Should You Use an Internal Representation Letter?
An internal representation letter can help finance leaders gather input from the executives who understand different areas of the organization before signing the formal representation letter requested by the external auditor.
By Calvin Webb III, CPA, CIA, CFE
In 2017, I decided to leave Gradient Solutions and join a small start-up company just south of Dallas in Waxahachie. Before making that decision, most of my professional life had revolved around external client service in audit or consulting. Thankfully, that experience prepared me well for a new reality: serving within a single business as its Chief Financial Officer from June 2017 through September 2019.
During that time, I helped the organization complete three external audits of its financial statements.
As a consultant, I would regularly recommend methods to improve oversight, reduce risk, or better align processes with organizational strategies. One recommendation we often made to finance and accounting leaders was to use an internal representation letter with the executives or management team members who possessed important knowledge about the organization, its activities, and the information underlying its financial statements.
The formal management representation letter requested by an external auditor is necessarily broad. As a result, there is a reasonable risk that knowledge of an event or condition addressed by the letter may escape even a well-informed Chief Financial Officer, Chief Executive Officer, Chief Accountant, or other executive who is expected to sign it.
During my first external audit as CFO, I decided to take my own advice and issue an internal representation letter to our executive team. It was a relatively simple process, but it gave me greater confidence when it was time to sign the formal representation letter provided by the external audit team.
An internal representation letter is not a replacement for the official management representation letter or for the organization’s responsibility to provide complete and accurate information to its auditors. It is an internal process that can help the individuals signing the formal letter gather information from others who may have relevant knowledge.
Here are the steps I followed and would recommend that finance leaders consider.
1. Review the Auditor’s Representation Letter
First, I reviewed the proposed representation letter with our internal accounting team and legal counsel.
If we were uncomfortable with an item or believed that the wording needed clarification, we proposed changes to the external audit team. When our concerns were reasonable, we were generally able to reach common ground on the proposed language.
This review helped ensure that the accounting and legal teams understood the representations being requested before the letter was circulated more broadly.
2. Prepare an Internal Representation Letter Draft for the Team
Next, I took the final unsigned draft of the auditor’s representation letter and rewrote the relevant portions in a form that could be reviewed by our executive team.
I did not send technical accounting representations to executives who would not reasonably be expected to understand or verify them. Instead, I focused on broader business matters and blanket statements for which other leaders might possess information that had not yet reached the accounting team.
Each internal representation letter will look somewhat different and should be tailored to the organization. Questions and representations to consider may include:
Knowledge of related-party transactions or confirmation that the transactions already identified are complete.
Knowledge of fraud or suspected fraud.
Knowledge of material weaknesses, significant deficiencies, or other important breakdowns in internal controls, particularly those involving financial reporting, privacy, or information security.
Knowledge of reports, studies, investigations, or reviews—whether internal or external—that have not been provided to the accounting team.
Knowledge of regulatory or compliance matters that could affect the organization.
Knowledge of significant health and safety matters that could create a financial, legal, or operational obligation.
Knowledge of litigation, threatened litigation, or confirmation that the matters already identified are complete.
Knowledge of subsequent events or confirmation of the events already disclosed.
Knowledge of the destruction, loss, impairment, or significant change in condition of major organizational assets.
Knowledge of new or significant contracts, commitments, or agreements.
Knowledge of significant staff turnover that could materially affect the organization’s ability to prepare accurate financial information or maintain appropriate financial controls.
The purpose is not to turn executives into accountants. It is to ask whether they know something within their areas of responsibility that finance, legal counsel, or the external auditors should consider before the financial statements and formal representation letter are completed.
3. Explain Why Executive Participation Matters
Before distributing the internal letter, I sent an email or spoke directly with each executive to explain what I needed and why I needed it.
This communication was important. Executives needed to understand that the request was not simply another administrative document. Their input mattered because of the breadth of the representations being made to the external auditor and because different executives had visibility into different parts of the organization.
The process also created an opportunity to explain several important internal-control concepts and how those concepts related to each executive’s responsibilities.
In that sense, the internal representation letter also became a short training document. It gave the executive team a concise view of some of the issues that external auditors consider when evaluating the organization’s financial statements, controls, commitments, risks, and disclosures.
4. Distribute the Internal Representation Letter and Document
Finally, I distributed the internal representation letter through DocuSign.
Because I was working in a start-up environment, I had the fortunate or, some might say, unfortunate responsibility of having my hands in many of the organization’s shared-service functions. With DocuSign, I was able to upload and distribute the document for signature without requiring assistance from IT or other departments.
The electronic process made distribution, follow-up, signatures, and documentation efficient. Organizations do not necessarily need to use DocuSign, but they should use a process that clearly records:
Who received the internal letter;
Who responded;
Whether any exceptions, concerns, or additional information were reported; and
How those matters were evaluated and communicated to the appropriate members of management, legal counsel, or the external audit team.
A Practical Step Before Signing
The process did not require a significant amount of time, but it helped me feel more comfortable signing the formal representation letter provided by the external audit team.
If you are one of the individuals responsible for signing that letter, I encourage you to consider a similar process. The internal document does not need to be highly formal or technical. It can be a short, carefully prepared list of representations or questions that asks knowledgeable members of the organization to confirm what they know or identify information that finance and the external auditors should consider.
The value is not found in collecting additional signatures for their own sake. The value is in creating a deliberate opportunity for important information to surface before organizational leaders make broad written representations to the external auditor.
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