When Professions Collide-lawyers' Responses to Auditors' Requests
| Publication year | 1992 |
| Pages | 27 |
61 J. Kan. Bar Assn. February, 27 (1992). WHEN PROFESSIONS COLLIDE-LAWYERS' RESPONSES TO AUDITORS' REQUESTS
Vol. 61, February, 1992
Copyright (c) 1992 by the Kansas Bar Association; Charles D. Lee
Most business lawyers periodically receive auditors' request letters. The letters come to the lawyer on the client's letterhead at the behest of the client's accountants who are conducting an audit of the client's business. Before responding to the letter the practitioner should understand the audit process, to which the auditors' letter is an adjunct, as well as the possible consequences that flow from the lawyer's response. In addition, every firm should have an established procedure for responding to the auditor's inquiries.
THE AUDIT PROCESS
An audit is an examination of financial statements or other data that are derived from a businesses' accounting process. The usual objective of the auditor's report is to provide an independent opinion on whether the company's financial statements present fairly the financial position of the business as of a specified date and in conformity with generally accepted accounting principles consistently applied.
To form an opinion regarding a company's financial statements, the auditor must consider those items that are material to the financial position of the business. The concept of materiality is fundamental to the audit process. The concept recognizes that some matters, individually, or in the aggregate, are important for the fair presentation of financial statements. The consideration of materiality is a matter of professional judgment made in light of surrounding circumstances, and necessarily involves both quantitative and qualitative considerations.
Quantitative considerations regarding materiality involve the nature and amount of an error in relation to one or more items in the financial statements. An amount that is material to one entity may not be material to another. For example, an error of $2,000 in recording an invoice might be material to a company with sales of only $20,000, and receivables of $2500, but would probably not be material to a company with sales of $20,000,000 and receivables of 2.5 million dollars.
Qualitative considerations may influence the auditor to decide that a quantitatively immaterial error may be material for other reasons. For example, a small error in the calculation of working capital that, if corrected, would result in default under a loan agreement could become material.
Information that may be material in respect to the financial condition of a business includes information concerning contingent claims that are not presently asserted. The latter known generally as contingent liabilities and technically as unasserted possible claims, has been the source of considerable controversy between lawyers and accountants. The controversy has been exacerbated by the increasing number of malpractice actions filed against accountants for failure to make required financial statement disclosures in connection with sales and purchases of securities. Accountants have responded, in part, by seeking more information from lawyers regarding undisclosed liabilities of the client. The club accountants have attempted to use is the threat of supplying a qualified opinion that might make an audited statement unacceptable for the purpose of required filings with the Securities and Exchange Commission and also the basis for default under many standard types of loan agreements and other contracts.
THE GRAND COMPROMISE
Because the needs and expectations of the accounting and legal professions in connection with the audit process are so widely disparate, the American Bar Association and the American Institute of Certified Public Accountants reached an agreement in 1976 on major issues. The resulting document is entitled ABA Statement of Policy Regarding Lawyers' Response to Auditors' Requests for Information and *28 the primary guides is "The Auditor's Letter Handbook." [FN1]
Two other important documents involved in this accord are the American Institute of Certified Public Accountants Statements on Auditing Standards No. 12-Inquiry of a Client's Lawyer Concerning Litigation, Claims and Assessments, which is the AICPA equivalent of the ABA policy statement, and the Financial Accounting Standards Board-Statement of Financial Accounting Standards No. 5-Accounting for Contingencies, which sets forth the accounting guidelines for the necessity and form of disclosure for contingent claims. Both explain the auditor's obligations and both are available from the AICPA.
THE AUDITORS' LETTER
The primary purpose of an auditors' letter is to gather or verify information as to what the auditors call "loss contingencies." These include liabilities that may arise from pending or threatened litigation or from unasserted possible claims or assessments.
The disclosure required of a lawyer in responding to an auditors' request is, to a large degree, determined by the request itself. An illustrative form of an auditors' request follows.
[Name and Address of law firm]
Dear Sirs:
In connection with an examination of the consolidated financial statements of [insert name of client] (the "Company") and its subsidiaries at [insert balance sheet date] and for the [insert fiscal period under audit] then ended, our auditors, [insert name and address of accounting firm], have asked that we request you to furnish them with information concerning certain contingencies involving matters with respect to which you have been engaged and to which you have devoted substantive attention on behalf of the Company and/or any of its subsidiaries. (For your convenience, a list of such subsidiaries is attached). This request is limited to contingencies which [ [ [insert standard of materiality to be used] and they therefore should be considered in connection with our audit. Pending or Threatened Litigation (excluding unasserted claims). Please furnish to our auditors details relating to all matters of pending or threatened litigation your firm is handling on our behalf, which meet the standard of materiality stated above, including (1) a description of the nature of each matter, (2) the progress of each matter to date, (3) how the...
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