 thus a count-receivable confirmation. Confirmation is one of the eight type of evidence that we looked at in the prior session. Let's go over them one more time. Physical examination, confirmation, inspection, analytical procedures, inquiries, recalculation, and performance and observation. Now, confirmation is very important and effective that we're gonna be spending one whole session explaining the various type of confirmations. We have more than one. We have positive, we have negative. We need to discuss those. Now, confirmation is considered good evidence and the reason is it's generated by a third party. Remember, if the documents that you have is being generated by a third party, third party means other than the client, then there's no reason, not there's no reason, but it has more reliability versus a document that's generated or a figure that you obtain from the client themselves because they always have the bias. Because it's generated by a third party, it has more reliability. You can put more weight on it. Now, bear in mind, international auditing standard does not require the use of confirmation. However, confirmation satisfy existence, occurrence, and cutoff objectives, which we will discuss those later on, but it does a great job meeting the audit objective of a count receivable. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's gonna help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today, no obligation, no credit card required. As I mentioned, U.S. standard for confirmation, they're not used internationally, but in the U.S. you should employ external confirmation for a count receivable, unless the total account receivable is not material, it's not important, it's not large enough, it doesn't seem to be important for the users. Or the user thinks confirmation is ineffective evidence. Why? Well, maybe the customers, means the customers of the client, there's a high likelihood they will not respond. So you're gonna send them, they're not gonna respond. So how good is the confirmation? Three, the risk of material misstatement is assessed low. It means the auditor can do what? Can gather evidence about a count receivable using alternative evidence to support their conclusion. Under those circumstances, if that's the case, if you opt out, if you don't want to send those receivable, those confirmation of receivable, that's fine. But you must document the rationale for your decision in the audit files. Basically, document it and explain why. For example, I'm relying on strong internal control, low inherent risk, whatever you want to say, just you have to justify. Now, as I mentioned, we have more than one type of confirmations, we're gonna start with positive confirmation. Here, the auditor requests the customer, means the customer of your customer. Remember, we have the auditor and we have the auditee, the company that's being audited, then the auditee will have their customers and we're sending the information to their customers and that's why this group is a third party, third party between the auditor and the auditee. That's why it's reliable. So you will send the confirmation to the customer, request the customer to respond to the confirmation, whether they agree or disagree with the stated balance. In a positive confirmation, you're gonna state the balance, okay? Here, you are expecting a response in all cases. So what's gonna happen is they will tell you, I agree, I disagree, or they don't response, you have to perform some followup procedures. Now, positive confirmation provide a higher level of assurance since they require you to explicitly look at the confirmation. Okay, explicit agreement, whether you agree or not. And this method is used when there's a higher risk of material misstatement in the account receivable and when the control are deemed to be weak. That's why you want to use a positive confirmation. So this is a sample of a positive confirmation and basically they will say, you will send it to the client, their client, we are currently auditing, conducting an audit of your client company name for the period. As of the balance sheet date, 1231, our record indicate an outstanding balance of 315,000. I just made up that number, okay? So basically what they're asking you, please review this information and confirm its accuracy. It's either yes, I confirm or it's incorrect, the balance is 280. And they, please, if the balance isn't incorrect, provide an explanation for the discrepancy. And usually what you do is you give them an envelope, self-addressed envelope, and you will tell them to mail it back to you within 10 days or at their earliest convenience. Now, when I was an auditor, especially when you're starting an audit, you will do send those confirmation a lot. So I was very familiar with those confirmation, know how to follow up these confirmation, but it's something that you do as a staff accountant. Also, you can send the blank confirmation. What's a blank confirmation? So remember we said the amount is 315,000. You don't tell them what the amount is, okay? You just don't say, you just tell them, could you confirm the amount and ask them to look it up and for them to write it up, whether it's 315 or 290 or whatever the amount is, this is what a blank confirmation is. The auditor sends a confirmation without providing the balance or other details. Now, the customer is then asked to fill in the necessary information, such as outstanding balance and other relevant details before returning it to the auditor. Now, does this system have