Chapter 14 External Confirmation Flashcards
Define external confirmation
A procedure used by the auditor to obtain evidence directly from an external party in written form
e.g. Debtors, Creditors, Banks, and Lawyers
write Benefits and drawbacks of external confirmation.
Benefits:
> It provides very highly reliable audit evidence (being in written, external and direct)
> It provides evidence about existence, rights and obligations, accuracy, and cut off.
Drawbacks:
> It does not provide evidence of completeness
> Many parties do not respond or respond without verification
In which cases auditor may not use external confirmation?
An auditor may omit external confirmation in the following situations:
i. When Inherent Risk and Control Risk both are assessed as low, or
ii. When the total balance is not material, or required
iii. When sufficient appropriate evidence can be obtained from other substantive procedures or
iv. When management requests the auditor not to send a confirmation request and there is a reasonable justificationforthis.
Write the procedures of sending external confirmation.
- Decide the timing of confirmation (i.e. whether to be used at an interim date or the final date).
- Decide appropriate confirming parties (e.g. major parties, or where risk is high).
- Decide the information to be requested (i.e. only closing balance or also other information)
- Decide the type of confirmation (i.e. whether positive or negative)
- Obtain the signature of an authorized representative (e.g. CFO) and send letters.
- Appropriate procedures should be performed on replies (e.g. if the reply is not received or there is disagreement)
- Preparation of summary and reachingaconclusion
What procedures are to be performed at year end if confirmation is sent at an interim date?
- Compare individual balances at year-end with balances at an interim date, and investigate unusual variations.
- For transactions (e.g. sales and receipts in case of debtors) between the interim date and final date:
a. select a sample of transactions, and perform tests of controls to ensure the operating effectiveness of control.
b. select a sample of material transactions, and perform tests of details to ensure that these are not materially misstated. - Send confirmation letter also at year-end(ifnecessary).
- Define Positive confirmation
- Risk in it
- How to reduce it
- A positive confirmation request asks confirming party to reply auditor in all cases whether he agrees or disagrees with the information provided in the request.
- Risk in positive confirmation: If the balance to be confirmed is included in the request (Method 1), confirming party may reply without verification.
- To reduce this risk, another method (Method 2 i.e. Blank Confirmation) is used i.e. balance to be confirmed is not included in the request. Confirming party is asked to fillitout himself.
- Define negative confirmation
- Risk in it
- A negative confirmation request asks confirming party to reply auditor only if he disagrees with the information provided in the request.
- Risk in negative confirmation: Negative confirmation is less reliable because there is no explicit evidence that confirming party received and verified confirmation. Confirmation may be lost or disregarded by the party
State the circumstances in which auditor may send negative confirmation.
Negative confirmation is used only when all of the following conditions are met:
1. Relevant population consists of large number of small balances.
2. Inherent risk and control risk are low, and the auditor has obtained evidence about the operating effectiveness of controls.
3. A very low exception rate is expected, and
4. Auditor is not aware of any circumstances that confirming party will disregardsuchrequests.
What procedures are to be performed when a response to a confirmation indicates disagreement?
If there is a disagreement, the auditor shall ask the client to reconcile the balances in its records with the balances confirmed by the parties. Reconciliation prepared by the client should be checked by the auditor to determine whether this exception is b/c of
1) Timing difference (i.e. cash in transit or goods are in transit), or 2) Misstatement in records of the client, or
3) Misstatements in the record of confirming party.
If not reconciled. If the exception is indicative of weakness in internal control or fraud, the auditor shall also increase the risk of materialmisstatement.
What procedures are to be performed when a customer does not reply to a positive confirmation?
Follow-up procedures should be performed (e.g. send another request, or ask the client to convince the party to reply). If still the response is not received, the auditor shall perform alternative procedures.
1. Examine cash received from customer after the balance sheet date. Obtain explanation for cash not received within the credit period.
2. cash is not received or partly received from the customer, the auditor shall inspect the customer signed sales orders, sales invoices, Goods Dispatch Notes, and other documents acknowledged by the customer.
3. If any amount is disputed, examine correspondence with the debtor, the lawyer’s opinion, and the appropriateness of the provision.
4. Perform the cut-off test by examining sales near the balance sheet date.
5. Compare the balance with monthly account statements sent by the debtor(ifavailable).
What procedures are to be performed when response is received electronically?
When a response is received electronically (e.g. email or fax): The auditor shall obtain evidence whether:
1. source is authentic.
2. communication process is secured and controlled e.g. by use of encryption, and digitalsignature.
Write the procedures to be performed when management refuses to send a confirmation letter.
If management refuses to allow the auditor to send a confirmation request, the auditor shall inquire about the reason for refusal from management (eg. it may be because of a legal dispute or ongoing negotiation) and shall validate the reason for refusal.
a) If the refusal is reasonable:
The auditor shall try to perform alternative audit procedures to obtain evidence. If the auditor is unable to obtain evidence from alternative procedures, it will be a scope limitation Auditor shall express a Qualified opinion (if the effect is material) or a Disclaimer of opinion (if the effect is pervasive)
b) If the refusal is not reasonable:
Discuss the issue with TCWG and request to allow the auditor to send a confirmation letter. If the auditor is still not permitted, it will:
> Affect the audit as follows:
It will be a scope limitation imposed by management. The auditor shall express a Qualified opinion (if the effect is material) or a Disclaimer of opinion (if the effect is pervasive).
> Other Implications on audit:
The auditor shall re-evaluate the integrity of management and shall consequently revise the risk of material misstatement (including the risk of fraud) and shall also modify the nature, timing, and extent of auditor procedures.
If the auditor has serious concerns about the integrity of management, he may also consider withdrawal fromengagement.
What information is to be requested in bank confirmation request?
- Full Title and account number of all bank accounts held in the name of the client, along with balances at year-end.
- For all accounts closed during the period, full titles and dates of closure.
- The separate amounts of interest credited/charged during the period
- Details of unpaid interest/bank charges.
- If there is any restriction on bank accounts, information regarding the nature and extent of the restriction.
- Details of overdrafts and loans. 7. Details of any assets held as security by the bank.
- Terms of Interest/Markup.
- Repayment Schedule.
- Debt-covenants
What information is to be requested in the legal confirmation letter?
- List of litigation and claims pending against the company
- Assessment of the outcome of the litigation and claims.
- Estimates of the financialimplications.
