[Submitted by Aditya,
CA (final) student]
August 24, 2011
“Let every eye negotiate for itself and trust no agent; for beauty is a witch. Against whose charms faith melteth in blood” so said Shakespeare in Much Ado About Nothing. The fact that one has to trust beyond oneself is more of a psychological challenge.
From the time man has known how to do business; there is curiosity to know the results of the activities. From the back of Horses on which the goods were transported and traded to the era of the e-commerce where everything is available at the click of a mouse, questions that are always asked is: How do I know the numbers are correct? How does the owner know everything is fine, especially when he is not around? And the owner is not Omni present and therefore has to trust his people.
The owner employs people in whom he has to place trust. Kautilya in his famous treatise, Arthashastra, has discussed the topic on Segregation of Duties in great detail. The treatise deals with the role and responsibilities of the Courtiers and the Staff of the King and other Administrators; penalty and reward processes are also deliberated to safeguard and mitigate any possible fraud or siege. Considering the complexity of the business, varied interest of the stakeholders, compliance with domestic and cross-border regulations; it is imperative to ensure high quality of financial statements and also adequate risk management practices.
The volume and intricacies of business is as such that one Manager may not be able to have focus on a particular area. This coupled with challenges at the availability of requisite skill set to monitor the activities and consistently do so. The systems should be part of business, such that decision making is not affected by individual choices. So how does a Management ensure, that the financial statements are of high quality and the show goes on; it’s by an Audit. An Auditor looks into the details from a different perspective; relying upon the documents underlying the assertions of the Management.
What if the Documents are insufficient? What if the Auditor is not satisfied with the audit evidence available?
Let the Management Speak
It is essential the Auditor places reliance on Audit Evidence gathered during the course of assignment to report appropriately on the subject matter for which he is appointed. In certain instances such as where knowledge of the facts is confined to management or where the matter is principally one of purpose, a representation by management may be the only audit evidence which can reasonably be expected to be available.
How does an Auditor ensure he has all the information?
Not every piece of information required to form an audit opinion may be available, for example; incidence of a fraud, non-compliance of a statute, access restrictions to Accounts, etc., An Auditor shall then obtain a written representation from the Management confirming the existence or non-existence of an activity which affects the Auditor’s Responsibility. The above non-compliance or incidents do impact the presentation and disclosure in financial statements but may not be evidenced in any fashion. How then is the Auditor expected to report on the true and fairness of financials when he is in dark about a situation? This is when the Written Representations are to be used.
However, during the course of an audit; if an Auditor discovers any other evidence which is contrary to what Management has confirmed; the other evidence gains more prominence and needs to be reported on.
Is a Written Representation Conclusive Evidence?
A Written Representation acts only as corroborative evidence to the Audit Evidence already available. It primarily confirms certain matters and does not include assertions in the financial statements or supporting books and records. The documents only acts as a confirmation from the Management that they have given all the information that is required for an auditor to perform his duties. Or in exceptional circumstances, an auditor may request specific comments from those charged with governance and management.
What does the Written Representation Contain?
Having done all the audit, how does the Auditor ensure that everything that needs to be presented is actually presented, there are no ambiguities in the submissions of the management and most importantly, that he knows everything that he is supposed to know.
An Auditor is required to obtain a representation letter from the Management clearly indicating that he has been provided with all the information that they have knowledge about and there were no restrictions placed on his duties.
Where information is already available on record, is well documented and there is no ambiguity in accounting; these need not be rendered again in the representation letter.
Should the Written Representation contain confirming the amounts in financial statements?
An Auditor in his report clearly indicates that the financial statements are the responsibility of the Management and his responsibility is to express true and fairness of such financial statements. The confirmation that the assertions in the financials are true and fair should be discussed by the Auditor more than the Management. The Management is anyway responsible for the financials. It is upto the Auditor to gather evidence that the assertions of the Management are accurate. Only in a circumstance, as rendered above, that there is insufficient information or there is ambiguity in statements or there is a difference in interpretation; Written Representations are to obtained as a matter of confirming the Management’s view.
The written representations also are part of Audit Evidence.
When is the Written Representation given?
An auditor has to obtain the written representation letter, before completion of the assignment; to ensure he has adequate information before an opinion is formed.
Any exceptions that Management can make?
If the information is already available in public domain or law or regulation requires that the Management make public statements about its responsibilities, then these need not be mentioned in the Representation letter. The idea of the representation letter, is to address the grey areas where information is inadequate and is not known to outsiders. But when information is already available for example, CFO and CEO of a listed company are required to certify that the internal controls are in place is a SEBI requirement and is also disclosed in the Annual Report, need not be mentioned in the Representation letter.
Is the Management reliable? Can’t they make false statements?
To start with an Audit; An Auditor should know who manages the show in the Company and to concentrate more on what is not on the paper than what is available.
The Manager’s or the Owner’s competence, integrity, ethical values or management style talks a lot about their culture. An Auditor is not expected to rely upon the Management without adequate evidence. In this scenario the Audit Risk is high; and the Auditor may if situation demands can withdraw from the engagement or is required to have additional audit evidence to mitigate the concern of mis-statements of financials. SA 705 also requires the auditor to disclaim an opinion on the financial statements in such circumstance. Further, an auditor is required to consider effects of the pervasiveness of the information not available for his audit and report accordingly.
What if the Management hesitates from giving Written Representations?
An Auditor can detail the circumstances which require the representation from the Management and communicate to them to acknowledge his understanding or view on the subject matter. If the Management disagrees to do so, an Auditor should only then mention about inadequacy of information for audit in his report.
Is there a Standard Format of Written Representation Letter?
SA 580 gives an illustrative format of the letter, but this may be modified to suit the audit requirements.
Should the Auditor audit the Written Representation? How does he ensure that the Statements made are the Truth and are reliable?
During the course of an audit, an auditor either looks into getting as much audit evidence possible and cross verifies the same to ensure its reliability. Inquiries with staff members are also important source of information, especially when the feedback varies for the same question. When the audit evidence is subjective and is not fully reliable, the auditor has to perform additional audit procedures to be satisfied with his observations.
Auditor should ensure he is not mislead by the Management. Therefore, even the Management has given a written representation on certain areas, it is the duty of the auditor to ensure that these statements are indeed correct by gathering corroborative audit evidence.
To make things simple, if the Management claims that there existed a fraud; an auditor should investigate into how the fraud occurred? What is the financial impact? Why the internal control lapsed? What is it’s impact on other processes? This confirms the existence and impact of fraud.
If the Management claims that all the information is made available to the auditor; Auditor on the other hand should also test by asking various documents to satisfy that assertions in financials are adequately documented.
As Ronald Regan rightly said, “Trust, but Verify”.