Overcoming obstacles to engagement letter use

By Deborah K. Rood, CPA

Why should CPAs use engagement letters? The reasons are many and varied. Professional standards require an engagement letter for attest services. Standards for other services require the CPA to establish an understanding with the client of the services to be performed. In addition, the use of an engagement letter generally provides for a more efficient resolution of client disagreements. Finally, the AICPA Professional Liability Insurance Program's experience demonstrates that the use of engagement letters has a positive impact on reducing claim severity.

Despite all of the benefits supporting the use of engagement letters, many CPAs fail to do so. If you are one of the CPAs who does not use an engagement letter, perhaps one (or more) of these is the reason you've been using.

I'm not convinced engagement letters really work.

In short, yes, engagement letters work. While they are not a "get out of jail free" card if a claim occurs, engagement letters support a defense if a claim arises. Consider this story where a solid engagement letter may help to avoid a future claim:

A CPA firm's corporate tax client becomes subject to sales tax collection and remittance obligations in various states following the Supreme Court's decision in South Dakota v. Wayfair, Inc., No. 17-494 (U.S. 6/21/18). The client sold goods over the internet and did not collect sales tax in South Dakota and other states that impose sales tax collection obligations on out-of-state retailers that meet certain "economic nexus" standards. Dissatisfied with the new tax obligations, the client blamed the CPA firm for failing to advise it to review its sales tax filing obligations in other states. The CPA firm responds by referring to its trusty engagement letter, which contains two important, applicable provisions, namely:

  • "CPA Firm is not responsible for advising Client Name on nexus in other states unless specifically engaged to do so"; and
  • "Tax planning services are not included as part of the engagement but can be provided pursuant to a new engagement letter."

To further shield the CPA firm from the client's displeasure, the firm sent a newsletter to all clients explaining the impact of the Wayfair decision and advising clients to contact the firm for assistance in applying the decision to their specific facts and circumstances.

I have long and close relationships with my clients. They would never sue me.

Some attorneys who defend CPAs refer to these types of clients as "frenemies." Perhaps you have known them since grade school. Or maybe you attended their children's weddings. You may believe that they would never sue their good friend and CPA ... until something goes wrong. Consider this story of a CPA being sued by a seemingly loyal client:

The CPA performed a compilation and prepared tax returns for his high school buddy who ran a scrap metal business. The two had known each other more than 30 years and worked together at least 20 years, and everything was running smoothly, or so the CPA thought. A trusted employee of the client embezzled over $1 million of inventory over five years. When the scheme was revealed, the high school buddy sued the CPA for failing to discover the theft or informing him of weaknesses in internal controls.

Other times it may not be a longtime client who sues the CPA, but a minority owner in the business or a beneficiary of a trust created by the longtime client. Consider this scenario:

The CPA performed bookkeeping services and prepared a partnership tax return for a business that was 97% owned by a longtime client and 3% owned by his three adult children. Following the father's death, the children brought a claim against the CPA, asserting that the CPA aided and abetted the father in misappropriating business assets by paying for personal expenses such as overseas trips, country club dues, and vehicles for his wife, the children's stepmother.

As a sole practitioner, I do not have time to deal with engagement letters.

Make no mistake, implementing engagement letters takes administrative time. However, there are several strategies any CPA firm can employ to reduce the time spent managing the engagement letter process, including:

  • Using engagement letter templates. The AICPA, professional liability insurers, and for-profit businesses all have samples that a CPA firm may leverage.
  • Employing unilateral or "negative" engagement letters. This type of engagement letter does not require a client's signature. Rather, the engagement letter includes a provision that the client agrees to the terms and conditions of the engagement letter by sending its organizer or other tax information to the CPA firm. Unilateral letters can be appropriate for low-risk engagements such as preparing simple individual tax returns. However, unilateral engagement letters are not for everyone, so CPA firms should check with their professional liability insurers and/or attorney before implementing them.

So much of what I do is ad hoc consulting that cannot be standardized. An engagement letter will not work for me.

Having clients ask for advice on a regular basis is often relished by a CPA, but doing so without establishing a scope of service greatly increases the risk of a client dispute. Indeed, in 45% of consulting claims asserted to CNA in 2017, an engagement letter was not used. When an engagement letter is not used, it is the client's word against the CPA's.

Consider using a formal engagement letter for the primary service or services provided. When the client expands the scope of services by asking a question or requesting advice, send an email or other written correspondence confirming the scope of services and the estimated fees, and indicating that the terms and conditions of the original engagement letter apply. While not as effective as a formal, signed engagement letter, this protocol, at a minimum, documents the scope of services in the event of a dispute. CPA firms should consult with their professional liability insurers and/or attorneys before implementing this protocol.

My clients are not going to understand a 6-page engagement letter.

Sample engagement letters are intended to comply with professional standards, as applicable; to memorialize services to be performed for the client; and to help allocate risk between the client and the CPA firm. CPAs should customize engagement letters for their client base, as well as for individual engagements. In an attempt to shorten engagement letters, CPA firms may delete provisions that appear to be "legalese." However, the risks those provisions are intended to address may not be obvious. So, before eliminating provisions that are not fully understood, consider contacting the firm's professional liability insurer, attorney, the AICPA, or other practitioners to get a better understanding of the reason for the provision.

OK, I've run out of reasons. What now?

First, start early. Implementing the use of engagement letters will require a learning curve on the firm's part, and clients should be educated in this area or may have questions as well.

Creating engagement letter templates for your firm is a good start. Customizing the template for individual engagements will complete the process.

Take a risk-based approach. Tackle high-risk clients and engagements first. Also, going forward, consider implementing engagement letters for any new clients to get them started on the right track.

If your practice includes a large percentage of simple individual tax returns, consider using unilateral engagement letters. Each year, increase your engagement letter use. Next thing you know, you'll have engagement letters for all clients and will be an engagement letter all-star!


Deborah K. Rood, CPA, is a risk control consulting director at CNA. For more information about this article, contact specialtyriskcontrol@cna.com.

Continental Casualty Company, one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available at 800-221-3023 or visit cpai.com.

This article provides information, rather than advice or opinion. It is accurate to the best of the author's knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.

Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice.

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