Confirmation procedures and alternatives for non-reply confirmations

Welcome to the World of External Confirmations!

Hello! Today we are diving into one of the most reliable ways auditors gather evidence: External Confirmations. Think of this as the auditor’s way of "fact-checking" a company’s story by talking to someone outside the company. If a company says, "Customer A owes us $10,000," we don't just take their word for it—we ask Customer A directly!

Don't worry if this seems a bit technical at first. By the end of these notes, you’ll understand exactly how to handle these requests and what to do when people don't write back.

1. What is an External Confirmation?

According to HKSA 505 External Confirmations, this is audit evidence obtained as a direct written response to the auditor from a third party (the confirming party). It can be on paper, electronic, or via another medium.

Why do we do it? Evidence from sources outside the company is generally more reliable than evidence generated inside the company. It’s much harder for a company to fake a letter from a bank than to fake an internal spreadsheet!

Key Terms to Know:

Positive Confirmation Request: A request that the party responds directly to the auditor indicating whether they agree or disagree with the information, or providing the information requested. (Think of this as: "Please reply no matter what.")
\nNegative Confirmation Request: A request that the party responds only if they disagree with the information. (Think of this as: "Only reply if I'm wrong.")
\nNon-response: When a positive confirmation request is not returned, or is returned undelivered.
\nException: A response that shows a difference between what the company’s records say and what the third party says.

Quick Summary: External confirmations are "outsider" evidence. Positive requests need a reply every time; negative requests only need a reply if there is a mistake.

2. The Step-by-Step Process

When performing confirmation procedures, the auditor must maintain control. We can't let the client "help" too much, or they might hide the truth!

Step 1: Determine the information to be confirmed. Usually balances (like Accounts Receivable) or terms of agreements.
\nStep 2: Select the confirming party. We choose which customers or banks to write to.
\nStep 3: Design the request. Ensure it is addressed correctly and includes a way for the reply to come directly to the auditor.
\nStep 4: Send the requests. The auditor (not the client!) should mail the letters or send the emails.

Did you know? If the client offers to mail the letters for you to "save you the stamps," you must say NO. This is a huge red flag! If the client handles the mail, they could change the numbers or throw away letters they don't want you to see.

3. Positive vs. Negative Confirmations: When to use which?

Positive confirmations provide "stronger" evidence because the auditor expects a reply. Negative confirmations are "weaker" because if you don't get a reply, you don't know if the person agreed or if they just threw the letter in the trash!

Only use Negative Confirmations when ALL of these are true:

1. The risk of material misstatement is low.
\n2. You are checking a large number of small balances.
\n3. You expect a very low exception rate.
\n4. You have no reason to believe the recipients will ignore the request.

Memory Aid: Use the "L-S-L-I" trick for Negative Confirmations:
\nL - Low Risk
\nS - Small Balances
\nL - Low Exception Rate
\nI - Ignore (Believe they won't ignore it)

4. Dealing with Non-Responses (The "Plan B")

What happens if you send a positive confirmation and you hear nothing back? You can't just ignore it! This is a common exam topic.

First Step: Follow up. Send the request again. Sometimes people are just busy!

Second Step: Alternative Procedures. If they still don't reply, you need to find other ways to prove that balance exists and is correct. The goal is to get evidence that is just as good.

Alternative Procedures for Accounts Receivable:

1. Subsequent Cash Receipts: Check if the customer paid the bill after the year-end. If they paid it in January, it must have been a real debt in December!
\n2. Shipping Documents: Look for delivery notes or bills of lading. This proves the goods were actually sent to the customer.
\n3. Sales Invoices: Check the original bill sent to the customer to verify the amount and date.

Alternative Procedures for Accounts Payable:

1. Subsequent Cash Disbursements: Check if the company paid the supplier after year-end.
\n2. Supplier Statements: Look at the monthly statements sent by the supplier.
\n3. Receiving Reports: Prove the goods were received from the supplier before the year-end.

Key Takeaway: If you don't get a reply, you must perform "alternative procedures" to verify the balance. Subsequent cash receipt is usually the best alternative evidence for receivables.

5. When Management Says "No"

Sometimes, management might ask the auditor not to send a confirmation to a specific party. Maybe they are in a legal dispute and don't want to "annoy" the customer.

What should you do?
\n1. Inquire: Ask management why. Is their reason valid and reasonable?
\n2. Evaluate: Does this refusal change your risk assessment? Are they trying to hide a fraud?
\n3. Alternative Procedures: Perform other checks to get evidence for that balance.

If management's refusal is unreasonable or you can't get evidence through alternative procedures, you must talk to "Those Charged With Governance" (the Board) and consider the impact on your Audit Report (Scope Limitation).

6. Common Mistakes to Avoid

Mistake 1: Accepting an oral response as a confirmation. An oral response (like a phone call) is not an external confirmation because it is not a direct written response. It’s just "other evidence." You should still ask for a written reply.
\nMistake 2: Only checking the amount. Confirmations can also be used to check "Rights and Obligations" (e.g., has the debt been sold to a bank?) or specific contract terms.
\nMistake 3: Ignoring "exceptions." If a customer writes back saying "I only owe $8,000, not $10,000," you must investigate! It might be a simple timing difference (money in the mail), or it could be a sign of an error or fraud.

Final Quick Review Box

- Direct response: Must go from the third party straight to the auditor.
- Positive: Reply required (Strong evidence).
- Negative: Reply only if disagree (Weak evidence).
- Non-response: Must perform alternative procedures (like checking subsequent cash).
- Control: The auditor must control the mailing and receiving process.

Great job! You've mastered the essentials of confirmation procedures. Keep practicing these concepts, and you'll be ready for any scenario the QP throws at you!