If the trial balance of the General Ledger agrees to the inclusion of the balance in the total accounts governing the Bought Ledger and the Sales Ledger (instead of individual balances of accounts contained therein), it would not necessarily prove that the balances in the account of the Bought and
Sales Ledgers are correct. For there could still be compensating errors in the ledgers which would not affect the agreement of the trial balance. Therefore, it is essential that the individual balances of debtors and creditors should be verified on obtaining either confirmation of balance from them or detailed
statements of account. AAS 30, “External Confirmations”, lays down standards for external confirmation of balances. As per the Standard, the auditor should determine whether the use of external confirmations is necessary to obtain sufficient appropriate audit evidence to support certain financial
statement assertions. In making this determination, the auditor should consider materiality, the assessed level of inherent and control risk, and how the evidence from other planned audit procedures will reduce audit risk to an acceptably low level for the applicable financial statement assertions. The
auditor should employ external confirmation procedures in consultation with the management. Auditing and Assurance Standard (AAS) 5, “Audit Evidence” states that the reliability of audit evidence is influenced by its source and nature. It indicates that, in general, audit evidence from external sources is more reliable than audit evidence generated internally, and that written (documentary) audit evidence is more reliable than audit evidence in oral form. Accordingly, audit evidence in the form of written responses to confirmation requests received directly by the auditor from third parties who are not related to the entity being audited, when considered individually or cumulatively with audit evidence from other procedures, may assist in reducing audit risk for the related financial statement assertions to an acceptably low level.
External confirmation is the process of obtaining and evaluating audit evidence through a direct communication from a third party in response to a request for information about a particular item affecting assertions made by management in the financial statements. In deciding to what extent to use
external confirmations, the auditor considers the characteristics of the environment in which the entity being audited operates and the practice of potential respondents in dealing with requests for direct confirmation. The process of external confirmations, ordinarily, consists of the following:
- Selecting the items for which confirmations are needed.
- Designing the form of the confirmation request.
- Communicating the confirmation request to the appropriate third party.
- Obtaining response from the third party.
- Evaluating the information or absence thereof.
External confirmations are frequently used in relation to account balances and their components, but need not be restricted to these items. For example, the auditor may request external confirmation of the terms of agreements or transactions an entity has with third parties. The confirmation request is
designed to ask if any modifications have been made to the agreement, and if so, the relevant details thereof. Other examples of situations where external confirmations may be used include the following:
- Bank balances and other information from bankers.
- Accounts receivable balances.
- Stocks held by third parties.
- Property title deeds held by third parties.
- Investments purchased but delivery not taken.
- Loans from lenders.
- Accounts payable balances.
- Long outstanding share application money.
The reliability of the evidence obtained by external confirmations depends, among other factors, upon the application of appropriate procedures by the auditor in designing the external confirmation request, performing the external confirmation procedures, and evaluating the results of the external confirmation procedures. Factors affecting the reliability of confirmations include the control which the auditor exercises over confirmation requests and responses, the characteristics of the respondents, and any restrictions included in the response or imposed by management. The following procedures should be followed for confirmation of the balances of debtors and creditors at the close of the year:
- Confirmatory letters, in respect of the balance, either as at the date of the Balance Sheet or as at another selected date before the close of the year, should be sent out within a period of 15 to 21 days after the end of the year even when the audit is taken up much later.
- If the number of accounts is large, letters may be issued only in respect of balances in the accounts of principal debtors and creditors, selected according to some system, which would ensure that the accounts selected would constitute a representative sample of all accounts of debtors and creditors. After the size and the contents of the sample have been determined, the client should be requested to prepare confirmatory letters requesting the parties to confirm the balances in their accounts as on a specified date.
- The balances shown in the confirmatory letters should be compared by auditors with the book balances of the debtors and creditors before the letters are despatched. He should also take control of the copies of these balances to prevent these being erased subsequently. The letters
should be posted by the auditor. In case these are being posted by the client, there should be adequate check by the auditor that all the letters prepared have been duly posted. - Each confirmatory letter should show the balance in the account of the debtor or creditor and the address of the auditors at which the confirmation under the signature of the party is to be sent. It should be signed by the client or the auditor, as has been mutually agreed upon. Also a stamped
envelope containing the auditor’s name and address should be enclosed. The envelope containing the letter of confirmation should have the address of the auditor as the sendor. - The debtors or creditors who fail to reply within a reasonable time should be reminded. Also, letters received back undelivered should be sent again at the correct address.
- On the confirmations being received, the auditor should verify that in each case either the balance has been confirmed or it can be satisfactorily reconciled. In case the balance in the account differs from that confirmed by the party, the client should be requested to prepare a reconciliation
statement. - In every case, where a reconciliation statement has been prepared, it should be verified that the difference in the amount confirmed and that shown by the books of account is not the result of an omission to credit any amount received from the party or failure to debit him with any amount of sales or to credit him with the value of goods received with a view to suppressing or inflating profits.
- If the difference is the result of some dispute or claim for an allowance or return, etc. not granted to the party, it should be confirmed that a provision equal to the difference which ultimately have to be credited to the party has duly been made.
Selection of accounts for direct verification : A few suggestions as regards selection of accounts for obtaining direct confirmation from parties are given below:
- Credit Balances : Balance in the accounts of suppliers, depositors, employees, securities deposited by creditors.
- Sundry debtor balances : Balances of advances to suppliers, balances recoverable for goods sold, securities deposited, etc. especially when the balances are in round figures have been continually increasing. It is usually not possible to obtain confirmation of amounts outstanding against Government Departments. These, thus, should be left out.
- A certain percentage of total number of accounts should be selected: some on the basis of largeness of their balances and others according to numerical or alphabetical order. For example, all accounts having balances above Rs. 10,000 may be included in the list of balances prepared for obtaining confirmations. Also accounts of parties with names beginning with, say “B” and “M” may be included in the list.
A few amount with no unpaid items, as well as those the balance whereof have been written off during the period under review should be specially included. Furthermore, accounts wherein payments or other credits have been adjusted subsequent to the confirmation date should not be omitted, Accounts of parties, any cheque whereof has been received back unselected and accounts which are ‘dead’, i.e., wherein there has been no operation during the year should also be included.
The group of accounts selected in the foregoing manner for obtaining confirmation of the debtor’s and creditors’ balances would be representative sample of all the accounts of debtors and creditors. Unless there is evidence that the difference in the amounts confirmed and those shown by the respective accounts in the books is the result of some omission of fictitious entries, the position as revealed by direct verification of a sample of accounts could be accepted.
