Question

Required information

Accounts Receivable Confirmations

Read the case and answer the questions that follow.

Audit standards require analytical procedures at two stages during the audit: at the risk assessment (planning) phase and again at the end of the audit. They are optionally used as a substantive procedure during the course of an audit.

CONCEPT REVIEW:

Often times it does not seem to be productive or effective for auditors to send accounts receivable confirmations, yet the standards require it. It is important that auditors understand how to maximize effectiveness and efficiency in this required audit procedure.

Read the case. Then answer the questions based on it.

BACKGROUND:

Audit standards indicate that there is a presumption that auditors will confirm accounts receivable unless the balance is immaterial, confirmations are deemed ineffective, or the auditors' assessment of risk is low and other procedures will achieve the same objective. However, these instances are considered few and far between and current trends in auditing indicate that there is an expectation that accounts receivable will be confirmed. Auditors may stratify the population, use haphazard or judgmental sampling, and send positive or negative requests.

Jenner & Jenner CPAs are the auditors for the Leno Company. In reviewing the accounts receivable aging, the auditors learn that there is a high number of accounts with balances, there are some very large and very small balances, and many customers' balances consist of multiple invoices.

1. Should Jenner & Jenner CPAs send accounts receivable confirmations?

2. How should the auditors mitigate the risk associated with both very large and very small balances?

3. Because so many customer balances consist of multiple invoices, what could the auditors do to eliminate unnecessary reconciliation?

4. What procedures can be performed on customers who do not respond?

Answer 1

1. As per Standards on Auditing-505 "External confirmations", It is necessary to obtain external confirmations for the auditors. If its not possible any of reason then alternative procedure must be applied to reduce the risk. Thus Jenner & Jenner CPAs should send accounts receivable confirmations.

2. There are two type of confirmations

(i) Positive confirmation request:- A request that the confirming party responds directly to the auditor indicating whether the confirming party agrees or disagrees with the information in the request,or providing the requested information.

(ii) Negative confirmation request:- A request in which the confirming party responds to the auditor only when he disagrees with the information provided in the request.

Negative confirmations provide less persuasive audit evidence than positive confirmations. Accordingly,the auditor shall use negative confirmation requests as the sole substantive audit procedure only when all of the following conditions are present :-

(a) Low risk of misstatement

(b)Population comprises of large number of small, homogenous accounts balance or transactions

(c)A very low exception rate is expected.

(d) The auditor is not aware of circumstances or conditions that would cause receipients of negative confirmation requests to disregard such request.

Since in very large balances high risk is associated , so auditor should use positive confirmation requests and in the case of small balances negative confirmation requests should be used.

3.Auditor should send blank space letter to those customers and request them to fill their balances in those letters and afterwards he should check whether its correct or not.

4. It depends on which type of confirmation request has been send to those customers, because in negative confirmation request customer responds only when he disagrees with the auditors. So there are less chances of misstatement in those balances. But though it is possible customer can directly disregard those requests because of extra work load for them.

So auditor should use alternative procedures to those customers who did not respond the confirmation request. Like how much sales made to the customer, subsequent cash received from them and accordingly they can arrive at clsoing balance of that customer.