Small CPA firms deal with several challenges. Some are common to any small business, like credit and managing employees, while others, like maintaining a license and compliance with the rules of practice, are specific to CPAs. These are broadly termed practice risk.
The right engagement letter can reduce or eliminate the most common practice risks by avoiding legal claims, setting up proactive legal defenses, and reducing the impact of a claim. Surprisingly, 41% of small practices don’t use any engagement letters at all.
Avoiding claims. Of course, ensuring competency and currency with the professional rules is important to a successful practice.
But being good at what you do is not always enough. One of the most common causes of malpractice is failing to return client phone calls or other correspondence. Most clients don’t know enough about taxes to really know whether you are a good tax professional, but they know whether you answer the phone or promptly return their messages and emails.
Good communication is therefore an essential part of the accountant-client relationship. Best practices under U.S. Treasury Department Cir. 230 require clear communication with the client regarding the terms of an engagement. Using a written engagement letter is strongly encouraged.
Furthermore, accountants should aim for thorough, frequent and transparent communications throughout the engagement. The best time to update a client about the status of their project, for example, is well before the client is expecting it.
Defending Claims. Small practices only use tax engagement letters about half of the time while claims against accountants are overwhelmingly related to tax planning and compliance engagements. Claims usually involve improper advice, technical mistakes and filing errors.
An engagement letter can establish valid legal defenses to these sorts of claims. For example, complaints frequently amount to a “you didn’t tell me” theory about a tax rule affecting the client. An engagement letter avoids this problem by describing what work the accountant will do for the client and, more importantly, what work is outside of the scope of services.
Mitigating Claims. Engagement letters can mitigate consequences if a claim is made against your practice. For example, including a limitation of liability agreement in the engagement letter can reduce the amount of damages to no more than the fees paid for services. Even without a limitation of damages, successful claims against accountants were 30% higher when there wasn’t an engagement letter.
In summary, using an engagement letter strengthens the accountant-client relationship by clearly spelling out the terms of the agreement. A well written letter will set client expectations about everything from deliverable work to payment terms. Clear, transparent communication will build trust and strengthen the account-client relationship – the foundation of any successful accounting practice.