Final answer:
An engagement letter is a legal agreement between an auditor and a client that outlines the terms of their relationship before the audit begins. It is necessary to send a new engagement letter each year for a continuing client. AU-C 210 and AS 1301 provide guidance on the preparation of engagement letters.
Step-by-step explanation:
An engagement letter is a legal contract between an auditor and a client that outlines the terms and conditions of their relationship. It serves as an agreement and understanding between both parties before the audit begins. The engagement letter is prepared by the auditor and acknowledged by the client.
Statement 1 is incorrect because it is necessary to send a new engagement letter each year for a continuing client, even if the terms of the engagement remain the same. This ensures that both the auditor and the client are aware and agree to the terms of the engagement for that particular year.
AU-C 210 Terms of Engagement and AS 1301 Communications with Audit Committees provide guidance on the preparation of engagement letters, as mentioned in statement 2. These standards help auditors understand the necessary contents and format of an engagement letter.
The first stage in the client acceptance or continuance decision process, as stated in statement 3, involves the preparation of an engagement letter. It is an important step to establish clear communication and agreement between the auditor and the client.