Letter of Representation

Definition

A Letter of Representation is a formal written communication made by the management of an organization to its auditors, affirming the accuracy and completeness of certain information critical to the audit of the organization’s financial statements. This letter is prepared by the auditor but signed by the management, usually on a date close to the completion of the audit and issuance of the auditors’ report. The main purpose of the Letter of Representation is to document management’s acknowledgment and take responsibility for the fairness of the presented financial data and disclosures, especially on matters for which the auditor may not have direct corroborative evidence.

Examples

1. Legal Claims: If a company anticipates a future legal claim but there is no independent documentation or confirmation available at the time of the audit, management might include this contingency in the Letter of Representation.

2. Adjusting Events: Events that occur after the balance sheet date but may require adjustments to the financial statements, such as the settlement of a lawsuit, can be included in the Letter of Representation.

3. Inventory Valuation: Management may confirm specific methods and judgments used to value inventory when independent verification from other sources is not available.

Frequently Asked Questions (FAQs)

1. Why is a Letter of Representation necessary?

The Letter of Representation serves as an important piece of audit evidence, ensuring that management claims responsibility for the completeness and accuracy of financial statements. It supports the auditor’s opinion when direct verification is not feasible.

2. Who prepares and signs the Letter of Representation?

The auditor typically prepares the Letter of Representation while the management of the organization—usually senior management—signs it.

3. When is the Letter of Representation signed?

The letter is signed at the conclusion of the audit, just before the issuance of the auditor’s report, ensuring that it reflects the most accurate and up-to-date information.

4. What types of information are included in the Letter of Representation?

The letter often includes confirmations on significant judgments, potential liabilities, regulatory compliance, the accuracy of financial records, and other items that impact the financial statements.

5. Can the Letter of Representation replace other audit evidence?

No, the Letter of Representation cannot replace independent corroborative audit evidence but supplements it. In areas where direct evidence is unattainable, the letter becomes an invaluable supplement.

Related Terms

Auditors’ Report

The formal document issued by auditors at the conclusion of their examination of the financial statements, outlining their opinion on the accuracy and fair presentation of the financial information.

Balance Sheet

A financial statement that reports an entity’s assets, liabilities, and shareholders’ equity at a specific point in time.

Financial Statements

Records that convey the financial activities and conditions of a business or entity, typically including the balance sheet, income statement, and cash flow statement.

Adjusting Events

Events that provide additional evidence of conditions that existed at the balance sheet date and thus require adjustments in the financial statements.

Online Resources

1. American Institute of Certified Public Accountants (AICPA) – Management Representation Letter

2. International Federation of Accountants (IFAC) – ISA 580, Written Representations

Suggested Books for Further Studies

1. “Auditing and Assurance Services” by Alvin A. Arens, Randal J. Elder, and Mark S. Beasley: This comprehensive book offers an in-depth exploration of auditing standards, including management representation letters.

2. “Principles of External Auditing” by Brenda Porter, Jon Simon, and David Hatherly: An excellent resource to understand the external auditing process, including the role of representation letters.

3. “Auditing: A Risk-Based Approach” by Karla M. Johnstone, Audrey A. Gramling, and Larry E. Rittenberg: This book provides a risk-based perspective on auditing practices with sections dedicated to representation letters and their importance.

Accounting Basics: “Letter of Representation” Fundamentals Quiz

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