advantages? Yes, it does, it has advantages and disadvantages when you send a blank confirmation. The advantages are you provide a higher level of assurance compared to a pre-populated confirmation. You don't tell them what the balance is. You are asking them to do what? To actively verify records and prove the outstanding balance. And this can help identify discrepancies and misstatement because they're not basically signing the letter that I sent and returning it. They're actually looking, actively looking. So the customer is not influenced by the balance you provided. They're looking at their system then right and down the balance. Now, do you see any disadvantages or drawback for this? Yes, it's gonna require a lot of work from the customer and customers don't like this. Therefore, you're gonna have a lower response rate. Believe me, customers don't response. Small companies, they don't have people to assign this work to. Sometimes you don't know how to send it to. Sometimes it get lost in the company. No one knows who's responsible or what does that mean? Although you explain in the letter exactly what we are doing. We are auditing a client company that's yours that you have a business relationship with it, but they said, I am not going to do it. There's nothing you can do. You could also send an invoice confirmation. What's an invoice confirmation? It's the process of verifying the accuracy and validity of an invoice. One invoice issued by a company. Usually you do this if there's only one balance and that balance is large. So the primary goal of invoice confirmation is to ensure that the invoice detail matches the term, agreed upon and the actual goods and services delivered. So here you're also looking for errors in discrepancy or potential fraud, but you're looking for one invoice. Now, because it's one invoice, usually it could improve response, especially if that invoice is large or important, must be large and important for both parties. You're asking for one invoice, but it does not help if there's more if there's an ending balance that's different from the invoice. So you're gonna get the number on that invoice, but if there's other transaction, it's not gonna help you with that. Then we have negative confirmation. Remember we have a positive, positive could be blank, but now we have a negative confirmation. What is a negative confirmation? Here's what you're doing. You're making it easy for them. The auditor requests the customer to respond only if they disagree with the balance. So you show them the balance, 315. They don't have to response. They only response if they don't think the balance is 315. So no response is considered an agreement with the balance and followup procedures may or may not be necessary for non-responses. If you're comfortable with the balance, you don't have to followup. Now, negative confirmation, they provide a lower level of assurance in comparison to a positive, since the lack of response is assumed to indicate agreement and how do you know that they even looked at it? You don't know, you just assume it's good. Now, when do you use this method is when the risk of material misstatement is low? It means they have a good control. The auditor believes the customer are likely to respond. You know the customers that they would respond if the number does not agree and the company internal control system are strong. And this is a sample of a negative confirmation. Again, you explain to them what you're doing and our record indicate the balance of your account. You just say, as of the balance sheet date, you put the balance. If you disagree with the recorded balance or have any concern regarding your account, please contact us immediately by mail using the enclosed self-addressed envelope. You send them an envelope that's stamped, easy for them, or by email if you're sending electronic. When I was in practice, everything was envelope. There was nothing in email. I'm sure it's work. Now that's how they do it these days. So if we do not receive a response within 10 days, we'll assume you agree with the balance. And that's that. Now, sometimes this makes them, you know, nervous if they disagree. They wanna make sure that they correct the balance. Now, when should you use positive? When should you use negative? Again, positive has a greater reliability. Negative is much more cost-effective, okay? You don't have to follow up for any negative confirmation. Simply put, you assume no news is good news for negative confirmation. Now, bear in mind, negative confirmation can be employed as the only substantive procedure when the following conditions are met. You cannot just send always negative. First, the risk of material misstatement is assessed low. Means inherent and controlled risk are low, indicating confidence in the system and the internal control of the company. The population comprise a high number of small homogeneous account. So you're dealing with low balances, maybe $400, $300 balances. And most of them are that low and it's a high number of them. And there's a low expectation rate as anticipated by the auditor. And you think those figures are correct. There's no reason because you have a good control. When these conditions exist, then that's fine. You can use negative. And the auditor expect the recipient will look at that confirmation, review it carefully to check on the account balances, okay? So which one to choose? Well, the main factor is, again, we mentioned a few of them that influence whether you use positive, negative, or sometime you