In this episode of Risky Records, we discuss engagement letter creep and managing expectations. My guest, Anthony Carolei, Risk Manager for Hanover Insurance, shares a compelling story about how engagement letter creep led to a claim against an accounting firm. Anthony highlights the importance of using risk management tools to mitigate legal exposure, incorporating protective language, managing client expectations, and conducting thorough due diligence.
To close out the session, we spun a favorite from my Vinyl Vault: Bruce Springsteen’s Greetings From Asbury Park, a beloved album for both Anthony and myself.
A critical issue
In this blog, we explore the key takeaways from our discussion, highlighting the importance of managing client expectations and using engagement letter wording to prevent issues.
Understanding engagement letter creep
Engagement letter creep occurs when the scope of services an accountant provides extends beyond what was initially agreed upon in the engagement letter.
Creep often happens informally, without an amendment to the initial agreement. As Anthony pointed out, this situation can arise from the accountant’s desire to be helpful, but it can backfire and result in legal claims.
As Anthony explained, “Any of the professionals that we deal with, they like to solve problems. They like to help out. They see a situation, they try to fix it. But the problem is that has the possibility to embroil you into a claim.”
The tax preparer’s dilemma
In our discussion, Anthony shared a story about a tax preparer who faced legal trouble due to engagement letter creep. The tax preparer was initially hired to handle annual tax returns for a client who was in the process of selling a business. However, the client sought advice on the sale’s tax implications that went beyond the original scope of their agreement and was not formalized in a new document. Consequently, the sale resulted in higher-than-expected tax liabilities, with the client blaming the tax preparer and beginning a negligence claim.
Also read: Engagement Letters for Accountants & CPAs
Another case Anthony discussed involved a CPA firm hired to perform due diligence for a client’s acquisition. The original engagement required the firm to ensure the financial representations of the target company were materially accurate. Over time, the client’s desire to cut costs reduced the scope of due diligence without formalizing these changes in the document. When the acquisition resulted in financial losses, the client sued the CPA firm for failing to cover the costs.
To avoid these situations, accountants should:
- Continually assess whether the advice given is within the original scope of engagement
- Formalize any additional services with a new or amended document
- Communicating clearly with the client about the implications of reduced services
- Ensuring that any disclaimers or limitations are explicitly stated in the letter
- Ensure protective language is in the document to manage risks
What do protective measures look like?
Here are a few protective measures accounting firms can include to prevent engagement letter creep:
- Clearly delineate the scope of work: Define the services to be provided explicitly, leaving no room for ambiguity.
- List out services not provided: Clients can assume a lot, and it is an effective tool against scope creep to outline which services you do not provide as part of the engagement letter.
- Limitations and disclaimers: Include language that limits the accountant’s liability for advice outside the agreed-upon services.
- Alternative dispute resolution: Consider mediation or arbitration clauses to resolve disputes without litigation.
- Fee-shifting provisions: Clarify which party is responsible for legal fees in the event of a dispute.
Clearly outline the services provided, the duration of the engagement, any fees or payment terms, and the full responsibilities of both parties. You may also add a section that details how a client can purchase additional services outside the scope of the initial agreement (preferably subject to an addendum or separate engagement letter). Additionally, consider including a confidentiality clause that outlines under which conditions the engagement can be terminated.
Ongoing communication is also crucial in managing client expectations. Many issues arise from misunderstandings or assumptions, making it essential to document all communications and any changes to the engagement formally. Even more critical is regularly updating the client on the progress and any changes in the scope of work to prevent misunderstandings.
Update constantly
To avoid the pitfalls of engagement letter creep, always ensure that you are creating a living document, updated as the scope of work evolves. This proactive approach will help maintain a clear understanding between the accountant and the client, ultimately leading to a more successful and risk-free engagement.
If you still have questions about this potentially thorny area of practice, you can draw on McGowan PRO’s more than twenty-five years of experience helping CPAs and their partners. Contact us now or reach out to me directly.
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