The Hindu Business Line : Various forms of audit confirmation

Audit confirmation is one of the substantive procedures carried out by the auditor in his endeavour to lend more credibility to the information in his possession.

Checking the facts.

M. V. Kali Prasad

An auditor has to satisfy himself about the financial statements before expressing an opinion on such statements.

Gathering of audit evidence, its analysis and evaluation and drawing conclusions form the crux of auditing. The auditor forms an opinion based on such conclusions. Several procedures are carried out by the auditor to gather such audit evidence, which can be classified as substantive and compliance procedures.

Substantive procedures are those carried out by the auditor so as to substantiate the transaction. One of the substantive procedures widely accepted is confirmations.

Audit information

The auditor gathers information which may either be solicited or unsolicited. Unsolicited information is by way of newspaper clippings, advertisements released by the entity, and so on, in general, and draft accounts, schedules, and so on, in particular.

Solicited information is by way of replies to audit queries, minutes of meetings, stock statements, returns filed by branches, etc.

Having gathered the information, the auditor should subject the same to further examination as he deems fit in order to lay the foundation for drawing conclusions and, thereby, forming opinions.

One such method is confirmation. Audit confirmation is one of the substantive procedures carried out by the auditor in his endeavour to lend more credibility to the information in his possession.

The word confirmation in general means reiterating some thing which is already known. Once confirmed, levels of acceptability and reliability raises significantly.

What’s to be confirmed?

It is for the auditor to decide, based on his judgment, which of the information he would like to be confirmed and also the source from where he can seek such confirmations.

The auditor is guided by the following factors to decide which of the matters need to be confirmed: nature and complexity of the transaction; perceptions of the management; existence of internal controls in respect of such transactions and their effectiveness; circumstantial evidence in support of the transaction; his own past experience with the entity and understanding of the related circumstances.

Types of confirmations

These confirmations can be either from the management and are, therefore, internal (on the lines of internal evidence) or from an external source (external evidence).

Internal confirmations: For certain transactions where there is no external evidence, the auditor seeks confirmations from internal sources being the top management and, in some cases, from those charged with governance. Seeking management representation (AAS 11) is but a procedure to seek internal confirmations from the management.

Some examples for which internal confirmation is sought are:

a) From those charged with governance: These confirmations such as the following are generally sought from “those charged with governance” being heads of departments, executives and from field officers:

i) Stocks lying in shop floors, stocks out on approval, job works, consignments, etc. ii) imprest lying with various departments; iii) staff advances; iv) response to letters of weakness; v) production charts, valuation of work-in-progress, scrap reports; vi) year-end procedures — provisions, depreciations; vii) cut-off procedures, cut-off transactions; viii) investment decisions, etc;

b) From the management: Certain items such as requirements of compliance are secured from the management directly. Confirmations in the matters such as the following are to be secured from the management directly: a) Changes in accounting policies, if any; b) opening or closing of any areas of business activity or of branches, etc.; c) compliance with law and regulatory authorities; d) requirements of Section 274(1)(g); e) proposed dividends; f) confirmation of certain items of CARO such as physical verification of fixed assets, verification of stock-in-trade, etc.

External confirmation: The other source of confirmation is external confirmation. Sources of such confirmations are as follows: i) bankers (for balances in bank accounts); b) sundry debtors and creditors (for balances lying with them); c) stocks lying with others such as consignees, job workers, on approval; d) share brokers (for investments held); e) demat account; f) lessees for the assets lying with them; g) lenders for the balances due to them; h) government agencies such as encumbrance on properties; i) legal advisors for the likely outcome of suits pending; j) expert opinions such valuation of assets, legal opinions, etc; k) tax advisors (if they are a separate firm) for the tax calculations.

In certain cases, the auditor would do well to seek both internal as well as external confirmations. While auditing a deposit with bank, the auditor should require the management to produce in original, the term deposit receipt issued by the bank. This confirms the balance to the credit of the deposit account as reflected in the ledger account.

The scepticism of the auditor should work under these circumstances. It is also possible that the entity provides an indemnity bond to the institution (stating that the fixed deposit receipt was misplaced) and withdraws the deposit.

But the original deposit receipt (lying very much with the entity) is produced in original for verification of the auditor, whereas the fact remains that the deposit is withdrawn.

To guard from such situations, he should also seek a confirmation from the bank on the same matter to render the ledger balance more reliable. The auditor should seek confirmations from both internal as well as external sources.

AAS 30: Realising the importance of such confirmations, the ICAI has released an auditing and assurance standard (AAS 30) on audit confirmations. The AAS does not dwell on internal and external confirmations, but elaborates on positive and negative confirmations.

Positive and negative confirmations

AAS 30 classifies confirmations as positive and negative. Where the auditor seeks the respondent to communicate only if he has data different form the one communicated to him, it is called negative confirmation. In such a case, the respondent need not communicate if the balances match with his books. But it is not without its drawbacks. It is possible that the data available with the respondent is different from the one sent to him, but he may not have communicated to the auditor for several reasons, including that he does not bother about responding. If the auditor does not get a reply from the respondent, it might lead to misleading conclusions.

If the respondent is required to respond irrespective of the balances matching, it is a positive confirmation. Whether and to what extent the respondent replies to the auditor is a debatable point.

Blank confirmations

The auditor might ask the respondent to fill up the information on a blank format. Such a confirmation is called blank confirmation. This type of confirmation does not, generally, evoke much response since considerable work is required to be put in by the respondent. The respondents might just put away the communication received from the auditor.

It is a common experience that the postal ballot papers are not taken seriously by the shareholders, thereby vitiating the very concept and defeating the purpose of postal ballot scheme.

Drawbacks of such confirmations: Though such confirmations are a useful tool to the auditor in the process of drawing audit conclusions, he exercise caution for the following reasons:

The respondent prefers not to respond at all.

The confirmations provided by the other person are not totally foolproof.

The replies received may not substantiate the evidence already in possession of the auditor.

The confirmation might be pre-empted.

These confirmations may be tampered by the management.

Precautions to be taken:

The auditor has to be cautious while opting for confirmations.

He should select the person from whom he seeks a confirmation (such as an expert) very carefully.

He should ensure that the confirmation reaches him directly and not routed through the client.

The timing of seeking such confirmations would be important. It is because the confirmation received may lead to further audit procedures and the audit plan might have to be reworked.

Analysis of confirmations

The auditor should carefully analyse the confirmations so received and draw conclusions.

He should use his judgment to decide whether and to what extent he might accept such confirmations.

These confirmations received from a debtor or a creditor merely gives a confirmation of the balance outstanding but there will be no information about quality of the account balance.

Risk involved in accepting confirmations: Where the assessed levels of inherent and control risks are low, the auditor may rely less on the substantive procedures.

The auditor should use his judgment to decide whether these confirmations reduce the audit risk to an acceptably low level by considering the materiality of the account balance and his own assessment of audit risk.