Question

Describe the confirmations process. Explain the types of confirmations – and the benefits of each type of confirmation.

Answer 1

Conformation Process:

In its regular course of business, a company needs to verify its balances and turnovers with the banks, suppliers or other counterparties. So, confirmation process is one of the ways to obtain such information. It is a form of inquiry. It consists of obtaining representations from third parties, which are required as per the company’s financial management procedures or as per the request of the auditors.

A typical confirmation process would include such steps as:

1.Selecting items to be confirmed:

For audit purposes the items are selected in response to both audit risk and fraud risk. Depending on the circumstances, the company may elect different approaches to the sample selection and size (up to 100% coverage if applicable). For example, if a merchandizing company runs a bonus system for its dealers, it may decide to perform a circularization procedure with the top 20 dealers confirming annual sales volume, accounts receivable balances and bonuses due to the dealers at the financial year end. On the other hand, financial auditors usually select some items randomly or on the risk basis. It is to be noted that confirmation of accounts receivable is a required procedure under auditing standards in the USA (unless certain exception criteria are met).

2. Designing requests and their proper authorization:

Auditing standards don’t provide a specific form of a confirmation letter; therefore, companies tailor confirmation requests to their needs and objectives. At the same time, large audit firms use standardized confirmation letters and would require a company being audited to adhere to them. Confirmation requests are prepared on the audited company letterhead and are properly authorized (usually by a financial director and/or chief accountant).

3.Communicating and sending requests:

To obtain relevant and timely information, confirmations are firstly sent electronically (e.g., by fax or e-mail) followed by a hard copy that enables counterparties to prepare responses beforehand. It is important to know that confirmation requests prepared for financial statement audits are required to be handled (e.g., mailed out) by auditors themselves.

4.Obtaining responses:

Circularization helps to identify discrepancies in accounting records, identify missed operations or cut-offs, double-check existence, right and obligations. Based on responses obtained and communication with counterparties, a company (as well as auditors) sometimes can assess recoverability of outstanding balances, reconcile missed shipments or payments, etc. For auditors, obtaining responses is the most critical stage in terms of information reliability. Counterparties should send responses directly to the auditors, and not to the accounting department of the company under the audit, otherwise confirmation letters would be considered unreliable and additional work would need to be performed.

5.Evaluating results:

Since the response rate may not always be satisfactory, second confirmation requests may be necessary. Any discrepancies are followed up and correction entries are posted. For instance, if a company’s customer is in bankruptcy and it is unlikely that the amount due will be collected, the account receivable balance is either written off or fully provided for (i.e., reserved for).

Types of Conformation Process:

In the types of confirmations. The most common are Positive confirmations and negative confirmations. The most reliable evidence from confirmations is obtained when they are sent as close to the balance sheet date as possible.

Positive Confirmation:

Positive confirmation is an auditing inquiry that requires the customer to respond to the auditor whether the customer's records do or do not correspond with the auditor's records. Positive confirmation requires proof of accuracy, affirming that the original information was correct or providing the correct information if the original information is found to be inaccurate.

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.

Positive vs. Negative Confirmation

While positive confirmation requires supporting information regardless of whether the original records are accurate, negative confirmation requires a response only if there is a discrepancy. During a negative confirmation request, a business may be asked to confirm that an account balance is listed at a specific amount, such as $100,000. If the account balance currently reflects the amount as $100,000, then no additional action is required to satisfy the request. If the balance reflects any amount aside from $100,000, additional information must be provided to justify the difference.

Negative confirmation is more commonly used if the individual's or business's records are generally considered to be highly accurate by nature, often based on stringent internal requirements or business practices.