. Then implement engagement letters on all consulting services, including tax consulting. Finally, consider unilateral engagement letters for individual income tax preparation.
- Make it a part of your workflow. Incorporate engagement letters into your internal processes and procedures when onboarding any client.
Read Buckle Up: Crafting Effective Engagement Letters for more.
Do I really need an engagement letter for everything?
Sometimes, it may seem that preparing an engagement letter can take more time than delivering the service. Because of this, CPAs may not prepare an engagement letter for smaller engagements. However, disputes can arise regardless of the length of an engagement, and an engagement letter is highly recommended for any new client, for existing clients if the service falls under different professional standards than the initial engagement, or if an additional service would take significant time or could have a material impact on the client or other stakeholder.
That said, in certain situations, other forms of documentation, such as an engagement letter addendum or email, while not ideal, may be sufficient. These circumstances may include minor changes to an existing engagement, such as preparing a tax return for an additional state or modifying the analysis period in a due diligence engagement. For more information on what should be included in an engagement letter addendum or email alternative, read Do I Really Need a New Engagement Letter for That? CNA policyholders can access sample email templates for scope changes and minor, discrete engagements in the Policyholder Resource Center
Where can I find sample engagement letters for accounting firms?
Sources of sample engagement letters and sample terms and conditions include a CPA's professional liability carrier, the AICPA (particularly the Tax Section), paid providers, and alliance networks. Leverage samples to help create accounting engagement letter templates that are best for your firm, services, clients, and risk tolerance. Remember to have an attorney familiar with the laws in your jurisdiction review your templates for enforceability. CNA policyholders can access sample engagement letters for 35+ services in the Policyholder Resource Center.
My client has proposed edits to my engagement letter. Should I agree?
All provisions in an engagement letter serve some purpose in managing the firm's risk, and making any change affects risk in some way. Therefore, before agreeing to a client's request for modification, be sure to understand whether the client's request increases risk beyond the firm's risk tolerance. It is also helpful to understand why the client is requesting the change, because there may be a better alternative to address their concern. For example, if a high-risk, high-net-worth client wants to strike a one-time fees limitation-of-liability provision, is the engagement now too risky? Perhaps the client might accept a higher multiple of fees instead of eliminating the term entirely? Read more about how to respond to client requests for changes in How Risk Allocation Provisions Can Mitigate Risk.
Client requests for the firm's defense and indemnification have become more common in recent years. Clients include defense and indemnification provisions in engagement letters in an attempt to insulate themselves from exposure and shift responsibility to the CPA firm. Pay particular attention if a client makes this request, and do not agree to the client's modifications before reviewing the specific wording carefully in consultation with your attorney and/or professional liability carrier. Depending on how they are written and what they address, requests for the firm's indemnification may lead to significant costs to a CPA firm that may not be covered by professional liability insurance. These requests can also impair independence depending on the circumstances. Learn why and understand strategies for responding by reading Deflecting a Client’s Request for Defense and Indemnification.
Stay engaged and informed
Want to learn more about the ins and outs of engagement letters and how they could impact your firm? Download our free ebook, Beyond the Boilerplate, and get tips, insights, and practical advice on how to craft engagement letters that can help keep you and your firm protected.
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Sarah Beckett Ference, CPA, is a risk control director at CNA. For more information about this article, contact [email protected].