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A “rep” letter – industry jargon for a “representation letter” – is an important document. When a managing agent recently abused the rep letter process, I realized that, like so many things, too little is understood about something that is just routinely signed. Boards need to know why rep letters are important to the board and why, except for a limited change, they should not be modified.
What is a rep letter? It is written confirmation from management to the auditor about the fairness of various financial statement elements. The letter’s purpose is to emphasize that the financial statements are management’s representations, and thus management has the primary responsibility for their accuracy. Also, the letter provides supplementary audit evidence by giving replies to auditor questions regarding matters that did not come to the auditor’s attention when he performed the audit.
Some auditors request written representations of all financial statement items. All auditors require representations regarding receivables, inventories, plant and equipment, liabilities, and subsequent events.
Frequently, all these representations are included in one letter. The letter is required at the completion of the audit fieldwork and before the financial statements are issued with the auditor’s opinion. Management acknowledges its responsibilities for running the company, the adequacy of financial policies employed, confirmation of practices observed during the audit, and confirmation to the auditor that management has made full disclosure of all material activities and transactions in its financial records and statements.
A typical rep letter often reads like this: “We are providing this letter in connection with your audit(s) of the [identification of financial statements] of [name of entity] as of [dates] and for the [periods] for the purpose of expressing an opinion as to whether the [consolidated] financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of [name of entity] in conformity with generally accepted accounting principles. We confirm that we are responsible for the fair presentation in the [consolidated] financial statements of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles.
“Certain representations in this letter are described as being limited to matters that are material. Items are considered material, regardless of size, if they involve an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would be changed or influenced by the omission or misstatement. We confirm, to the best of our knowledge and belief, [as of date of auditor’s report,] the following representations made to you during your audit(s).”
This is typically followed by such representations as “The financial statements referred to above are fairly presented in conformity with generally accepted accounting principles” and “We have made available to you all—a. Financial records and related data b. Minutes of the meetings of stockholders, directors, and committees of directors, or summaries of actions of recent meetings for which minutes have not yet been prepared.”
This letter clarifies the traditional roles that management and the accountant perform. Moreover, the standards for review engagements, Statements on Standards for Accounting and Review Services, require that accountants obtain rep letters from their review clients, making the letter a mandatory part of the audit process. The American Institute of Certified Public Accountants has deemed that the “management” of cooperative corporations and condominium associations includes off-site management companies, on-site management personnel, and the board of directors, so the board needs the letter to support its statements.
This is important because the manager has access to the most detailed information about the property and has daily, first-hand exposure to transactions and other events reported in the financial statements. A rep letter documents the information relating to the manager’s knowledge of the entity and its intentions, and complements other procedures the accountant performs to review the financial statements.
The rep letter has several benefits for management. It avoids misunderstandings and provides a checklist for important matters that affect the financial statements. During the review, the manager responds to many of the accountant’s questions, so the purpose of putting these representations in writing is to confirm the continued appropriateness of the information obtained in discussions with management. The rep letter does not reduce the accountant’s responsibilities; it simply affirms a responsibility that already exists. The representations made in a rep letter do not displace other essential review procedures. An inability to perform essential procedures would constitute a limitation on the scope of the review even if management were to provide representations covering such matters.
A review of financial statements consists principally of inquiries of company personnel and analytical procedures applied to financial data. As part of a review of financial statements, the accountant is required to obtain a written representation from his or her client to confirm the oral representations made to the accountant. It is important that questions regarding representations be thoroughly explored and answered to the full satisfaction of all concerned, which is why the accountant cannot issue a report without the rep letter. Without it, the accountant is left to wonder if management has withheld information, which might raise doubts in the accountant’s mind about the reliability and completeness of management’s oral responses to the accountant’s inquiries.
Finally, the opening paragraph usually provides that “we confirm, to the best of our knowledge and belief, the following representations made to you during your audit,” so the letter seeks only what the manager knows. In reviewing the co-op or condo’s books, the accountant is seeking information relating to: the extent to which the board of directors monitors and controls the managing agent’s activities related to the co-op or condo; the use of funds; the manner in which the managing agent is compensated; the extent, if any, to which the managing agent commingles operating funds, deferred maintenance funds, and replacement funds with other associations under management; whether the co-op/condo maintains separate records for transactions initiated by the managing agent; whether the co-op/condo controls funds separately from funds controlled by the managing agent; the policy or board review of managing agent reports; the frequency of managing agent reports; the control program used by the agent with respect to the co-op/condo; existence of a conflict of interest or ethics policies, or both, for the managing agent; professional designations of the managing agent; and training and continuing education of the managing agent and agent’s staff.
Why You Should Care
Generally, the purpose of the rep letter is to provide the accountant with comfort that the audit is complete and accurate. In that regard, the rep letter is as important to the board as it is to the accountant, because both the audit and the rep letter upon which the audit is based provide the board and the owners with the comfort they need to make certain that appropriate controls are in place.
So, I become concerned when I see a form rep letter without such required language as “We are not aware of any fraud or suspected fraud affecting the condominium,” or “We have no knowledge of any allegations of fraud or suspected fraud affecting the condominium received in communications from employees, former employees, regulators, or others,” or “We acknowledge our responsibility for reviewing the entries and understanding the nature of any proposed entries and the impact they have on financial statements,” or “We acknowledge our responsibility for having qualified management-level individuals responsible and accountable for overseeing these services.” And I become even more concerned when, upon asking the manager about it, he replies, “Well, if the accountant isn’t concerned about it, why should you worry?”
I’ll tell you why. The members of co-op and condo boards and especially their treasurers are too busy with their private lives and jobs to have to also monitor every action that is taken on their behalf. Since the members of the board have a fiduciary duty to the apartment owners to exercise prudent business judgment, they have to rely on their professional advisers to act on their behalf. If the accountant is unable to perform a proper audit because he has to negotiate a standard form, then the entire system breaks down and the board is put at risk. Shouldn’t that worry someone?