The financial statement review engagement letter is designed to spell out the who, what and how of the review. It generally contains five parts: the introduction, the CPA responsibilities, the company responsibilities, the report and other matters. Like any contact it is a binding legal agreement if properly prepared.
Care should be taken when writing an engagement letter. First, it is a tool to ensure that both sides perform as specified. And if not, it can be used to enforce penalties for non-performance. Second, the engagement letter must adhere to standards of SSARS (Statements on Standards for Accounting and Review).
Also, please review our Ultimate Guide to Financial Statement Review and Compilation for information on the review process from beginning to end.
Before accepting the engagement and creating an engagement letter the CPA must determine if they have the independence needed to perform the service. As well, If during the performance of the review, the CPA determines that his independence is impaired, he should withdraw from the review engagement.
So what is independence? The American Institute of Certified Public Accountants (AICPA) defines independence as: “the state of mind that permits a member to perform an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism”.
Further, “Independence in appearance is the avoidance of circumstances that would cause a reasonable and informed third party, who has knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or member of the attest engagement team is compromised”.
They can call this “plain English” all they want, but it’s still a little wonky. Let’s breakdown the first part. What they are saying is that if there is a situation that puts the CPA in a position to not properly perform without bias, it’s a problem. Things that can impair independence this way are:
The performance of certain services for the client such as acting in a management capacity, holding custody of their assets or having a close family member in a position of governance working for the client. These situations create a situation where the CPA is beholden to the company they must be independent from.
The second part uses a gauge to determine if independence is impaired. If a third-party outsider would consider the CPA to be impaired, they probably are impaired. This type of consideration is useful to give the CPA pause to step back and look at his situation from the outside.
The Engagement Letter
The introduction set out what will be done. It’s where the CPA explains that a financial statement review will be performed. It also provides the time frame that is being reviewed. The following from the AICPA is a standard introduction.
You have requested that we prepare the financial statements of ABC Company, which comprise the balance sheet as of December 31, 20XX, and the related statements of income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes to the financial statements and perform a review engagement with respect to those financial statements. We are pleased to confirm our acceptance and understanding of this engagement by means of this letter.
This section can be changed to reflect a variety of things. Perhaps the engagement is for comparative financials or is for only specific elements like only a balance sheet or all statements but with out the notes. It is key to get this section, dates and all, correct.
This section is actually entitled, Our Responsibilities. That is because it is being written from the perspective of the CPA firm. There are quite a few items that appear here the following is a list from the AICPA of the basics to include.
The objective of our engagement is to:
a. prepare financial statements in accordance with accounting principles generally accepted in the United States of America based on information provided by you and
b. obtain limited assurance as a basis for reporting whether we are aware of any material modifications that should be made to the financial statements in order for the statements to be in accordance with accounting principles generally accepted in the United States of America.
We will conduct our engagement in accordance with Statements on Standards for Accounting and Review Services (SSARSs) promulgated by the Accounting and Review Services Committee of the AICPA and comply with the AICPA’s Code of Professional Conduct, including ethical principles of integrity, objectivity, professional competence, and due care.
A review engagement includes primarily applying analytical procedures to your financial data and making inquiries of company management. A review engagement is substantially less in scope than an audit engagement, the objective of which is the expression of an opinion regarding the financial statements as a whole. A review engagement does not contemplate obtaining an understanding of the entity’s internal control; assessing fraud risk; testing accounting records by obtaining sufficient appropriate audit evidence through inspection, observation, confirmation, or the examination of source documents; or other procedures ordinarily performed in an audit engagement. Accordingly, we will not express an opinion regarding the financial statements.
Our engagement cannot be relied upon to identify or disclose any financial statement misstatements, including those caused by error or fraud, or to identify or disclose any wrongdoing within the entity or noncompliance with laws and regulations. However, we will inform the appropriate level of management of any material errors and any evidence or information that comes to our attention during the performance of our review procedures that indicates fraud may have occurred. In addition, we will report to you any evidence or information that comes to our attention during the performance of our review procedures regarding noncompliance with laws and regulations that may have occurred, unless they are clearly inconsequential.
This section is titled Your Responsibilities. This is due to the fact that the letter is being aimed at the company. The following is from the AICPA and is preferred language.
The engagement to be performed is conducted on the basis that you acknowledge and understand that our role is to prepare financial statements in accordance with accounting principles generally accepted in the United States of America and to obtain limited assurance as a basis for reporting whether we are aware of any material modifications that should be made to the financial statements in order for the statements to be in accordance with accounting principles generally accepted in the United States of America. You have the following overall responsibilities that are fundamental to our undertaking the engagement in accordance with SSARSs:
a. The selection of accounting principles generally accepted in the United States of America as the financial reporting framework to be applied in the preparation of the financial statements
b. The preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America and the inclusion of all informative disclosures that are appropriate for accounting principles generally accepted in the United States of America
c. The design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of the financial statements that are free from material misstatement, whether due to fraud or error
d. The prevention and detection of fraud
e. To ensure that the entity complies with the laws and regulations applicable to its activities
f. The accuracy and completeness of the records, documents, explanations, and other information, including significant judgments, you provide to us for the engagement
g. To provide us with:
- access to all information of which you are aware is relevant to the preparation and fair presentation of the financial statements, such as records, documentation, and other matters,
- additional information that we may request from you for the purpose of the review engagement,
- unrestricted access to persons within the entity of whom we determine it necessary to make inquiries
h. To provide us, at the conclusion of the engagement, with a letter that confirms certain representations made during the review.
You are also responsible for all management decisions and responsibilities, and for designating an individual with suitable skills, knowledge, and experience to oversee our preparation of your financial statements. You are responsible for evaluating the adequacy and results of services performed and accepting responsibility for such services.
In general, management of the company is responsible for the financial information and that it complies with GAAP. They are also responsible for fraud detection and prevention and to comply with laws and regulations. They have a responsibility to provide the CPA with any access necessary to complete the review. Last they need to have a person of suitable financial knowledge to oversee the financial statement review.
This section discusses the report that will be issued with the financial statements. It also explains that the CPA does not assure that a clean (unmodified) report will be issued. It also provides an out if the CPA feels they need to withdraw from the engagement. Last it specifies what the company can and can’t do with the reviewed financials. From the AICPA this is an example wording.
We will issue a written report upon completion of our review of ABC Company’s financial statements. Our report will be addressed to the board of directors of ABC Company. We cannot provide assurance that an unmodified accountant’s review report will be issued. Circumstances may arise in which it is necessary for us to report known departures from accounting principles generally accepted in the United States of America, add an emphasis-of-matter or other matter paragraph(s), or withdraw from the engagement. If, for any reason, we are unable to complete the review of your financial statements, we will not issue a report on such statements as a result of this engagement.
You agree to include our accountant’s review report in any document containing financial statements that indicates that such financial statements have been reviewed by us and, prior to inclusion of the report, to ask our permission to do so.
Other Relevant Information
This area is designed for the CPA to insert the cost for services as well as charges for ancillary services like photo copying and other side items. They can also add legal things like how disputes are handled. Pretty much anything not covered above can be inserted here.
Attached to this post below is a copy of a financial statement review letter that I sometimes use. It is a guide that I base many letters off of. Enjoy!