Chances are Your Receivables Confirmation Process is Not Valid!

Since the issuance of SAS No. 31 and its successor, SAS No. 106 entitled Audit Evidence, auditors understand the primary purpose of the confirmation process is to verify the existence assertion.  Whether we send positive confirmations, negative confirmations or review subsequent collections and related sales invoices or shipping documents, the auditor’s control of the confirmation process makes the primary contribution to verifying the existence assertion.

Think about it. Negative confirmations are returned only when the customer notices an error and, studies have shown, errors are noticed only 2% of the time!  We think positive confirmations are more reliable but similar studies have produced similar results!  Furthermore, we rarely know the persons signing the positive confirmations--it could have been the night janitor!  We often review subsequent collections but don't examine related sales invoices and shipping documents to verify the existence, occurrence and cutoff assertions.  So what's left?  The confirmation process is our best tool for verifying the existence of a customer.  This may be a shocker, but chances are your confirmation process is also faulty!

Here's part of the process from one of my earlier blogs:

1.  Obtain an aged trial balance of accounts and reconcile it to the general ledger.
2.  Decide on a selection method (random-number, systematic or haphazard), calculate the desired sample size based on risk and materiality at the assertion level.
3.  Select accounts for confirmation preparation and decide on positive or negative requests.
4.  Prepare confirmations (or supervise client preparation).
5.  When client prepares confirmations, make sure all those requested are completed and that names, addresses and amounts agree to client records.
6.  Independently verify a sample of customer addresses (phone book, Google, city directories, etc.).

Whoa!  Let's stop here.  Verification of customer addresses is the foundation of the confirmation process.  The reliability of evidence obtained from confirmations depends on the validity of customer's addresses.  Here it is simply.  If the validity of customer addresses isn't tested properly, the confirmation process is invalid!

I once performed a director's examination of a small bank and sent confirmations to all individually significant notes receivable customers.  All confirmations were returned in a short time period with almost no discrepancies!  When the bank collapsed about six months later, a hand-writing analyst discovered at least 70% of the confirmations were signed by the bank's vice-president!  How did this happen?  We obtained customer's addresses from the bank's loan files, most of which files had been fabricated!  We sent the confirmations to fictitious addresses!

So, what's the solution?  Test customer addresses!  When performing and relying on tests of controls, include customer address verification as one of the procedures for the sales and collection cycle.  When performing a systems walk-through procedure and selecting 5, 10 or 15 transactions depending on risk, verify the customers' addresses.  If customers" addresses aren't verified prior to sending confirmations as tests of balances, verify addresses for some of the confirmation selections according to the assessed level of risk of material misstatement (usually at least 20-25%).

Address verification can be performed in numerous ways to provide some evidence about a customer's existence.  Google searches or, if necessary, requesting addresses from numerous online data collection organizations are usually the most efficient procedures.  Phone books, city directories or other published advertising materials may also provide independent evidence of customers' existence.  Whatever the source of the evidence, the sample of customers selected for address verification must be made in some representative way.  As with any sample selection method, documentation of the procedure must indicate how bias was avoided in the selection process.

As peer reviewers increase their focus on the reliability of audit evidence, what will they find in your audit files? A reliable confirmation process or an audit error? Worse yet, what would a plaintiff's attorney find if an adversarial action is filed against your firm? If you want more information on How to Audit Accounts Receivable (or other financial statement classifications), you can order my small PDF book, practice aids and PowerPoint slides for $29 by sending an email to larry@cpafirmsupport.com . You can also order a resource bundle of 12 recorded webcasts on how to audit all major audit areas (including text materials and practice aids) for $199 using this link:  http://www.cpelink.com/product/detail.php?p=2138 .
 

This blog

by Larry Perry, CPA, CPA Firm Support Services, LLC - Larry has over 40 years experience as a CPA practitioner, author of accounting and auditing manuals, author and presenter of live staff training seminars and author of webcast and self-study CPE programs.  He is co-founder of CPA Firm Support Services, LLC (www.cpafirmsupport.com), an organization providing resources, training and consulting to smaller CPA firms.  Larry writes a weekly blog on AccountingWEB.com focusing on small audits, reviews and compilations.  He is currently developing documentation manuals and handbooks for small audits, reviews and compilations and related electronic practice aids.

More from this blog

Bloggers crew

Steve Knowles has spent 25 years in business and practice in the UK, but he also worked in the states and the years haven't dulled his way of seeing an alternative view to everyone else, and every day is a new adventure.

42359

Joel M. Ungar, CPA is a lifelong resident of the Detroit area and a graduate of The University of Michigan. He is a principal with Silberstein Ungar, PLLC, a Top 15 auditor of SEC public reporting companies.

