Accounts Receivable ConfirmationConfirmation of accounts receivable, including a financial institution’s loans, is a generally accepted auditing procedure. It is therefore presumed that the auditor will request the confirmation of accounts receivable during an audit. In general, auditor uses confirmation process to obtain sufficient competent evidential matter. Confirmation is performed to obtain evidence from third parties about financial statement assertions made by management. In general, it is presumed that “evidential matter…obtained from independent sources outside an entity…provide greater assurance of reliability for the purposes of an independent audit than that secured solely within the entity”. Confirmation requests do not, however, address all assertions equally well. Accounts receivable confirmations are likely to be more effective for the existence and the rights-and-obligations assertions than for the valuation assertion.  SAS 67 addresses all types of confirmations including, but not limited to, accounts receivable confirmations. It relates the confirmation process to inherent and control risk.

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This post provides simple and easy technical application guides for confirming accounts receivable in auditing process conducted by auditors. As a complement of this post, I also provides some illustration and editable template examples that you can use as a handy tools to perform the task. If you have known this practical techniques but you just seek for accounts receivable templates, you can jump directly [here] Enjoy!

 

The Need for Presumption

The presumption that the auditor will confirm accounts receivable may be overcome if one of the following exists:

  • Accounts receivable are not material to the financial statements.
  • The use of confirmations would be ineffective (for example, based on experience, the auditor concludes that response rates will be inadequate or that responses will be unreliable).
  • In some circumstances, the auditor’s combined assessed level of inherent and control risk may be low, and that level, in conjunction with evidence expected to be provided by substantive tests, is sufficient to reduce audit risk to an acceptably low level for the applicable financial statement assertions.

 

Note:

  • If confirmations are not used because experience with the entity indicates the procedure would not be effective, the auditor needs to design suitable alternative procedures to achieve audit objectives.
  • If the auditor does not confirm accounts receivable, he or she should document the reasons for not doing so.

 

Timing Of Confirmation Request

For both positive and negative confirmation requests, the debtor is provided with the balance as of a specified date. The date may be as follows:

  • Year-end date.
  • Date prior to year-end. This date generally is one or two months prior to year-end.

 

It is recommended that confirmation requests be sent to debtors approximately a week before the date specified in the request. If the debtor is in a foreign country, the request should be mailed earlier.

 

Confirming Prior to Year-End

The auditor may decide to request that the debtor confirm the balance as of a date before year-end. If the auditor follows this procedure, however, he or she should perform the following procedures during the year-end procedures:

[1]. Perform selective other substantive tests of transactions from the confirmation date to the balance sheet date. These tests would include the following:

  • Review subsequent sales invoices and related bills of lading.
  • Review subsequent customer cash receipts and related remittance advices.

[2.] If balances change significantly from confirmation date to year-end, it is recommended that the auditor reconfirm.

 

The Use Of Negative Form Of Confirmation Request

If the negative form of confirmation request is used, the auditor should normally do one of the following:

[1]. Send out more requests than if the positive form is used.

[2]. Apply other auditing procedures to a greater extent than if the positive form is used. Other auditing procedures include examination of the following:

  • Subsequent cash receipts.
  • Subsequent cash remittance advices.
  • Sales and shipping documents.

 

Steps In Confirmation Process

The steps in the process of confirming receivables follow:

 

Step-1. Obtain Aged Schedule of Accounts Receivable

The auditor should obtain an aged schedule of accounts receivable as of the confirmation date. He or she should apply the following procedures to this schedule:

  • Determine that totals are correct.
  • Compare all or a selected sample of account balances with the account balances in the accounts receivable subsidiary ledger.
  • Investigate credit balances.

 

Step-2. Select Accounts for Confirmation

Auditors have used, and some continue to use, judgment in selecting accounts for confirmation. Statistical sampling methods, however, are ideal for the selection process.

Whatever method of selection is used, the auditor generally considers the following accounts:

[1]. All accounts with a balance over a predetermined amount. The predetermined amount is based on the auditor’s assessment of materiality.

[2]. Some or all accounts with zero balances.

[3]. Accounts with old unpaid items, especially when subsequent sales have been paid.

[4]. Accounts written off during the year under review.

[5]. Accounts with entities related to the client but not audited by the auditor.

[6]. Certain accounts that appeared on the prior year’s accounts receivable schedule but not on the current year’s.

[7]. Accounts with credit balances:

  • Occasionally, the client will not want confirmation requests sent to these accounts. If the amounts are material, it might result in a scope limitation; however, this is generally not the case.
  • If accounts with credit balances are not confirmed, alternative auditing procedures should be applied.

[8]. Of the remaining accounts, a representative portion both in dollar amount and number of accounts should be selected.

 

Step-3. Prepare and Mail Confirmation Requests

The auditor should observe the following procedures in preparing and mailing confirmation requests:

[1]. Prepare schedule of accounts to be confirmed.

  • Alphabetically.
  • Address.
  • Amount.
  • Assign each account a number. This number also should be placed on the confirmation request.
  • Total the dollar amount of receivables selected for confirmation and compute as a percentage of the total dollar amount of the receivables.
  • Determine the number of confirmation requests and compute as a percentage of the total number of accounts.
  • Leave sufficient blank columns after the customer’s name to insert the following information when the confirmation reply is received: (1) Date reply received; (2) Amount confirmed; and (3) Explanation of difference between amount customer confirmed and client amount.
  • Leave a blank column for insertion of the date the second request was mailed.
  • Indicate at bottom the date the first requests were mailed.

[2]. Request that client address confirmation forms and prepare customer statements.

