We're very close to the end of the audit now, and really just before the audit report is going to be signed, one of the final tasks is to obtain management representations, sometimes called a letter of representation.
This goes from the company to the auditors. It'll be written on company notepaper. It'll be signed probably by the chief executive officer and perhaps the secretary or the finance director. Audits require this. This is an essential piece of evidence and if the letters of representation are not obtained then auditors will be very reluctant to give any sort of clean audit report. They do not substitute for audit evidence in general. Otherwise, you could simply have in your letter of representation somebody saying the financial statements give a true and fair view, and you could really scrap the rest of the audit that that's that's not its purpose. you obtain representations on specific matters and this would be determined by the auditor and also there are some matters which are relevant to the financial statements where other appropriate audit evidence cannot be easily obtained, for example where knowledge is confined to management. So if management for example was thinking that they're going to close down a factory and they were thinking I'm going to close down this factory in January then really in the financial statements at the 31st of December the assets relating to that factory should be valued very differently. They should be valued for that factory on a breakup basis. They should probably be setting up liabilities for redundancy pay for the workforce that's going to lose their jobs.
And there is always a possibility that even though you'd expect something very large like closing down a factory to be talked about in the board meetings and therefore to be evidenced in the board minutes, there's always the danger that this is information which is solely within management's heads and they haven't shared it with the auditors. So, where knowledge is confined to management, then we have to really ask management to confirm that they have no plans to close down factories, that they have no plans. maybe to withdraw from a certain country or to withdraw a certain product, because if they suddenly withdrew a product, then there could be implications, of course, in the inventory values.
The second time, where we perhaps have to rely on management more than we'd like, like to as auditors is where they are using a lot of a judgment and opinion even on something like the valuation of stock or the recoverability of debts we have to fight this a little bit we have we can't just kind of take their view on the recoverability of debts and the value of inventory we're going to be challenging it but nevertheless if they are insisting that all the inventory can be sold at above cost Well, why don't we get a letter where they actually state that? It focuses people's attention on what they've told the auditors. It provides the auditors with a piece of documentary evidence. And it focuses people really to think about what they're saying and what they're putting their names to.
Otherwise, we are looking for matters in the letter of representation which add corroboration, in other words, additional evidence supporting what we've found. We're looking for consistency with what we've found in the financial statements.
And we're looking for reasonableness. So the sort of typical contents that you would find in a letter of representations would be these. And this is by no means comprehensive, but it's an example.
No material irregularities. A material irregularity would be a fraud. So maybe management has discovered a fraud They haven't told us about it and we haven't discovered it. Remember, there's no obligation for us to discover a fraud. But we know that if a fraud were discovered, we would have gone after it to try to see the extent of the fraud, how much money has been stolen and for how long. So we'd like management to say they haven't been any frauds or maybe there'd be no loans to directors which are maybe outside the rules of company laws and so on.
Disclosed all liabilities. Again, back to the repair and the roof We can try to collect evidence on liabilities and accruals. We can look at payments made in January but what happens if your roof repairer was really really slow with the paperwork and the invoice? didn't come in maybe till April and and you know we could be very difficult for us to pick up the fact that there's a substantial repair on the premises or machinery so we or what happens if they got an angry letter from a supplier saying I want compensation for this and you know it hadn't been maybe disclosed in the the board meetings and so on we want them to tell us all the liabilities have been included .
no subsequent events for example it could be they know a customer has gone into liquidation but there's no particular reason why we the auditors would know that about that customer there could be you know thousands of customers we can't be you know expected really to to identify every customer which has gone into liquidation perhaps or maybe they'll say there's no evidence that the the inventory is going to be down down and valued it that you know we haven't had to lower the selling price we haven't had to make people special offers to to shift the inventory
we've mentioned no plan to shut down any part of the operations this is something which could be locked in somebody's head and very difficult to find evidence about the absence or the presence of these intentions
no inventories valued at more than naturalizable value they would say also that they think all that's could be recovered and also
all charges all mortgages and assets have been disclosed you can't just tell by looking at an asset if it has been mortgaged to a lender I know we get bank certificates in relation to the bank but they could have mortgaged this asset to somebody else they could have mortgaged it maybe to a supplier who said unless I have some security for my supplies to you and the credit I'm giving you I need this charge over the asset and that should be disclosed this is part of the disclosure requirements for the financial statements and we're getting the directors to really sit back and think about this great list of stuff we put in the letter of representation and send it to us and then we'll be in a position to consider our audit report