might receive confirmation is the materiality and the total amount of the receivable. How large is the receivable? What's the materiality of it relative to the total receivable? The quantity and magnitude of the individual account. Do you have one individual account that's large or few large? Those are important. The level of risk and inherent risk, which is the risk of material misstatement. I know I'm repeating some of the information, but it's very important for your understanding. The efficiency of the confirmation is audit evidence. Is there an efficiency in our situation to use confirmation to audit account receivable? Do we have any alternative audit evidence that we can use, like test of detailed balance and litical procedures? Now, bear in mind, the more risk we have, we're gonna send positive confirmation and blank, we want them to look. Now, when to send the confirmation? Well, again, confirmation yield the most reliable evidence, especially when they are sent as close as possible to the balance sheet. We want the most recent balance for receivable. Now, bear in mind, when you send those, when you send them toward the end of the year, it may take a few days until they receive them. It may take maybe a week or 10 days for them to respond, then mail it back to you. So sometime you might miss the date for publishing the financial statements. For a timely audit completion, you can send them at interim date. For example, you can send them in November for November. Assuming internal control ensure proper recording of cash receipts and other credits between the confirmation and the balance sheet date, considering materiality and risk factors. There's not a lot of risk in doing so, why? Because if you can confirm November, then you can follow up with the cash payments. You will know what the December ending balance is. So when the auditor chooses to confirm receivable before year end, they typically create a roll forward schedule to reconcile. Basically, this is as of November confirmed, then we would look at December and we can roll it over. They can look at the cash transaction, cash receipts. We could look at selected transaction and some analytical procedures. Again, assuming we are comfortable with their internal control and inherent risk. Now, how many confirmations to send the size? Well, this is a sampling decision, basically. So the sampling size is based on the following factor. One is, again, we're here, we can go back to sampling, performance materiality. If the materiality is low, you have to be very careful. You cannot afford any mistakes. You want to send more confirmation. Inherent risk and control risk. The higher the RMM, the higher the sample. Again, you can see the sample module about sampling because if you have more risk, if you want to do more, you want to do more work. Also, can you achieve detection risk from other substantive testing, like transaction, test of detail, transaction, analytical procedures that determine how many you are going to send? Type of confirmation you send. If you're going to send a negative, you're going to send more negatives. Also, when you select the item, sometime you might have to stratify the desirable confirmation. Stratify means putting different account receivable in different groups, usually by a dollar amount. And choose the larger receivable and the one with older balances. You can select those. And if you have different segment for a business, for example, you have a commercial division and you have residential, sorry, commercial customers and residential customers, well, sample from every material segment. This is how you will do it. Again, at the end of the day, it's a judgment. And we talked about sampling and the sampling lecture, but it followed the same concept. How about if management says, you know, you cannot send confirmation for certain customers, they restrict you. What should you do then? Well, you should inquire about why they're not, we don't want to do it, they don't want us to do it. It could be maybe there's an ongoing litigation, a lawsuit between your auditee and the customer. Well, that's good. If that's the case, we have evidence for litigation, which we'll need later on. Or there might be some sort of a negotiation that's going on. Well, you could look at the board of directors minute, contract between the client and the customer. It's essential to gather evidence to assess the reasonableness of the client's request. So you don't just say, you know, they tell you don't send it, you just say, you accept it. You don't do that. And if it's suggested a heightened risk of fraud of material misstatement, you have to be on the lookout. When they tell you, you know, please don't send, you know, a confirmation to this client. Okay? So the auditor should consider and under those circumstances, if they accept the reasons, alternative method for obtaining the necessary audit evidence, for example, look at the cash receipts, subsequent cash receipts that we receive a payment from them. Look at other documents that support the sales, shipping documents, so on and so forth. Now, when you mail those confirmation, and again, as I told you, I used to mail them in person a lot. The auditor must carry the procedure to validate address or email addresses utilized for confirmation. Basically, I wanna make sure, usually I would call them for some companies, I would call them and say, do you have a place where I can send this audit confirmation? Some, they don't know what it is, some, oh yeah, we already know the