The Letter that bothers you

Well if it is about love letters I believe it is easier to handle.

However what we need to face now is not love letter but letter in relation to Audit.

Commonly you will have engagement letter, management letter and letter of representation (management representation) in the audit environment.

Engagement letter (EL)

This letter is between the Auditor and the Audit client. It made me worried when student is not able to understand some basic fact about EL

EL is a letter sent by Auditor to the Board of Directors(BOD). This is a contract between the Audit firm and the Audit client. Since BOD manage the Company, it should be address to the BOD.

EL should be sent out prior to commencement of the Audit process (prior to Audit Planning)

The purpose is to

1. Define clearly the extent of the auditors and directors' responsibilities
   
2. Reduce the possibility of any misunderstanding between the client and the auditor
   
3. Provide written confirmation of the auditor acceptance of the appointment
   

Al though it is a best practice to sent out EL on yearly basis however this practice has its disadvantages too. It will be costly and impracticable for Auditor to do so and Audit client might not like such practice too.

It will be good if A EL is re-sent based on the following situation:-

1. Any indication that the client misunderstand the objectives and the scope of audit
   
2. A recent change of management, board of director and audit committee
   
3. A significant change in ownership such as a new holding company
   
4. A significance change in the nature or size of the client business
   
5. Any relevant change in legal or professional requirement
   

Management Letter (ML)

This is the "love Letter" sent from Auditor to the BOD after they have completed their audit work (Audit Review) and before the issuance of the Audit report

Do remember that it is the Director responsibilities to detect fraud and improve weaknesses of the Company. However Auditor needs to highlight to the Company if they come across any of the fraud and weaknesses. So how will Auditor communicate with Director on this subject? They issue Management Letter.

Therefore in simple, ML highlights the weakness or possible fraud in the Company which auditor identified during their normal course of audit.

Remember by issuing the ML, Auditor will reduce the Audit risk and discharge their responsibilities as their responsibilities is to highlight and report any subsequent action taken will be the responsibilities of the Director.

In the content of the ML there are four major contents namely; the weakness highlighted, the impact to the Company, suggestion by auditor to resolve the weakness and Management Action (reply by management on what they will do to mitigate risk).

Letter of representation/Management representation (LOR)

Well this is the letter Auditor should receive prior to issuance of Audit report. Without the letter of representation Auditor should not issue audit report as this generally increased the Audit risk should such letter is not in the hand of the auditor.

LOR is a letter sent by the BOD to the Auditor. The purposes of the letter is to Confirm director judgement on various issue especially area involved estimation. This is also to ensure that auditor have been informed of all facts that are relevant to the company.

If the management refuses to provide written confirmation of a representation that the auditor consider necessary, the auditor should consider the implication of this scope of limitation on the report

Note: the above is just a brief explanation and the objective is to help you to understand the basic concept of the topic. Please refer to the handout for more details. Should you required further information, please do not hesitate to contact me by leaving your comment or email me.