Auditing and Attestation- Certified Public Accountant (CPA) Practice Exam -

Which element is typically included in an auditor's engagement letter?

1. Billings to be paid in the form of stock of the entity

2. Assessment of risk of material misstatement

3. The advantage of statistical sampling

4. The inherent limitations of an audit

The correct answer is: The inherent limitations of an audit

The inclusion of inherent limitations of an audit in an auditor's engagement letter is important because it sets the expectations for what an audit entails and helps manage the client's understanding of the audit process. This element acknowledges that audits are based on sample testing rather than exhaustive examinations, meaning that there is always a risk that some material misstatements may not be detected. Inherent limitations stem from various factors, including the use of judgment in selecting procedures, the potential for human error, and the consideration that some information may be unavailable or could be intentionally concealed. By outlining these limitations, the auditor informs the client that while they will perform their duties with professional skepticism and due diligence, there are constraints on the assurance the audit can provide. Including this element in the engagement letter also highlights the distinction between an audit and other types of financial reviews or compilations, providing clarity on the level of assurance provided. This transparency is crucial in establishing a proper working relationship based on mutual understanding and realistic expectations. The other options do not align with common practices for what is included in an engagement letter. For instance, billing arrangements typically relate to payment terms and methods but do not usually include stock as a form of payment. Assessing the risk of material misstatement is part of the audit planning