Engagement letters are basically an upfront contract between accountants and their clients. They make the scope of the agreement more transparent, so that the client has an understanding of exactly what services they have agreed to.
"It keeps everyone on the same page," said Rudy Rudolph, risk advisor for Aon, the manager of the American Institute of CPA's professional liability insurance program. "They ensure that the client has an understanding of exactly what services are being provided. When you drop off your car at a mechanic's garage, the mechanic might call and inform the customer that they noticed several things that need to be addressed, and ask for instructions. You wouldn't drop off the car and pick it up without knowing what work was done," he said. "And you'd be sure to question any charges for additional work."
It may be different in the case of smaller firms, Rudolph acknowledged.
"A lot of firms are old-school," he said. "They're in a town where everyone is on a first-name basis. Their attitude is that 'I know everyone, and none of them would sue me.' But the engagement letter is one of the most important defense tools for CPA firms. If they say they don't see the need for it, and that their clients won't sue them, would it really hurt to have them sign a piece of paper just explaining what I'm doing?"
Rudolph cited a case where the CPA, a small-town accountant, had been doing a friend's tax returns for 30 years. The friend had a scrap metal business, and discovered that an employee had embezzled more than $1,000,000 over a five-year period.
"The business owner sued the CPA for not catching the embezzlement. The question is at what point would someone sue — the greater the amount of money that was lost increases the likelihood that the accountant will get sued. Any kind of consultant in business would want an understanding of what they were doing for them regardless of friendship or how small the town is."
Another objection might be that redundant work doesn't really require a formal contract. "There are a lot of tasks that smaller firms might not be able to do to require a customized letter for every client, but at least they should have a template and be able to alter it on the fly," he said. "Having to sign an engagement letter should make it easier to confirm how the business relationship is working out."
The agreement itself is important in setting the parameters for recovery. For instance, where a CPA firm prepared returns for an individual and two business entities, A and B, the CPA prepared engagement letters for each. These included a business credit for A. Some years later, a different CPA firm discovered that Entity B qualified for the same credit. The business owner tried to sue the previous CPA for not applying for the credit for Entity B. For the original CPA, the engagement letters provided a solid defense: They were enough to show that he had been asked to do the credit for one business — Entity A — rather than for both A and B.
The agreement itself can set the parameters for recovery. For instance, where the CPA firm prepared returns for an individual and two business entities, A and B, all three had engagement letters. Where the CPA firm prepared returns for business A, the owner tried to sue the previous CPA for not applying for entity B. It was enough to show that the previous CPA had been asked to do the credit for one business rather than across the board.
Whether it's a generalized statement about the scope of work, it is probably one of the most important tools a CPA can use, and is the No. 1 defense tool that attorneys look for regarding a CPA's work.
"Having a piece of paper — the engagement letter — as a contract of the work being done is such a great resource to retain as much money as the CPA may potentially stand to lose," said Rudolph.
