How do you feel about engagement letters? Do you find them a pain or think they're a waste of time? If so, it might be time to reframe your thinking. Engagement letters are incredibly valuable, and they don't have to be painful. Read on for why we think engagement letters matter and how to make them feel like less of a burden.
Back to basics
What is an engagement letter meant to be? In a nutshell, an engagement letter serves as a document of agreement between a client and an accounting firm. It outlines important details such as:
Fee structure;
Responsibilities; and
Obligations of both the firm and the client.
An engagement letter is obviously useful for legal purposes, but it goes beyond this. Here are three reasons you might attribute a bit more value to your engagement letters in the future.
1. They help you manage scope creep
When your client knows exactly what to expect from you in terms of your services, you're much less likely to suddenly find additional obligations creeping up on you. And you can specify how you would like to proceed when/if the client needs more work done in your engagement letter.
2. They help you reduce risk
Using engagement letters can help you to reduce professional liability insurance premiums. Many insurers also require it. Plus, with all your obligations and the expectations of your client laid out in writing, you are less likely to face litigation at a later point. As Zan Tomich writes for Accounting Today:
"No matter how small and seemingly insignificant an engagement may seem, it should only be undertaken after an engagement letter is signed by both parties. Engagement letters are critical because they detail the scope of an engagement and important details that could otherwise give rise to dispute, such as fees and client responsibilities. If there is a dispute, each parties’ respective rights and obligations under the engagement letter will govern it."
If a client doesn't want to pay you the agreed-upon amount and they suggest that it was not what they agreed to, then at least you have it in writing that they did in fact agree to this amount.
3. They help you to avoid errors and miscommunication
If everything is clearly laid out in your engagement letter, then there's less room for confusion and miscommunication. There's also less of a chance that you'll make a mistake when it comes to doing your work or invoicing your clients.
Things to include in your engagement letter
With that being said, here are a few things you may want to consider including in engagement letters you send to clients:
A brief introduction: introducing the letter concisely
Company overview: keep this short and sweet, explaining how you can help and who you serve
Professional body requirements: get into the nitty-gritty details, such as the purpose of the letter, services included and how they'll play out, and how you'll handle disputes
Scope and price: clearly define every service you will provide and how much each service will cost your client
Preferred communication mode: such as email, phone, etc.
Expected delivery deadlines: short, simple, clear
Information to be communicated to the accounting firm from your client: anything you need from them before you begin working
Billing practices: including your terms for late payment and the different ways in which clients can pay you
Alternative dispute resolution: this is important if any disputes come to light at a later stage
Note 📝: The presence of an alternative dispute resolution (ADR) process in an engagement letter does not relieve you of responsibility for failing to uphold the pertinent professional standards or release your client from accountability for deceiving you. Regardless of the ADR, some state boards of accountancy compel accountants to self-report awards or settlements that surpass a specific threshold and are connected to claims of professional malpractice.
You will also want to include the following:
Withdrawal provisions;
Limitations of liability;
Intellectual property, ownership of data, and data protection;
Confidentiality agreement; and
Privacy policy.
Case Study: the time a client takes his CPA to court
In a blog article for AICPA, Deborah K. Rood, CPA, MST, Risk Control Consulting Director for the Accountants Professional Liability Insurance Program of Continental Casualty Company, stresses that engagement letters are definitely worth the effort, with "a resounding YES!". Rood shares the story of an incident in which a CPA was engaged to prepare income tax returns for a small business and the business's owner for several years. The business owner told his accountant on numerous occasions that he intended to sell the business one day and retire and, finally the day came when he made good on his plans and moved to a new town for his retirement.
Once in his new town, the former business owner employed a new CPA. When she was employed, she reviewed his business and personal tax returns from the past three years as part of her due diligence and noticed that the business owner could have saved a ton on taxes if he had elected S corporation status before selling the business. So, the retired business owner sued his original CPA for failing to advise him accordingly.
As the original CPA hadn't created an engagement letter which showed that the scope of his services included only income tax return preparation, the jury agreed that the CPA was also engaged to be the client's business advisor and, therefore, he was held responsible for the additional tax that his client paid. As Rood puts it:
"An engagement letter is not a “get out of jail free” card. But a clearly defined scope of service, including a provision that tax advice would be subject to a separate engagement letter, may help mitigate a claim."
Because this CPA hadn't specified that advisory services were not part of the services he was obligated to provide, he was held liable for failing to provide services that were actually out of scope. This is one reason why having an engagement letter can be incredibly beneficial to you as an accountant.
Final thoughts
Engagement letters can feel like a pain - just as any kind of admin work can. However, they're critical when it comes to setting out expectations, preventing scope creep, and making sure that if there ever is a sticky situation when you get taken to court or blamed for something that isn't your fault, you have the letter to defend you.
What's more, engagement letters don't have to be painful or time-consuming. If you create a template and repeat it with a few minor changes going forward, the time you spend on engagement letters will be negligible.
So, as you may have guessed, we'd recommend you use engagement letters with every client - ASAP.