Chapter 14: External Confirmation Flashcards
What is external confirmation?
External confirmation is a procedure where the auditor obtains direct written evidence from a third party (e.g., debtors, creditors, banks) to verify financial information.
What are examples of situations where external confirmations are used?
- Confirming balances with debtors and creditors.
- Verifying bank balances and loan details.
- Confirming inventory held by third parties.
- Verifying investments held by brokers.
Why is external confirmation considered highly reliable evidence?
- It is written and directly obtained from a third party.
- It provides evidence about assertions like existence, rights and obligations, accuracy, and valuation.
What are the limitations of external confirmation?
- It is less relevant for completeness (only recorded amounts are confirmed).
- Some parties may not respond or respond without verifying the information.
When can an auditor omit external confirmation?
- When inherent risk and control risk are low.
- When the balance is immaterial.
- When sufficient evidence can be obtained from other substantive procedures.
- When management provides a reasonable justification for not sending confirmations.
What are the steps for designing a confirmation request?
- Decide the timing (interim or final date).
- Obtain and verify the list of parties.
- Select appropriate confirming parties (e.g., major debtors, high-risk accounts).
- Decide the information to request (e.g., closing balance, transaction details).
- Choose the type of confirmation (positive or negative).
- Obtain management’s authorization and send the requests.
- Perform procedures on replies (e.g., investigate disagreements).
What are the two types of confirmation requests?
- Positive confirmation: The third party must reply whether they agree or disagree with the information.
- Negative confirmation: The third party only replies if they disagree.
What is a blank confirmation request?
A type of positive confirmation where the balance is not provided. The third party must fill in the balance themselves, reducing the risk of unverified replies.
When is negative confirmation appropriate?
- The population consists of many small balances.
- Inherent risk and control risk are low.
- A low exception rate is expected.
- The auditor believes the third party will verify the information.
What should an auditor do if a positive confirmation is not responded to?
- Send a follow-up request.
- Perform alternative procedures:
- For debtors: Check subsequent cash receipts, inspect sales documents.
- For creditors: Check subsequent payments, inspect purchase documents.
What are alternative procedures for non-responses to debtor confirmations?
- Examine cash received after the balance sheet date.
- Inspect supporting documents (e.g., sales orders, invoices, delivery notes).
- Perform cut-off tests for sales near year-end.
- Compare balances with monthly statements from debtors.
What should an auditor do if a confirmation response indicates a disagreement?
- Ask the client to reconcile the difference.
- Investigate the cause:
- Timing differences (e.g., cash/goods in transit).
- Misstatements in client or third-party records.
- If the difference indicates weak controls or fraud, increase the risk assessment.
What should an auditor do if a confirmation is returned undelivered?
- Check for a wrong address and resend the confirmation.
- If the party is non-existent, investigate for potential fraud.
What are the procedures for bank confirmation letters?
- Request account details (titles, numbers, balances).
- Verify overdrafts/loans (terms, security, repayment schedules).
- Confirm contingent liabilities (e.g., guarantees, letters of credit).
- Obtain details of restrictions on accounts.
What information is requested in a legal confirmation letter?
- List of pending litigation and claims.
- Assessment of outcomes (e.g., likelihood of loss).
- Estimated financial impact of litigation.
What should an auditor do if management refuses to allow external confirmations?
- Inquire about the reason for refusal.
- If the reason is reasonable, perform alternative procedures.
- If the reason is unreasonable, discuss with TCWG (those charged with governance).
- If still not permitted, treat it as a scope limitation and modify the audit opinion.
What is the impact of management’s refusal to allow confirmations?
- Scope limitation: Auditor may issue a qualified opinion or disclaimer of opinion.
- Re-evaluate management’s integrity and increase the risk of material misstatement.
- Consider withdrawal from the engagement if concerns are serious.
How does an auditor evaluate confirmation responses?
- Agreed responses: No further action needed.
- Disagreements: Reconcile differences and investigate causes.
- Non-responses: Perform alternative procedures.
- Oral/indirect responses: Request written confirmation or perform alternative procedures.
What is the purpose of a bank confirmation letter?
To verify:
1. Account balances and details.
2. Loan/overdraft terms and security.
3. Contingent liabilities (e.g., guarantees).
4. Restrictions on accounts.
What is the purpose of a legal confirmation letter?
To obtain information about:
1. Pending litigation and claims.
2. Likely outcomes and financial implications.
What should an auditor do if a confirmation response is received indirectly (e.g.
through management)?
What should an auditor do if a confirmation response is received electronically (e.g.
email)?
How does an auditor project misstatements from confirmation results?
- Calculate the ratio of unresolved exceptions to the sample size.
- Apply the ratio to the total population to estimate misstatements.
- Compare the projected misstatement to materiality to determine its significance.