address. Sometime I'll go to their website and they have that address listed as well. The auditor will control the mailing process. In other words, you don't let the customer do anything in this process. So when sending confirmation by mail, the auditor needs to retain control over the mailing until they are received and back from customer. They tell them to send it back to you, not back to the customer, you mean the auditee. While the client can help prepare the confirmation, that's not a problem, but it's preferably not. The auditor is responsible for mailing them. And the return address should be auditors to guarantee that the indeliverable confirmation, if it doesn't exist, return to the auditor rather than the client, okay? So the process should be conducted outside the client mailing system. Don't ask the client to mail them out for you to save on postage. Do it yourself, do it yourself. So what happened if there are no responses? What do you do with following up, okay? Non-responses to positive confirmation do not provide audit evidence. While non-responses for negative confirmation, remember, it provides some evidence that the account receivable exists and the balance is correct. When using positive confirmation, the standard mandate follow up procedures, okay? So what could you do? Well, you could look at subsequent cash receipts if they did not respond. Evidence of cash payment received after the confirmation, that's fine. If you send them a confirmation and you said you owe us $315,000 and they did not respond, look to see if they paid $315,000 or they made a payment. If that's the case, that's great. I mean, depending if they paid $315,000, that's great. You know, the receivable is legit and they paid it. If they paid less, well, then it's a judgment, what should you do next? You could look at duplicate sales invoices. Look at the sales invoices and verify the issuance of invoices, confirm the date. Look at the shipping document. Again, those are internal documents, but nevertheless, that's all what you have to work with now. See if you can correspond with the client. See if there's any dispute that's going on in this balance, okay? So the procedure that you will use, depending on the materiality of the account, how important in this account. And guess what? For non-responses, if you choose based on the judgment, you can treat the non-response as a 100% overstatement of account balance. In other words, you'd say, this account receivable, I am not gonna count it. I am not satisfied. It doesn't exist. It's an overstatement. Okay, you can do that again based on your judgment. Now what happened when there's a difference between what you told them and the response? Analysis of difference could happen. And there are many reasons why it could happen. One of the reasons is the payment already made. You told them, as of 1231, you owe us 315,000. I keep using this number. Well, they send the payment January 5th and they did not receive this confirmation till January 10th. When they looked at their systems, like they did not pay attention that you told them as of 1231, they look at their system and the balance is zero. So they would say the balance is zero. Then what you have to do is you have to go back and see if they indeed a payment was made. If the payment was made, then they're correct, we're all correct, okay? So the balance is 315 at the end of the year, but now it's zero, that's fine. Goods not received. You build them, you're all the team build the customer, but they did not receive it. Therefore they don't have a receipt. As far as they know, they don't have a payable. For them it's a payable. This usually occur because the client records the sale on the shipping date, but the customer may not have received the good. So they have no payable on the record because they did not receive it. Or the goods were returned. And the client failed to record the credit memo for sales return. Again, this could be a problem with their internal control. This is if that happens, if they told you we return the goods and you see the client did not process it yet, assume enough time has passed by, you're gonna say, well, for next year, I have to look at their sales return a little bit more carefully. Or it could be a clerical error and disputed amount. So typically the author would request the client to reconcile these differences. All in all, once the discrepancies are resolved, the auditor will need to reassess internal control. So let's assume we thought we're gonna have 10 exceptions, like 10 problems. And we find out we only had three. Or we thought we're gonna have 10 and we find out there's like 15 accounts were misstated. Well, guess what? We're gonna have to, based on this, we can reassess internal control. Some statements must be examined to determine whether they aligned or deviate from the original assessed level of control risk. Now we have more information. For next year, we would know that we might have to do more work or less work based on the responses. Now, the considerable number of misstatement are inconsistent with the control risk assessment. We must revise our assessment because what we thought the system looks like it didn't really serve what it wanted to serve and evaluate the impact of this revision on audit. On the audit, what should you do now? Go to Farhat Lectures and look at MCQs, True, False, Additional Resources. That's gonna help you in your classroom and your CPA review course and your accounting profession. 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