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Oct 1991

Client representation letters: optional or required? (Quality Review)

by Mancuso, Anthony J.

    Abstract- The use of representation letters in the auditing functions of an accounting firm is a sound business practice that should be encouraged. Written representations are mandated as a professional standards requirement under the Statements on Auditing Standards 19. These representations are obtained to complement the other auditing processes of the independent auditor. The specificity of the representations is based on the purpose and nature of the financial report's presentation and on the conditions of the audit engagement.

SAS 19 establishes a requirement that the independent auditor obtain written representations from management as part of an audit performed in accordance with GAAS and provides guidance concerning the representations to be obtained.

SSARS 1 provides the following guidance for reviews of financial statements. "The accountant may wish to obtain a representation letter from the owner, manager, or chief executive officer, and, if appropriate, the chief financial officer." In addition, SSARS states:

"A review of financial statements

consists principally of inquiries of

company personnel and analytical

procedures applied to financial data.

Because a review does not contemplate

tests of accounting records and

of responses to inquiries by obtaining

corroborating evidential matter,

among other things, the accountant

may consider it advisable to obtain a

written representation from his client

to confirm the oral representations

made to him."

Statement on Standards for Accountant's Services on Prospective Financial Information states that in performing a compilation of prospective financial statements the accountant should "confirm his understanding of the statements (including assumptions) by obtaining written representations from the responsible party." In addition, in an examination of prospective financial statements "the accountant should obtain written representations from the responsible party acknowledging its responsibility for both the presentation and the underlying assumptions." However, with regard to agreed-upon-procedures, AICPA standards do not require representation letters.

The Personal Financial Statements Guide states that "because of the informal nature of most personal financial records, among other things, it is advisable to confirm the oral representations made in all personal financial statement, engagement."

The Representation Letter in an


Obtaining written representations in audit engagements became a requirement of professional standards with the issuance of SAS 19. One of the primary reasons for management to acknowledge responsibility for financial statements. During an audit, management makes both oral and written representations to the independent auditor in response to specific inquiries or through the financial statements. Such representations are part of the evidential matter the independent auditor obtains, and reduces the possibility of any misunderstanding regarding matters that are the subject of the representations. However, the representations obtained are not considered a substitute for the application of those auditing procedures necessary to afford a reasonable basis for an opinion on the financial statements.

Written representatives from management are obtained by the independent auditor to complement other auditing procedures. The independent auditor applies procedures specifically designed to obtain corroborating information concerning matters that are also the subject of written representations. There are times when an auditor may be unable to obtain information through other auditing procedures to corroborate management's plans or intent. In such case, written representations provide confirmation of management's plans or intent. The written representations obtained depend on the circumstances of the audit and the nature and basis of presentation of financial statements.

The professional standards do not specify what representations be obtained by the independent auditor. The specific representations depend on the circumstances of the engagement and the nature and basis of presentation of the financial statements. What is of utmost importance is the fact that if written representations are not obtained in accordance with professional standards, the independent auditor is precluded from issuing an unqualified report. Management's refusal to furnish written representations constitutes a limitation on the scope of the audit sufficient to preclude an unqualified opinion. Results of quality reviews to date indicate that many practitioners are not getting representation letters for all their audits. Such oversight results in a substandard engagement and a potential "black mark" in a quality review.

The Representation Letter in a


In SSARS engagements, present literature provides guidance for reviews of financial statements and indicates that the accountant may wish to obtain written representations. However, SSARS states that once requested, if management refuses to sign a client representation letter, the accountant is precluded from issuing a report on the financial statements. Such refusal should cause the accountant to question the validity of management's verbal representations and accordingly, the propriety of the financial statements.

Other Matters in a Letter of


Both SAS 19 and SSARS present illustrations of matters to be included in the typical representation letter and practitioners should refer to those standards for guidance. In addition to the matter illustrated, the auditor or accountant may decide, based on circumstances of the engagement, that other matters, including the following, should be specifically included in the representation letter. 1. The company's exclusion of a short-term obligation from current liabilities because management intends to refinance the obligation on a long-term basis. 2. Specific representations by management concerning matters that are unique to particular industries. 3. Representations from a parent company's management specifying that they pertain to the consolidated financial statements and, if applicable, to the separate financial statements of the parent company. 4. Acknowledgement of the responsibility of management for adjusting entries. 5. Acknowledgement by management that the company's accounts do not contain any personal transactions. 6. Acknowledgement that management has been orally informed of any reportable conditions, as provided under SASs 60 and 61. 7. In instances where a company has not retained counsel, a statement indicating same. 8. Specific representation that company assets are pledged as collateral for obligations. 9. Representations concerning interim financial information accompanying audited financial statements. 10. Representations from management of the parent company concerning matters that may affect the subsidiary in instances where the auditor or accountant provides services to the subsidiary only. 11. Representations on required supplementary data.

Sometimes modification of the standard wording may be appropriate in order to define some of the technical terms unfamiliar to small business owners. Accordingly, alternative wording could be used under the circumstances.

Generally, representation letters would not contain items that are not material to financial position or results of operations.

Client representation letters are generally prepared by the auditor or accountant, and addressed to them, but are signed by members of management whom the auditor or accountant believes are responsible for and knowledgeable, directly or through others in the organization, about the matters covered by the representations. Normally, the CEO and CFO should sign the representations.

Because the auditor or accountant is concerned with events occurring through the date of his or her report that may require adjustments to or disclosure in the financial statements, the representations should be dated as of the date of the auditor's or accountant's report.

Sometimes the auditor or accountant is confronted with resistance from management in providing written representations. To alleviate management's anxiety in such cases, the AICPA publishes a brochure which is designed to explain the representation letter. When representation letters are forwarded to a client for signing, it may be appropriate to include the AICPA's brochure entitled "The Representation Letter."

The Direction is Clear

Representation letters are mandated in audited engagements in order to conform to GAAS, while representation letters are not a requirement of SSARS engagements, only a suggestion. However, obtaining a representation letter is sound business policy and is strongly urged.

The AICPA Accounting and Review Services Committee is currently considering whether to make representation letters a requirement of its standards.

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