74548

Allan Boress, CPA, with over 25 years as a practitioner and consultant to the accounting profession. Mr. Boress is the author of 12 published books in 6 different languages, including a best-seller, The "I-Hate-Selling" Book.

47338

Larry Perry, CPA, CPA Firm Support Services, LLC, is the author of accounting and auditing manuals, author and presenter of live staff training seminars, and author of webcast and self-study CPE programs. He blogs about small audits, reviews, and compilations.

86933
Sandra Wiley, COO and Shareholder, is ranked by Accounting Today as one of the 100 Most Influential People in Accounting as a result of her prominent role as an industry expert on HR and training as well as influence as a management and planning consultant. She is also a founding member of The CPA Consultant's Alliance. Sandra is a certified Kolbe™ trainer who advises firms on building balanced teams, managing employee conflict and hiring staff.
19871

Maria Calabrese, CIR, Human Resources manager for Fazio, Mannuzza, Roche, Tankel, LaPilusa, LLC in Cranford, New Jersey, Maria's topics revolve around the world of: Mentoring, Performance management, and The "Y Generation," a.k.a. "The whY generation".

54449

William Brighenti is a CPA, Certified QuickBooks ProAdvisor, and Certified [Business] Valuation Analyst, operating an accounting, tax, and QuickBooks consulting firm in Hartford, Connecticut, Accountants CPA Hartford.

79084

Ken Garen, CPA, is the co-founder and President of Universal Business Computing Company (www.ubcc.com), a software development firm of high-volume, high-productivity accounting and payroll technology.

24497

Eva Rosenberg, MBA, EA, is the publisher of TaxMama.com, and author of the weekly syndicated Ask TaxMama column. She provides answers to tax questions from taxpayers and tax professionals worldwide.

62834

Amy Vetter, CPA, CITP is the CPA Programs Leader for Intacct Corporation responsible for leading the CPA/BPO Partners nationally.

33871
Brian Strahle is the owner of LEVERAGE SALT, LLC where he provides state and local tax technical services to accounting firms, law firms and tax research organizations across the United States. He also writes a weekly column in Tax Analysts State tax Notes entitled, "The SALT Effect." For more info, visit his website: www.leveragestateandlocaltax.com
100789
Scott H. Cytron, ABC, is president of Cytron and Company, known for helping companies and organizations improve their bottom line through a hybrid of strategic public relations, communications, marketing programs and top-notch client service. An accredited consultant, Scott works with companies, organizations and individuals in professional services (accounting, finance, medical, legal, engineering), high-tech and B2B/B2C product/service sales.
25121

Rita Keller is a nationally known CPA firm management consultant, speaker, author, mentor and blogger. She has over 30 years hands-on experience in CPA firm management, marketing, technology and administrative operations.

51297
Stacy Kildal is the mom of two fantastic kids, an Advanced Certified QuickBooks ProAdvisor, Certified Enterprise Solutions ProAdvisor, Sleeter Group Certified Consultant, a nationally recognized member of the Intuit Trainer and Writer Network, and co-host of RadioFree QuickBooks.
26945
Michael Alter's blog specializes in providing practical advice to those who seek greater profitability and practice management tactics that enhance deeper client relationships.
31254

Sally Glick, CMO, Principal, Marketer of the Year in 2003 and AAM Hall of Famer in 2007, leads a lively discussion of the constantly expanding roles of marketing and the professional marketers that drive this initiative in accounting firms of all sizes.

98140

The IMA Young Professionals Blog features the insights of IMA’s Young Professionals Committee. Committee members share advice and experiences on careers, continuing education, work/life balance, and other issues affecting young accounting and finance professionals.

32446

FEI Financial Reporting Blog provides highlights from SEC, PCAOB, FASB, IASB, and other regulatory news, including reporting under Sarbanes-Oxley Sect 404. It is written by Edith Orenstein, Director of Technical Policy Analysis at FEI.

109032

Sue Anderson has 30 years of experience in continuing education for accountants. Currently she is the program director for online CPE provider CPE Link.

59526

Jim Fahey is COO of Apple Growth Partners, a regional CPA firm in Ohio. His focus is on the effective and efficient use of technology within the firm by all team members.

38512
Caleb Newquist is the Editor-in-Chief of Sift Media US, overseeing content for both AccountingWEB and Going Concern.
65417

Leita Hart-Fanta, CPA, CGFM, and CGAP is the author of "The Yellow Book Interpreted" and owner of Yellowbook-CPE.com a website devoted to training for governmental auditors.

91226

AccountingWEB is more than just a U.S. team of journalists and financial and technology experts - we have an international side, too! Members of our British team who publish AccountingWEB.co.uk share their ideas, insights, and perspectives from across the pond.

52307