1.Under what circumstances would a positive confirmation of accounts receivable bepreferable to a negative confirmation? A negative confirmation is a document issued by an auditor to the customers of a client company. The letter asks the customers to respond to the auditor only if they find a discrepancy between their records and the information about the client company's financial records that are supplied by the auditor. Show
Example of a Negative ConfirmationFor example, a confirmation letter tells a customer that the client company's records at year-end show an ending accounts receivable balance for that customer of $500,000. If the customer agrees with this number, it does not have to contact the auditor to confirm the supplied information. The auditor will then assume that the customer agrees with the information presented to it in the confirmation. When to Use a Negative ConfirmationA negative confirmation is designed for use in situations where a client company's internal controls are already considered to be quite strong, so that the confirmation process is used as a secondary audit method for the accounts under review. Disadvantages of a Negative ConfirmationA key concern with issuing negative confirmations is that the auditor has no idea if the confirmation was sent to the correct address, since no attempt is made to follow up with the recipient. This means that a problem might never be found, due to the nature of the confirmation. The Difference Between a Negative Confirmation and a Positive ConfirmationA positive confirmation is one in which the customer is required to send back a document, either confirming or disputing the account information sent to it by the auditor. A negative confirmation does not require as much follow-up work by auditors as a positive confirmation, but is also not considered to be as high-quality a source of audit evidence as the positive confirmation, since some customers may not be bothering to send back a confirmation document, even though they have detected a discrepancy. For this reason, most auditors prefer to use positive confirmations over negative confirmations, despite the additional cost. A negative or positive confirmation is not restricted for use with a client company's customers. They are also commonly used with suppliers to confirm small-dollar account balances. A negative confirmation is rarely used with a lender, since auditors want to be very sure about the ending debt balances reported by their clients. In this case, positive confirmations are nearly always used.
May 14, 2022 May 14, 2022/ A positive confirmation is an inquiry made by an auditor to a third party that requires a response. The inquiry is in regard to whether the third party's records match those that the auditor is examining. Even if there is a match, with no exceptions, the auditor still requests a response. Positive confirmations are usually associated with the audit of receivables, payables, and debt arrangements. The other type of confirmation is a negative confirmation, where the third party only has to respond if there is a discrepancy between the records. A positive confirmation is considered to represent a higher quality of evidence than a negative confirmation, since the auditor receives explicit evidence from the third party. Related CoursesHow to Audit Cash How to Audit Liabilities How to Audit Receivables How to Conduct an Audit Engagement May 14, 2022/
Auditors’ Assumptions Underlying ConfirmationsAuditors apply professional judgment in deciding which confirmation method is most appropriate in reference to the audit’s risk for material misstatement. An auditor must employ analytical, systematic, and objective judgment when deciding on which confirmation procedure to apply. Below are two primary judgments an auditor must make when deciding to accept an external confirmation from a third party:
The confirmation’s value is completely reliant on the independence of the external party. For example, consider when an auditor sends a confirmation of a fraudulent account receivable to the person who committed the fraud. In such a scenario, the value of the confirmation is nil, as the fraudster would act in their self-interest and conceal their behavior. Confirmation of the account balance with a third party is important because it explains the managerial assertions behind the stated balance. It is important to assess managerial accounting assertions relative to generally accepted accounting principles (GAAP), as well as to apply testing procedures that comply with generally accepted auditing standards (GAAS). If the auditor is not satisfied with the third party”s quality of confirmation, they should practice further professional skepticism, and implement further audit procedures. Types of Confirmation Decisions1. Positive confirmationA letter sent to the debtor requesting direct confirmation of the account balance’s accuracy. If inaccurate, the debtor must produce a reason for the discrepancy and update the account balance. If accurate, the debtor must simply confirm the account balance through a response. 2. Blank confirmation formBlank confirmation forms are a type of positive confirmation requiring the debtor to return a letter detailing the account balance. The number is then used to cross-reference against the listed receivable balance to ensure accuracy. 3. Negative confirmationA letter sent to the debtor that denotes a specific account and value associated with its balance. The third party can choose to reject the balance and supply their number for the suggested account, or they can choose not to respond to the letter. A suggestion of a differing balance or nonresponse is considered confirmation. When to Use Negative ConfirmationNegative confirmation is best applied in cases where the risk of material misstatement is low. The primary drivers of the risk of material misstatement are inherent risk and control risk. If acceptable audit risk is held equal, a decreased risk of material misstatement increases the detection risk of an auditor failing to identify material misstatements. Logically, the auditor is willing to accept a higher risk of failing to identify material misstatements due to a less perceived risk of the business’ operating environment and internal processes. Generally, negative confirmations are most effective when the following are true:
Why Use Negative Confirmations?Negative confirmations are advantageous in terms of cost and efficiency. It is measurably less expensive to distribute negative confirmations instead of positive confirmations, and therefore, more can be distributed for the same total cost. Depending on the auditor’s detection risk, the auditor may need confirmation from hundreds of customers, and it can be more efficient to use negative confirmations to collect audit evidence in such a manner. Practical Usage of Negative ConfirmationsIf an auditor significantly tests internal controls, negative confirmations are utilized to provide audit evidence of the account balance. Generally, negative confirmations are most often used in audits, where the primary consumer is the general public. For example, municipalities, retail stores, and banks are all typical audit clients where negative confirmations are utilized in the evidence-gathering process. The primary factors affecting the confirmation decision are:
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