Chapter 14: External Confirmation Flashcards
- What is external confirmation?
External confirmation is a procedure in which an auditor obtains audit evidence directly from a third party in written form (on paper, electronically, or via another medium).
- In which situations is external confirmation typically used?
It is used to confirm information from debtors, creditors, banks, lawyers, third parties holding inventory, and brokers handling investments.
- What audit assertions does external confirmation support?
It supports the existence, rights and obligations, accuracy, valuation, and allocation assertions by providing highly reliable, external, and direct written evidence.
- What is one limitation of external confirmation?
It is less effective for confirming the completeness assertion since it only covers recorded amounts.
- Under what conditions might an auditor choose to omit external confirmation?
When inherent risk and control risk are low, the balance is immaterial, sufficient evidence is available from other procedures, or when management justifies not sending confirmation requests.
- What are the key steps an auditor must follow when planning to use external confirmation?
Steps include: deciding the timing (interim or final), obtaining and verifying the list of parties, selecting appropriate confirming parties (especially major or high-risk ones), determining the information to request, choosing the confirmation type (positive or negative), obtaining an authorized signature (e.g., from the CFO), sending out the letters, and planning for follow-up procedures and summarization.
- What additional procedures are required if the confirmation is sent at an interim date?
The auditor should compare year-end balances with interim balances, investigate unusual variations, test controls on transactions between interim and final dates (including tests of details for material transactions), and send a year-end confirmation if necessary.
- What is a positive confirmation request?
It is a request that requires the confirming party to reply in all cases, whether they agree or disagree with the information provided.
- What risk is associated with a positive confirmation request when the balance is included, and how can this risk be mitigated?
There is a risk that the confirming party may reply without verifying the balance. This risk is mitigated by using a blank (or Method 2) confirmation, where the balance is omitted from the request and must be filled in by the confirming party.
- What is a negative confirmation request?
It is a request that asks the confirming party to reply only if they disagree with the information provided.
- Under what conditions is negative confirmation considered appropriate?
Negative confirmation is appropriate when the population consists of a large number of small balances, inherent and control risks are low, a very low exception rate is expected, and the auditor is confident that the confirming party will verify the balance.
- What should the auditor do if a confirmation reply indicates agreement with the balance?
A reply indicating agreement is considered sufficient appropriate audit evidence, and no further action is required for that item.
- What actions are taken if a confirmation reply indicates an exception or disagreement?
The auditor should request that the client reconcile the differences, determine if the discrepancy is due to timing differences, misstatements in the client’s records, or misstatements in the third party’s records, and adjust the audit risk if internal control weaknesses or fraud are indicated.
- What alternative procedures should be performed if a customer does not reply to a positive confirmation?
The auditor should examine cash receipts after the balance sheet date, inspect supporting documents (such as sales orders, invoices, and dispatch notes), perform cut-off tests on sales, and compare balances with monthly account statements if available.
- What alternative procedures should be followed if a supplier does not reply to a positive confirmation?
The auditor should examine cash payments after the balance sheet date, review supporting documents (including purchase orders, invoices, and goods received notes), perform cut-off tests on purchases, and compare balances with monthly creditor statements if available.
- How should the auditor handle an oral confirmation response?
An oral response does not meet the definition of a confirmation letter, so the auditor must request a written confirmation; if none is received, alternative audit procedures must be performed.
- What must an auditor do when a response is received indirectly (via management)?
The auditor should obtain a direct confirmation from the third party because an indirect response does not satisfy the confirmation requirements.
- What special considerations apply when a confirmation is received electronically?
The auditor must verify the authenticity of the source and ensure that the communication process is secure and controlled, for example, through encryption or a digital signature.
- What should the auditor do if management refuses to allow sending a confirmation request?
The auditor should inquire about and validate the reason for the refusal, attempt alternative procedures to obtain evidence, and if such evidence is insufficient, treat it as a scope limitation which may lead to a qualified or disclaimer opinion.
- What actions should be taken if management’s refusal is not reasonable?
The auditor should discuss the issue with Those Charged With Governance (TCWG) to request permission to send the confirmation, reassess management’s integrity, adjust the audit risk, modify the nature, timing, and extent of procedures, and possibly consider withdrawal from the engagement if necessary.
- How does an auditor summarize the results of confirmation procedures to reach a conclusion?
By categorizing sample responses into: replies that agree, exceptions that are reconciled, non-responses verified through alternative procedures, and unresolved exceptions; then projecting any misstatements to the entire population.
- What is the formula to project misstatements in the population from sample results?
Projected misstatement = (Unresolved exceptions in the sample / Total sample balance) × Total population balance; this amount is then compared to the materiality threshold.
- What key information is requested in a bank confirmation letter?
Information regarding bank accounts (full titles, account numbers, year-end balances, details on closed accounts, interest credited/charged, bank charges, and any account restrictions), overdrafts/loans (amounts, security details, interest terms, repayment schedules, debt covenants), contingent liabilities, and additional banking relationships.
- What details are typically requested in a legal confirmation letter?
A legal confirmation letter requests a list of pending litigation and claims, an assessment of their likely outcomes, and an estimate of the financial implications.
