Question

According to your textbook, to minimize the risk of material misstatement, auditors seek third-party verification of account balances by mailing customers their statements. Discuss the advantages of positive and negative confirmations, and ascertain whether or not email and oral confirmations are acceptable to increase customer response rates. Support your position.

Discuss the key differences between substantive tests of transactions and substantive tests of balances. Next, identify at least two situations when an auditor should test account balances. Support your rationale with related examples of such circumstances.

Answer 1

Third party verification of account balances are useful because it provides a legally trail and allows both vendors and customers to verify transactions that have taken place. Email confirmation are economically friendly and are ethical as well. Advantage of positive and negative confirmations:

• It helps in the identification of the loopholes and to correct the mistakes.
• It enables customers to perform online transactions.
• Customers and business organizations can maintain digital records, thus, reducing paperwork.

Oral confirmations may not stand ethical and reliable. Hence, oral confirmation should not be practiced. Oral confirmation does not have any reliability, and these confirmations may not be able to gain 100% trust of the consumers.

Substantive test of transactions measures the operating effectiveness of internal controls and the monetary correctness of transactions in the accounting system. Substantive test of balances measures whether the dollar amounts of account balances are materially misstated. An auditor should test account balances if they suspect that a balance may be understated. For example, if an auditor obtains evidence that indicates that the accounts receivable balance may be understated because the client did not include a charge, then the auditor would test the balance to determine the reasonableness of the account. An auditor should also test account balances if they receive confirmations from customers that are not reflected in the client’s records. Audit sampling for test of balances measures monetary misstatements, which means that a misstatement exists whenever a sample item is misstated. If a customer balance does not match client records, an auditor should test account balances by obtaining additional evidence to determine the likelihood that the balances are fairly stated.