Reducing the High Cost of Audit Confirmations
What does a confirmation cost? To answer this question, we need to review the confirmation process. Here’s a summary of the accounts receivable confirmation process:
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, remittance advices, etc.).
7. Make copies of confirmations to use as second requests.
8. Stuff envelopes, or supervise client stuffing.
9. Insert CPA firm return address envelopes into confirmation request envelopes.
10. Obtain postage and deliver to an off site mail drop.
11. Clear exceptions from replies by inquiries of client personnel and inspection of supporting records.
12. Send second requests on non-replies by repeating steps 7 through 11.
13. Perform alternative procedures on non-replies to second requests by inspecting supporting documents (records for sales, shipments and subsequent collections).
14. Consider proposing adjustments, recording errors on an Error Analysis Worksheet and performing qualitative error analysis.
15. Project sample error rate to the sampling population.
16. Summarize confirmation statistics to support the existence assertion.
What does a confirmation cost? To determine the cost of a confirmation, we obviously need to sum the time it takes to perform the confirmation procedures and divide the total by the number of confirmation requests. What’s your guess for the receivables confirmation process above? 20 minutes? 30 minutes? More?
Let’s say a good guess is 30 minutes for each confirmation. To state the obvious, every confirmation I can eliminate will save me 30 minutes. Reducing my number of confirmation requests by 5 saves me 2 ½ hours! Eliminate 10 and I reduce my time charges by 5 hours! I’m sure you get the picture.
How can we reduce the number of confirmation requests? In previous blogs and webcasts I’ve discussed a number of ways to save time by considering risk and materiality at the assertion levels. Here are a few of those ways:
• Pay attention to the risk assessment process. Whenever risk of material misstatement at the assertion level is less than high, we have opportunities to reduce the number of confirmations.
• Base the lower limit for individually significant items at the assertion level on tolerable misstatement determined at the lower risk level (as risk goes down tolerable misstatement goes up).
• Use the higher level of tolerable misstatement in the model approach to sampling applications.
• When risk is less than high, raise the lower limit for individually significant items.
• When risk is moderate to low, consider using negative confirmations for smaller account balances.
Reducing the high cost of audit confirmations is simple. Really, it is! We just need to know what we’re doing! We need to move outside the box of dependence on standard practice aids, know exactly what the auditing standards require and take advantage of every lower risk situation to reduce the amount of work necessary to verify relevant financial statement assertions. This is one of the ways we can make more money on audits!