Question

Question 4

As audit senior in charge of the audit of Q Limited, you have asked your audit staff to review the audit files and make a list of items for inclusion in the management representation letter. The staff have provided the following draft list of points:

Liabilities

• All contingent liabilities have been discussed and appropriate disclosures made in respect of all known contingencies.
• All known subsequent events have been discussed and appropriately treated in the financial report.

Property, Plant and Equipment

• All non-current assets are stated at a value below their recoverable amount.
• All assets are being depreciated over their estimated useful lives.

Trade Receivables

• Adequate allowance has been made for all known doubtful trade debtors.
• Current assets include other receivables of $650,000 in respect of amounts receivable on settlement of a contract for the sale of commercial property. The directors confirm that it is their intention to settle the contract during the 2019/2020 financial year.

Required:

1. Outline the main purpose of a management letter. From the information gathered above, outline the items which should be included in the management representation letter, giving reasons.

                                                                                                                                                       (1+6= 7 marks)

2. The directors of Q Limited have refused to provide a management representation letter. What action should the auditor take as a result of this refusal?                                                                     

Answer 1

1. Management representation letter

A management representation letter is a form letter written by a company's external auditors, which is signed by senior company management. The letter attests to the accuracy of the financial statements that the company has submitted to the auditors for their analysis. The CEO and the most senior accounting person (such as the CFO) are usually required to sign the letter. The letter is signed following the completion of audit fieldwork, and before the financial statements is issued along with the auditor's opinion.

               The letter states that all of the information submitted is accurate, and that all material information has been disclosed to the auditors. The auditors use this letter as part of their audit evidence. The letter also shifts some blame to management, if it turns out that some elements of the audited financial statements do not fairly represent the financial results, financial position, or cash flows of the business. For this reason, the statements that the auditor includes in the letter are quite broad ranging; encompassing every possible area in which management's failings could lead to the issuance of inaccurate or misleading financial statements.

                        Management representation letter serves following two purposes:

(a) Provides a formal acknowledgment regarding management responsibility as regards financial statements.

(b) Serves as evidence where other sufficient appropriate audit evidences cannot reasonably be expected to exist.

Following is a sample of the representations that may be included in the management representation letter:

a. Management is responsible for the proper presentation of the financial statements in accordance with the applicable accounting framework

b. All financial records have been made available to the auditors

c. All board of directors minutes are complete

d. Management has made available all letters from regulatory agencies regarding financial reporting noncompliance

e. There are no unrecorded transactions

f. The net effect of all uncorrected misstatements is immaterial

g. The management team acknowledges its responsibility for the system of financial controls

h. All related party transactions have been disclosed

i. All contingent liabilities have been disclosed

j. All unasserted claims or assessments have been disclosed

k. The company has disclosed all liens and other encumbrances on its assets

l. All material transactions have been properly recorded

m. Management is responsible for systems designed to detect and prevent fraud

n. Management has no knowledge of fraud within the company

o. The financial statements conform to the applicable accounting framework

b. If management does not provide one or more of the requested written representations, the auditor shall:

(i) Evaluate whether sufficient appropriate audit evidence can be obtained from other sources:

(ii) If sufficient appropriate audit evidence cannot be obtained from other sources than this will constitute a scope limitation and the auditor should express a qualified opinion or disclaimer of opinion.

(iii) Re-valuate the integrity of management and evaluate the effect that this may have on the reliability of representations (oral or written) and audit evidence in general; and

(iv) Consider possible implications that the refusal may have on the auditor’s report.

(v) Re-assess the continuation of engagement with the audit client.