I recently read your article "Management representation letters: Spitting in the wind" (April 8-21, 2002; Mano et al., p. 26) and I am spitting mad. It is perhaps one of the most irresponsible articles I have ever read.
First, let me state that I agree with the authors that a representation letter is not audit evidence. However, representation letters were never intended to be that and I don’t think that most practitioners believe that is their purpose. Clearly, representations made by management must be audited. To say that a representation letter is useless and should be scrapped is ridiculous.
Let me suggest that representation letters have a purpose and can be extremely useful if the auditor takes them seriously. The following are some comments in defense of the representation letter:
It does put responsibility on management. I am surprised that your authors, especially the attorney, believe that litigation only comes from third parties. In fact, I believe that a majority of litigation against local practitioners comes from clients. The fact that management makes a statement in writing that later proves false makes it more difficult for management to claim that it was the auditor’s fault. I recommend to practitioners that, in their engagement letters, they include a clause that states that management will be asked to make certain written representations at the conclusion of the audit and that, if they are proven to be knowingly false, management will indemnify and hold the auditor harmless. I believe it was Grant Thornton who was able to recover $750,000 from a partnership client because of just such a clause.
There are certain representations that can only be known by management. A statement on which they did not consult with an attorney or the attorney that was sent a legal letter was the only attorney consulted is such an event. Yes, I agree that the auditor should look at legal fees to determine who was paid. But suppose an attorney was engaged but not yet paid or paid by another person or entity not under audit.
I once asked a client’s principal if there were any board of director’s meetings and he said, "no." When that statement appeared in the representation letter, he decided to ask his attorney. It turned out that they had a "telephonic board meeting" that the client had honestly forgotten.
Many small clients are not sophisticated about GAAP and accounting rules. They often rely on the auditor to get it right. There is, often, a tendency for the auditor to make decisions that best belong to management. For example, is it management’s intent to sell a long-lived asset? Is a security trading or available for sale? Are there any undisclosed related party transactions?
Do your authors see no benefit in the client representing in writing that all of the books and records were made available to the auditor? In one situation, a $100 "other asset" turned out to be an investment that had to be consolidated with a material gross up of revenue and expenses. I assume that your authors would not suggest
that a $100 asset would conceivably be within their audit scope. Who else is there but the client to tell the auditor about this "new" investment?
It documents in writing that certain requests for information were made of the client. This is especially so if that information is not available from another source. I believe that a statement in a representation letter that the client has given me and copies of any correspondence from regulatory agencies not only documents that I asked for the information but, additionally, makes the client think twice before casually saying, "no."
Fortunately, the auditing standards require management representation letters and, therefore, the article’s bad advice will not stop auditors from obtaining them. However, the danger is that the article fosters a "compliance-only" mentality that defeats the whole purpose of the representation letter.
The representation letter should foster a dialogue between the auditor and the client regarding items the auditor would have no way of knowing about without those representations and should provide an opportunity to explain GAAP, tax or other bases of accounting to a client.
Loscalzo & Co. LLC
130 Monmouth Street
Red Bank, N.J.
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