  • If auditor desires that client not know which accounts are to be confirmed, he or she should have his or her staff address confirmations.
  • If auditor desires that client not know which accounts are to be confirmed but wants client to address confirmations, he or she should request client to address confirmation to all accounts and then eliminate the accounts not selected for confirmation.

[3]. When the auditor receives the addressed confirmation with the account balance and the customer statement, he or she should compare that balance with the balance on the schedule.

[4]. Independently, some customer addresses should be checked. These tests can be made by comparing the address on confirmation with the address in the telephone book.

[5]. After confirmations have been reviewed and numbered, the auditor should insert them and the customer statement in his or her firm’s envelopes, that is, envelopes with the firm’s return address.

[6]. In addition to inserting the confirmation request in the envelope, insert a postagepaid return envelope bearing the auditor’s address.

[7]. When the requests have been stamped, the auditor should mail them.

From the time the auditor receives the addressed confirmation requests containing the account balances, he or she should never lose control. The confirmation requests always should remain in the auditor’s custody or under his or her supervision until mailed.

 

Step-4. Process Responses to Confirmation Requests

When confirmation replies are received, the auditor should do the following:

[1]. Enter for each account the following:

  • Date received.
  • Amount confirmed.

[2]. If the amount confirmed differs from the account balance, the following should be done:

  • Photocopy confirmation reply.
  • Give photocopy to client and request that the difference be reconciled and provide documentation for reconciling items.
  • Review documentation for reconciling items.
  • If documentation is satisfactory, enter reasons for difference in receivable confirmation schedule.

[3]. If the amount confirmed differs from the account balance and the client cannot satisfactorily reconcile the difference, the auditor should do the following:

  • If the difference is small, the auditor may ignore it. If there are a significant number of small differences, however, the auditor should analyze them. If the analysis of the significant number of small differences indicates a deficiency in the receivable controls, the auditor may have to apply additional auditing procedures to satisfy himself or herself of the accounts receivable balance.
  • If the difference is significant, request the client to correspond with the debtor. Make certain the correspondence states that the debtor response should be sent directly to the auditor.

A CPA firm needs to establish a mechanism for ensuring that responses mailed to the CPA firm are obtained and considered by the audit team in the field on a timely basis. Also, a firm needs to ensure that responses that relate to transaction terms and other complex matters (such as compliance with laws and regulations for a governmental entity) are considered by appropriately experienced audit team members.

 

Step-5. Summarize Confirmation Results

Near the conclusion of the engagement, the auditor should prepare a worksheet summarizing confirmation results. The worksheet should contain the following:

[1]. Number and dollar amount of confirmations sent and the percentage of these to the total receivables.

[2]. Number and dollar amount of confirmations received with no exceptions indicated and the percentage of these to the total confirmations requests.

[3]. Number and dollar amount of confirmations received with exceptions that were satisfactorily reconciled by the client. Compute the percentage of these to the total confirmations requested.

[4]. Number and dollar amount of confirmations received with exceptions that were not satisfactorily reconciled by the client.

  • Determine total dollar amount of differences between client records and confirmation responses.
  • Determine reasons for differences and materiality of differences.
  • Compute the percentage of these to the total confirmations requested.

[5]. Review statistics and determine if the results of the confirmation procedures provided sufficient competent evidential matter as to the existence of the receivables. If the auditor is not satisfied with the results of the confirmation procedures, he or she should perform other procedures such as the following:

  • Review subsequent cash receipts and accompanying remittance advices.
  • Review individual sales invoices and related shipping documents.

 

Non-response To Confirmation Requests

If a response to a confirmation request is not received within a reasonable period of time—two to three weeks—a second request should be sent. The auditor should note in the receivable confirmation worksheet the date the second request was mailed.

 

Telephone Call to Debtor

If the non-response pertains to an account with a significant balance, the auditor should consider making a telephone call to the customer. If the auditor confirms by telephone, he or she should do the following:

  • Obtain the name and title of the person providing the information.
  • Request that the information provided be confirmed in writing.

 

Other Auditing Procedures

If the non-response pertains to an account with a significant balance, the auditor should consider reviewing the customer file to determine the following:

  • Cash receipts subsequent to year-end.
  • Items paid for subsequent to year-end. This is done by reviewing customer remittance advices.

 

Non-delivery Of Confirmation Request

If a confirmation request is returned to the auditor because it was not delivered, the auditor should do the following:

  • Determine customer’s new address and mail confirmation request.
  • If customer went out of business, ascertain that client has established appropriate allowance.

 

Confirmation Responses Not Expected

Sometimes the auditor does not expect a response to a confirmation request based on past experience with the entity or with customers similar to those of the entity. When the auditor does not expect a response to a traditional confirmation request, he or she should do the following:

  • Request confirmation of specific items included in the account balance.
  • Review subsequent customer remittances. Where these amounts are significant, it is recommended that for a period of time subsequent to the balance sheet date, the auditor be present whenever the client receives mail. The auditor should open all mail from customers unable to confirm balances and compare remittance advices to ledger balances.
  • Undertake other procedures to validate the existence of the customer and sales to the customer. (For example, the customer could be looked up in a phone directory and called).

 

When fraud risk factors are present and confirmation of receivables is not possible, the auditor should employ unusual procedures if necessary to validate the existence of the customer and the sales to that customer.

 

Confirmation Checklist

To make certain all procedures have been applied in the confirmation of receivables, the auditor should design a confirmation checklist. One is presented in Illustrations on my next post “Audit: Accounts Receivable Confirmation Templates. I also present some templates as illustrations, you can adopt and modify the templates to best suit your need.