Engagement and disengagement letters are two of the fundamental building blocks of effective CPA risk management. Along with client screening and ongoing documentation practices, engagement and disengagement letters are crucial for addressing the high expectations that clients and the public have for CPAs. Those who pay proper attention to their professional liability exposures gear their risk management techniques not only to what the profession expects of them, but also to what the public expects of them.
A client’s engagement letter should be as detailed as possible in describing the nature and extent of the services that the firm is being retained to perform, as well as the services that the firm is not being retained to perform. Similarly, it should also be as detailed as possible regarding the client’s responsibilities and obligations that will facilitate the engagement (e.g., providing necessary documents and accurate information in a timely manner).
Here are some guidelines to follow:
Engagement Letter Dos
- State the purpose of the engagement.
- Define the scope and limits of the engagement — specifically what the firm will and won’t do.
- Specify known negative conditions or adverse situations.
- Note client instructions, responsibilities, deliverables and dates.
- Note reliance on facts provided by the client.
- Outline terms of fee collections and the consequences of late payment.
- Include a stop-work clause. Enforce the clause to prevent unpaid fees from building up to the point where the firm wants to sue for them or the firm is in financial distress.
- Indicate the firm’s record retention policy.
- Include third-party service provider language, if applicable.
- Confirm client’s acknowledgement to the terms of the agreement and request client’s signature.
Other considerations include inserting language regarding the client’s responsibility for the adequacy of internal control and, if applicable, explaining the limitations regarding financial statement distribution. It’s also important to include alternative dispute resolution language (i.e., mediation for all disputes and an arbitration clause for fee disputes only) and to evaluate the appropriateness and efficacy of including limitation of liability clauses.
Engagement Letter Don’ts
- Don’t use marketing language. The engagement letter should be viewed as a contract and composed accordingly. It is not the place to convince a client that your firm is the answer to all their problems. An engagement letter limits your services, rather than sells your services. Wording such as, “We are particularly suited for this type of work” may be appropriate for a proposal letter, but not for an engagement letter.
- Don’t use all-encompassing language. Because an engagement letter limits the scope of your firm’s work, avoid superlatives and absolutes. For example, use words such as notice, examine, follow, observe, study, investigate, test, watch and comment on. However, avoid words and terms such as all, every, analysis, any, absolute, complete, confirm, judge, determine, totally, thorough, validate and verify.
- Don’t use abbreviations or words only a CPA would understand. Any ambiguity in the engagement letter will most likely be decided in the client’s favor in a court of law, so keep the language simple and clear.
- Don’t use usurious interest charges. Instead, assess a “late fee” for unpaid balances.
General Tips
- Avoid evergreen letters. It’s wise to update engagement letters at least once per year or whenever engagements change.
- Limit the use of unilateral language to lower the risk in engagements (signed engagement letters are always the strongest “first line of defense”)
- Include the full or exact name of the client, entity type, specific state names and tax years for tax engagements and purpose of engagement.
- Review the letter with the client and get agreement regarding the terms and conditions before beginning the work.
Disengagement Letters
Most CPAs — even those highly skilled at client screening — will periodically encounter situations and client relationships that call for disengaging. While the subject of disengaging is typically thought of as (at best) unpleasant, disengaging can be a practice management tool that increases firm profitability and creates a better situation for both the CPA and the client.
Proper client disengagement procedures should be used to avoid causing a loss for the client. When the decision is made to disengage, it’s best to terminate the relationship professionally and formally, in writing. At a minimum, the disengagement letter should always contain the following:
- A clear statement that you are disengaging and the effective date of the disengagement (e.g., We must formally end our relationship with you as your accounting firm <effective immediately, or as of [date]>.)
- A description of any work that is in process or unfinished
- A statement of any due dates or filing deadlines that exist regarding the work, whether finished, in process or unfinished
It is often essential to provide ample lead time before a client’s deadlines to better protect the firm from a claim or from being forced to provide some crucial services before disengaging. Review and edit your disengagement letter carefully to ensure that it is professional, objective and rational. Situations that provoke disengagements are often emotionally charged. Don’t let your letter reflect your personal feelings. When done effectively, disengagement can leave your client feeling that you have acted in the best interests of both parties.
Disengagement is an important practice management tool, and knowing how to do it skillfully and professionally will serve to help you expand your practice and avoid liability. Any time you need advice about a client situation or a disengagement letter, call your risk advisor.
Effective communication is a key factor in any CPA-client relationship. When the firm stays informed and in control, it is better protected. In the end, good risk management is good practice management and will help the firm enhance its clientele and avoid liability.