An engagement letter refers to a legal document that defines the relationship between a business providing professional services (accounting, consulting, legal, etc.) and their clients. It sets the terms of the agreement between two parties and includes details such as the scope, fees, and responsibilities, among others.
An engagement letter is considered executed once it is signed by representatives of both parties. Once executed, the engagement letter forms a legally binding agreement.
An engagement letter refers to a legal document that defines the relationship between a business providing professional services and its clients.
Engagement letters set the terms of the agreement between two parties and include details such as the scope, fees, and responsibilities, among others.
Some of the benefits of engagement letters are that they are legally binding documents, they reduce misunderstandings, and they set clear expectations.
Benefits of Engagement Letters
Both parties to the engagement letter benefit from a fully executed contract. Some of the main benefits that the agreements provide are listed below:
1. Reduction of misunderstandings
Engagement letters provide clarity to both parties concerning the complete engagement process. The guesswork is taken out since the agreement specifically states the responsibilities, limitations, fees, and other details of the engagement.
2. Legally binding agreements
Since engagement letters are legally binding, it is possible to seek damages if the other party does not abide by their agreed-upon obligations. It reduces counter-party risk.
3. Setting of expectations
Engagement letters set expectations for both the client and the party providing the service, it specifies the exact service or task to be performed by the firm and the information to be provided by the client. All engagement letters also generally contain various deadlines for each sub-task.
When and How Often Are Engagement Letters Used?
Engagement letters are drafted and entered into before a professional services firm starts providing its service to the client. A single engagement letter may contain details regarding multiple services to be performed by a firm, but most often, each specific type of service to be performed is detailed in a separate engagement letter.
Engagement letters can be effective for a very long period. It is recommended to review the terms of the agreement at least annually to ensure that any updates, if needed, are noted. If changes are required, a new engagement letter or a supplement letter should be set in place.
Engagement letters usually also include a termination clause in place that allows either of the two parties to exit out of the agreement with certain applicable conditions that vary between each letter.
Typical Engagement Letter Format
Each engagement letter varies from the other, but they all follow a similar format. A typical engagement letter format is listed below:
Every engagement letter starts by stating the parties to the agreement. One of the parties is the professional services firm rendering its services, and the other party is the client receiving the services.
Each agreement also clearly states the type of service being provided by the firm to its client.
Specific service details
The agreement goes into detail regarding the specifics of the service being performed. It is done to avoid any misunderstandings and set clear expectations regarding the standard of service. The specific service section would typically also include deadlines and the fee structure.
Responsibilities of each party
The section specifies the responsibilities that must be carried out by both parties when engaged. The client may be required to provide certain information to the professional services firm.
The disclaimer section outlines the scope of the service performed. It emphasizes the limitations of the service and the caveats with which to view the final result.
Validity and termination
The engagement letter may be valid until a certain date or until the service is fully rendered and completed. The termination clause states the reasons why an engagement letter may be considered terminated and provides details regarding how to exit out of an agreement.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
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