Question

Financial Auditing

What is a lawyer's letter? What is their purpose? Describe the procedure for processing them. What should an auditor do upon receipt of a lawyer's letter? What should an auditor do if a lawyer's letter is not forthcoming?

Answer 1

A lawyer's/attorney's letter is a formal business letter sent by a CPA to a client's attorney. The attorney's letter serves as verification for information pertaining to litigation related to management. This letter apprises the auditor of any pending legislation against the client that could result in financial loss and impact the company's balance sheet and cash flow.

The attorney's letter constitutes a major procedure in the audit process. Auditors will request this letter if they have any doubt that the management of the company they are auditing has litigation pending against it that they have not disclosed to the auditor. This letter will then provide them with the information that they need.

Essentially, the letter seeks to confirm that the information provided by a client is accurate and complete. Upon receipt of a response from an attorney, a CPA can better determine whether a client’s legal situation has a material impact on the information reported in its financial statements. This is of special care when possible losses from damages awarded as the result of a lost lawsuit are a possibility.

Audit Procedure:

Since the events or conditions that should be considered in the financial accounting for and reporting of litigation, claims, and assessments are matters within the direct knowledge and, often, control of management of an entity, management is the primary source of information about such matters. Accordingly, the independent auditor's procedures with respect to litigation, claims, and assessments should include the following:

1. Inquire of and discuss with management the policies and procedures adopted for identifying, evaluating, and accounting for litigation, claims, and assessments.
2. Obtain from management a description and evaluation of litigation, claims, and assessments that existed at the date of the balance sheet being reported on, and during the period from the balance sheet date to the date the information is furnished, including an identification of those matters referred to legal counsel, and obtain assurances from management, ordinarily in writing, that they have disclosed all such matters required to be disclosed.
3. Examine documents in the client's possession concerning litigation, claims, and assessments, including correspondence and invoices from lawyers.
4. Obtain assurance from management, ordinarily in writing, that it has disclosed all unasserted claims that the lawyer has advised them are probable of assertion and must be disclosed. Also the auditor, with the client's permission, should inform the lawyer that the client has given the auditor this assurance. This client representation may be communicated by the client in the inquiry letter or by the auditor in a separate letter