ISA 505 - External Confirmation

Question 1

ISA 505

EXTERNAL CONFIRMATION
Benefits of external confirmation

Answer 1

• The confirming party is independent from client (Audit evidence is more reliable when it is obtained from independent sources outside the entity).
• The confirming party replies directly to the auditor (Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference).
• The reply from confirming party is in documentary form (i.e., not oral) (Audit evidence is more reliable when it exists in documentary form, whether paper, electronic or other medium).

Question 2

ISA 505

EXTERNAL CONFIRMATION

External confirmation procedures are frequently used to CONFIRM or REQUE

Answer 2

External confirmation procedures are frequently used to CONFIRM or REQUEST information.

▪ Confirmation regarding BALANCES

− Accounts receivable balances

− Accounts payable balances

− Bank / overdraft balances

▪ Confirmation on OTHER MATTERS

− Terms of agreement

− Property charged to bank

− Inventory, title documents held by 3rd parties

− Outcome of court case (ISA 501)

Question 3

ISA 505

EXTERNAL CONFIRMATION

Rules for the Auditor

Answer 3

RULES - the auditor shall:

− Determine the information to be confirmed or requested.

− Select the appropriate confirming party.

− Design the confirmation requests. (However, the confirmation requests are given to CLIENT to prepare on their letterhead)

− Confirm the correctness of the address of the person to whom the request will be sent.

Client CONSENT required!

Question 4

ISA 505
EXTERNAL CONFIRMATION

Receivables confirmation approaches

Answer 4

1/ Positive confirmation - Receivable to reply to the auditor
regardless of whether they agree or disagree
with the information in the auditor’s letter to him.

2/ Negative confirmation- Negative confirmations request a reply ONLY IF the receivable DISAGREES with the information provided in the request.

Therefore, if the auditor does not receive a reply from the
receivable, the auditor ASSUMES that the balance is correct.
Because of this, negative confirmations provide less
persuasive audit evidence than positive confirmations.

Negative confirmation requests can only be used when:

− Risk of material misstatement for receivables is low.

− A very low exception rate is expected.

(i.e. that receivables are likely to agree to the balance in the request & therefore will not reply)

− The auditor does not think that the recipients of negative confirmation requests will disregard such requests

− The population of receivables comprises a large number of small balances

Question 5

ISA 505
EXTERNAL CONFIRMATION

RESULTS of the External Confirmation Procedures (Positive confirmation)

Answer 5

1/ Agreed
2/ Not agreed (Reconcilised (invoicing errors, errors in posting, cash in transit, goods in transit)/Unable to reconcile)
3/ No response (2nd request > Follow up with phone call > ALTERNATIVE audit procedures)
4/ Returned - Gone Away, Address unknown

Question 6

ISA 505
EXTERNAL CONFIRMATION

Objective of the confirmation

Answer 6

1/ Existence (if receivable exists, the sale is also real)

▪ INSPECT cash book post year end to confirm payments from receivable. (Cash from the receivable will prove the existence of debt before the year-end!)

▪ INSPECT the Delivery Order signed by Customer Company
to confirm it contains Customer Company’s rubber stamp.

2/ Accuracy: Valuation & allocation

▪ INSPECT cash book post year end to confirm payments from receivable (Cash from the receivable will prove the recoverability of the debt)

3/ Completeness of the balance
That the balance is not understated. Meaning that there is proper CUT OFF. That all goods delivered to the customer before the year end have been invoiced & included in the receivables balance before the year end.

Question 7

ISA 505
EXTERNAL CONFIRMATION

Management Imposed Limitation

Answer 7

If, AFTER ACCEPTING THE ENGAGEMENT, the auditor becomes aware that MANAGEMENT has imposed a limitation on the scope of the audit that the auditor considers likely to result in the need to express a qualified opinion or to disclaim an opinion on the financial statements, the auditor shall request that MANAGEMENT remove the limitation.

Client’s permission required for external confirmation

Question 8

ISA 505
EXTERNAL CONFIRMATION

Management Imposed Limitation

Answer 8

A/ Imposition REMOVED
B/ Imposition NOT REMOVED > Find out if there is valid reason
* No valid reason > Request TCWG to remove the limitation
1. Imposition REMOVED
2. Imposition NOT REMOVED > Management INTEGRITY IN DOUBT > Effect is MATERIAL and PERVASIVE

• Valid reason > Perform ALTERNATIVE procedures > Able to obtain SAAE?
  1. YES
  2. NO > Effect is MATERIAL but not pervasive

Auditor has a CHOICE:
1/ He can withdraw if he so wishes (Resignation unlikely if audit is too advanced)
2/ Stay & disclaim an opinion