External conformation as audit evidence

 


External confirmation is audit evidence obtained as a direct written response to the auditor from a third party (the confirming party), in paper form, or by electronic or other medium.

External confirmation is considered reliable audit evidence in relation to such assertions as Existence, Completeness, Rights and Obligations.

External confirmation procedures are used to test the account balances and their elements, the terms of agreements, contracts, or transactions between an entity and other parties, about the absence of certain conditions (for example, “side agreement”).

There exist two types of external conformation:

Positive confirmation request – A request that the confirming party respond directly to the auditor pointing out whether the confirming party agrees or disagrees with the information in the request.

Negative confirmation request – A request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided.

Possible outcomes of external conformation sent to the confirming parties could be:

(a)    Response of the conforming party. In this situation the auditor decides whether the response received is reliable.

(b)    Non-response of the conforming party. In this case the auditor performs alternative audit procedures to obtain relevant and reliable audit evidence

(c)    Exception. When the response indicates a difference between information requested to be confirmed and information provided by the confirming party. Usually, the auditor investigates this difference to decide whether it is indicative of misstatements.

Examples of alternative audit procedures the auditor may perform include:

● For accounts receivable balances – examining specific subsequent cash receipts, shipping documentation, and sales near the period end.

● For accounts payable balances – examining subsequent cash disbursements or correspondence from third parties, and other records, such as goods received notes.

Situations where external confirmation procedures may provide relevant audit evidence in responding to assessed risks of material misstatement include:

● Bank balances and other information relevant to banking relationships.

● Accounts receivable balances and terms.

● Inventories held by third parties at bonded warehouses for processing or on consignment.

● Property title deeds held by lawyers or financiers for safe custody or as security.

● Investments held for safekeeping by third parties or purchased from stockbrokers but not delivered at the balance sheet date.

● Amounts due to lenders, including relevant terms of repayment and restrictive covenants.

● Accounts payable balances and terms

Factors that may help the auditor in determining whether external confirmation procedures are to be performed as substantive audit procedures include:

(a)    The confirming party’s knowledge of the subject matter

(b)   The ability or willingness of the intended confirming party to respond (May consider responding too costly or time consuming or may account for transactions in different currencies).

(c)    The objectivity of the intended confirming party – if the confirming party is a related party of the entity, responses to confirmation requests may be less reliable.

External Confirmation Procedures consists of following stages:

1.      Deciding the information to be confirmed or requested.

2.      Selecting the appropriate confirming party.

3.      Designing confirmation requests.

     When designing confirmation requests the auditor considers following factors: 

·       The assertions being addressees.

·       The layout and presentation of the confirmation request.

·       The method of communication Management’s authorization to the confirming parties to respond to the auditor.

·       The ability of the intended confirming party to confirm or provide the requested information.

4.         Sending the requests, including follow-up requests.

The auditor may send an additional confirmation request when a reply to a previous request has not been received within a reasonable time.

5.      Evaluating the evidence obtained.

In evaluating the evidence obtained the auditor may categorize such results as follows:

(a) A response by the appropriate confirming party indicating agreement with the information provided in the confirmation request or providing requested information without exception.

(b) A response considered unreliable.

(c) A non-response; or

(d) A response indicating an exception.

This evaluation helps the auditor in concluding whether sufficient appropriate audit evidence has been obtained or whether further audit evidence is necessary.

If management refuses to allow the auditor to send a confirmation request, the auditor must ask the management about the reasons for the refusal, evaluate the implications of management’s refusal on the auditor’s assessment of the relevant risks of material misstatement, perform alternative audit procedures to obtain audit evidence.

ISA 330

ISA 500

ISA 505

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