Question 4 (9 marks) As audit

Question 4

As audit senior in charge of the audit of Q Limited, you haveasked your audit staff to review the audit files and make a list ofitems for inclusion in the management representation letter. Thestaff have provided the following draft list of points:

Liabilities

  • All contingent liabilities have been discussed and appropriatedisclosures made in respect of all known contingencies.
  • All known subsequent events have been discussed andappropriately treated in the financial report.

Property, Plant and Equipment

  • All non-current assets are stated at a value below theirrecoverable amount.
  • All assets are being depreciated over their estimated usefullives.

Trade Receivables

  • Adequate allowance has been made for all known doubtful tradedebtors.
  • Current assets include other receivables of $650,000 in respectof amounts receivable on settlement of a contract for the sale ofcommercial property. The directors confirm that it is theirintention to settle the contract during the 2019/2020 financialyear.

Required:

  1. Outline the main purpose of a management letter. From theinformation gathered above, outline the items which should beincluded in the management representation letter, givingreasons.

                                                                                                                                                       (1+6=7 marks)

  1. The directors of Q Limited have refused to provide a managementrepresentation letter. What action should the auditor take as aresult of thisrefusal?                                                                     

Answer:

1. Management representationletter

A management representation letter isa form letter written by a company’s external auditors, which issigned by senior company management. The letter attests to theaccuracy of the financial statements that the company has submittedto the auditors for their analysis. The CEO and the most senioraccounting person (such as the CFO) are usually required to signthe letter. The letter is signed following the completion of auditfieldwork, and before the financial statements is issued along withthe auditor’s opinion.

              The letter states that all of the information submitted isaccurate, and that all material information has been disclosed tothe auditors. The auditors use this letter as part of their auditevidence. The letter also shifts some blame to management, if itturns out that some elements of the audited financial statements donot fairly represent the financial results, financial position, orcash flows of the business. For this reason, the statements thatthe auditor includes in the letter are quite broad ranging;encompassing every possible area in which management’s failingscould lead to the issuance of inaccurate or misleading financialstatements.

                       Management representation letter serves following two purposes:

(a) Provides a formal acknowledgment regarding managementresponsibility as regards financial statements.

(b) Serves as evidence where other sufficient appropriate auditevidences cannot reasonably be expected to exist.

Following is a sample of therepresentations that may be included in the managementrepresentation letter:

a. Management is responsible for theproper presentation of the financial statements in accordance withthe applicable accounting framework

b. All financial records have beenmade available to the auditors

c. All board of directors minutes arecomplete

d. Management has made available allletters from regulatory agencies regarding financial reportingnoncompliance

e. There are no unrecordedtransactions

f. The net effect of all uncorrectedmisstatements is immaterial

g. The management team acknowledgesits responsibility for the system of financial controls

h. All related party transactions havebeen disclosed

i. All contingent liabilities havebeen disclosed

j. All unasserted claims orassessments have been disclosed

k. The company has disclosed all liensand other encumbrances on its assets

l. All material transactions have beenproperly recorded

m. Management is responsible forsystems designed to detect and prevent fraud

n. Management has no knowledge offraud within the company

o. The financial statements conform tothe applicable accounting framework

b. If management does not provide one or more of the requestedwritten representations, the auditor shall:

(i) Evaluate whether sufficient appropriate audit evidence canbe obtained from other sources:

(ii) If sufficient appropriate audit evidence cannot be obtainedfrom other sources than this will constitute a scope limitation andthe auditor should express a qualified opinion or disclaimer ofopinion.

(iii) Re-valuate the integrity of management and evaluate theeffect that this may have on the reliability of representations(oral or written) and audit evidence in general; and

(iv) Consider possible implications that the refusal may have onthe auditor’s report.

(v) Re-assess the continuation of engagement with the auditclient.


 
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