The agreement between the auditor and client is important to ensure that both parties are aware of the scope of the audit. It also helps prevent misunderstandings and limits the liability of both parties in case of a misstatement. In addition, the letter sets expectations and establishes a legal basis for the professional relationship. Audit firms and other services companies offering tax, financial, consulting, and auditing help require engagement letters from their clients to clarify the terms of their work.
Disagreement between auditors and their clients can have serious consequences for the client firm. Disagreement can result in higher litigation risk for the client firm and may even lead to a lawsuit (Krishnan, Krishnan, and Stephens, 1996).
Auditors have a statutory responsibility to provide an independent opinion on their clients’ financial statements. However, clients want to build trusting relationships with their auditors while maintaining independence from them. It is therefore difficult for auditors to balance these conflicting objectives.
Studies have shown that the relative flexibility and accuracy of auditors’ judgments on financial reporting matters are lower than that of their clients. These studies also document that the negotiation behavior of auditors differs from their clients. Auditors are less likely to acquiesce to their clients’ preferred accounting choices and might consider resigning from the engagements (Defond and Jiambalvo, 1993).
The agreement between the auditor and client is usually drafted in an engagement letter which specifies the precise services to be rendered, the responsibilities of both parties, and the exact time frame for the service. This letter should be sent to all new clients and, in any event, before the commencement of the first audit engagement. agreement between auditor and client