During the final stage of the first audit of Nairobi National Bank Ltd. You request the client to provide you with a letter of representation. The Client reads representations you are requesting and refuses to furnish the letter. The client states its position to be as follows:-
―You are asking us to tell you all manner of things which we appointed you to find out. You are requesting us to say such things as ‗all the transactions undertaken the bank have been
properly reflected in the accounting records‘ and yet we pay you to carry out the audit. You should know whether these statements are true or not‖.
a) Explain to the client the purpose of the letter of representation. (6 marks)
b) Describe the nature of the content of a letter of representation. Your answer should be illustrated with specific examples of items which may appear in a letter of representation. (6 marks)
d) Explain the reliability of a letter of representation as audit evidence and the extent to which the auditors could rely on this evidence. (5 marks)
d) Explain the consequences of your client‘s refusal to furnish a letter of representation.
(Total: 20 marks)
A letter of representation is written the directors of a company to the auditors of that company normally towards the end of an audit before the auditor signs his audit report. The letter confirms verbal representations made the directors during the audit as well as providing audit evidence on areas where other audit evidence is not available e.g. where a company settles a legal claim out of court, the directors would then provide representations to the auditor that they know of no other claims on the company in this area.
In addition the letter of representation will serve the following functions:-
It reminds the directors of their duties concerning the financial statements. In the letter the directors acknowledge their responsibility for their preparation of the financial statements event though the auditor may have assisted in this area.
It provides the auditor with a further source of audit evidence to corroborate other information obtained.
Example of a letter of representation
Set out below is an example of a letter of representation, which relates to matters, which are material to financial statements and to circumstances where the auditor cannot obtain independent corroborative evidence and could not reasonably expect it to be available. It is not intended to be a standard letter because representations management can be expected to vary not only from one enterprise to another but also from one year to another in the case of the same client.
The letter of representation is considered reliable audit evidence because:-
It provides written confirmation of managements representation. It therefore has more credibility than oral evidence especially in instances where the management representations in the letter appear reasonable and consistent with other sources of audit evidence.
The reliability if the evidence will also depend on whether the individuals making the representations can be expected to be informed on the matter.
If the letter of representation is contradicted other evidence, the auditor should investigate the circumstances and where necessary, reconsider the reliability of other representations made management.
The Company‘s Act make it an offence to give the auditor false information thus the management is bound to provide the auditor with information that is true.
Management maybe unwilling to sign letters of representations.
If management declines the auditor should inform management that he will himself prepare a statement in writing setting out his understanding of any representations that may have been made during the course of the audit and then sends this statement to management with a request for confirmation that the auditor‘s understanding of the representation is correct.
If management disagrees with the auditor‘s statement of representation, discussions should be held to clarify the matters in doubt and if necessary a revised statement prepared and agreed. Should management fail to reply the auditor should follow the matter up to try to ensure that his understanding of the position as set out in his statement is correct.
In rare circumstances the auditor may be completely unable to obtain written representations, which he requires. E.g. because of refusal management to co- operate, or because management properly declines to give representations required on the grounds of its own uncertainty regarding that particular issue. In such circumstances the auditor may have to conclude that he has not received all the information and explanations required and consequently may need to consider qualifying his audit report on the grounds of limitation in the scope of the audit.