CAT / FIA FAU Syllabus D. Audit Evidence And Procedures - Receivables - Direct Confirmation - Notes ^{2 / 18}

Here the main risks of misstatement are..

• Bad debts (Valuation assertion)

• Doubtful debts (Rights & Existence assertions)

• Cut-off problems

Direct Confirmation

This is often referred to as the "Debtors circularisation". 

This means asking customers for written confirmation of their account balance

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• Problems with the Debtors Circular

  1. Not all customers reply

  2. Customers may reply without checking properly

• The Assertions and Receivables

  This relationship to assertions is important for the exam!

  • Existence - Ensure they really do exist and so not overstated

  • Rights and obligations Ensure client has the legal right to the amounts receivable

  • Valuation Ensure the receivables are stated at their appropriate amount

  • Cut-off Ensure transactions have been recorded in the correct accounting period

• Key things to be aware of..

  1. The auditor decides which customer gets asked (not the client)

  2. Auditor states that the reply comes to her directly

  3. Auditor sends out the request personally

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• The results of the Circular

  Things to watch out for

  1. Any doubts over the reliability - perform alternative tests

  2. If the response is not reliable for sure - then consider the effect on risk assessment and perform more alternative procedures

  3. If no response - perform alternative procedures

  4. Client confirms different amount - decide if this is just a timing difference or a problem with controls or fraud

  5. Finally consider the results as a whole to see if relevant and reliable

The process of the circular

This comes in 5 steps

1. Planning

2. Deciding Positive or Negative Confirmation

3. Selecting a Sample

4. What to do when you get the Replies

5. Summarising & Concluding

Planning

• 2 things need to be decided

  • When to do it (Timing)

  • Who to include (The sample)

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Decide Positive or Negative Confirmation

• Let's look at positive first

  1. A positive confirmation request asks the customer to reply to the auditor whether or not he agrees with the balance

  2. Method 1 Give him the figure and ask to confirm

  3. Method 2 Ask him to provide his balance himself

  4. Risk with Method 1 - customer confirms without checking
     Risk with Method 2 - Lower response rate from customers

• Now let's look at negative confirmations

  This asks the customer to reply only where he disagrees with the balance

  • If no reply is received - this means he agrees, however it might also mean he never received or checked

  • The evidence from negative confirmation circulars is therefore less reliable

• So why would an auditor use negative conformation circulars then???

  Well only when all of the following apply..

  1. Misstatement risk is low and controls are strong

  2. Population is made up of lots of small items

  3. A very low exception rate is expected

  4. No evidence that the customer would ignore the request for confirmation

Sample Selection

• Procedure for selecting the sample is as follows:

  1. Get the aged receivable listing (for the right date!)

  2. Check the listing is accurate by:

     1) Checking a sample of debtors individual balances to it
     2) Check total balance to control account in main ledger

  3. Ensure the sample is representative of the population

• Certain balances may always be included

  1. Overdue balances

  2. Negative balances

  3. Accounts on which round sum payments are received (instead of paying the actual invoice amounts)

  4. Nil balances

  5. All "material" balances

Procedures when getting replies

1. Check the following:

   • signed by a responsible official

   • replies are filed in the receivables section of the current audit file

2. If the balance agrees?

   • No further work required

3. If the balance doesn't agree?

   • Ask the client to reconcile their balance to the customers

   • Then check this reconciliation

   • Look to see if errors are:

     1) Control errors or
     2) Just timing differences

   • If just timing differences then no further work required

4. No reply received?

   These cannot be ignored!!

   • They are part of a sample chosen

   • So a conclusion needs to be reached

   • So alternative procedures must be carried out..

     1) Check cash received from customer after
     2) Check for signed purchase order
     3) Check for signed delivery conformation
     4) Check a sales invoice exists

Preparing the summary & Concluding

The summary shows which balances have not been verified 

They may indicate the existence of bad debts.

Then conclude on the likely level of misstatement in the total population based on the sample results, and whether this is material.