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Clarified Auditing Standards: External Confirmations (AU-C Section 505) – Part 2

Jul 8th 2015
CPA Firm Support Services, LLC
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In the first part of this article, the changes from previous auditing standards were discussed. This article focuses on the practical issues considering accounts receivable confirmations.

The Confirmation Process
Auditing standards stress the importance of control over the confirmation process for both hardcopy and electronic confirmations. Control over the process from beginning to end is the key to gathering sufficient, competent evidence to enable an auditor to evaluate relevant financial statement assertions.

Following is 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) and 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 the 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.). NOTE: Failing to perform this step can invalidate all evidence from the confirmation process.

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 nonreplies by repeating steps 7 through 11.

13. Perform alternative procedures on nonreplies to second requests by inspecting supporting documents (records for sales, shipments, and subsequent collections).

14. Consider proposing adjustments or recording errors on an Error Analysis Worksheet and performing qualitative error analysis for confirmations of individually significant items.

15. Project sample error rate to the sampling population for sampling applications.

16. Summarize confirmation statistics to support the relevant assertions.

Because of the substantial time required to prepare, control, and send confirmations, an auditor's objective should be to select just enough confirmations to satisfy the audit objectives. Here are a few of the ways this can be accomplished:

  • 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. Considering the confirmation process above, and the number of confirmations sent, the average time spent by an auditor is usually 20 to 30 minutes per confirmation. Even an assessed level of risk at slightly less than high could raise the lower limit for individually significant items, reduce the number of confirmations, and save several hours of an auditor's time.
  • Base the lower limit for individually significant items at the assertion level on tolerable misstatement (performance materiality) determined at the lowest risk level possible (as risk goes down, tolerable misstatement and the lower limit for individually significant items goes up).
  • At lower risk levels, use the higher-calculated amount of tolerable misstatement in the model approach to sampling applications.
  • When risk is moderate to low, consider using negative confirmations for smaller account balances.

Many CPA firms are learning that the time charges for the confirmation process can be reduced significantly by sending electronic confirmations. Electronic confirmation capability for accounts receivable is available through Capital Confirmation Inc. These electronic confirmations are secure, save substantial preparation time, reduce turnaround time, and are economically priced.

Confirmations and Risk
Confirmations are obtained from third parties to obtain evidence about financial statement assertions. As risk of material misstatement increases, which is the combination of inherent and control risk, more and better evidence is needed to evaluate financial statement assertions. Possible effects of high, moderate, and low risk on accounts receivable confirmation procedures are outlined below.

High risk. Send positive confirmations covering all individually significant items (ISIs) above the calculated lower limit based on risk and a number of units selected by using a nonstatistical sampling model or an extensive nonsampling plan at the engagement date.

Moderate risk. Send positive confirmations covering all ISIs above a higher-calculated lower limit based on risk and a small number of units in the remaining population based on the model approach or a nonsampling plan at the engagement date or one month before. Perform roll-forward procedures for the period from the confirmation date to the engagement date.

Low risk. Send positive confirmations for all ISIs above a calculated lower limit based on risk (which should be higher than moderate risk). A small number of units should also be judgmentally selected from the sampling population that are representative of the transactions it includes for negative confirmation or tracing to supporting sales and collection documents. Confirmation procedures may be performed 30 or 60 days before the engagement date. Perform roll-forward procedures.

More Information
These eBook resources, without CPE credit, can be obtained from my website:

  • Small Audits Made Easy and Profitable
  • Performing Auditing Tests of Balances Procedures
  • Staff Training Series for Entry-Level Accountants, New In-Charge Accountants and Engagement Leaders
  • Key Accounting Issues for Non-Profit Organizations
  • A Practical Potpourri of Time Savings on Audits
  • The Financial Reporting Framework for Small- and Medium-Sized Entities

My exclusive presentation of webcasts on and self-study courses covering various applications of auditing standards can be accessed by clicking the appropriate box on the left side of my home page, Registered users on my website receive a 20 percent discount on CPE materials presented by myself and numerous other authors on a variety of professional topics.

My assistance in CPA firm quality-control consulting, audit planning, and peer-review preparation can be obtained by sending an email using the “Contact Us” tab on my home page.

Related article:

Clarified Auditing Standards: External Confirmations (AU-C Section 505) – Part 1


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