When is the confirmation of receivables required?
AU-C 330 paragraph 20 states the following:
The auditor should use external confirmation procedures for accounts receivable, except when one or more of the following is applicable:
- The overall account balance is immaterial.
- External confirmation procedures for accounts receivable would be ineffective.
- The auditor’s assessed level of risk of material misstatement at the relevant assertion level is low, and the other planned substantive procedures address the assessed risk. In many situations, the use of external confirmation procedures for accounts receivable and the performance of other substantive procedures are necessary to reduce the assessed risk of material misstatement to an acceptably low level.
If receivables are material and confirmation procedures will be effective, then confirmations must be sent. (Normally, the existence assertion related to receivables is moderate to high. So, 3. above is not in play.)
When are Confirmations Ineffective?
AU-C 330.A56 states:
External confirmation procedures may be ineffective when based on prior years’ audit experience or experience with similar entities:
- response rates to properly designed confirmation requests will be inadequate; or
- responses are known or expected to be unreliable.
If the auditor has experienced poor response rates to properly designed confirmation requests in prior audits, the auditor may instead consider changing the manner in which the confirmation process is performed, with the objective of increasing the response rates or may consider obtaining audit evidence from other sources.
Alternative Procedures When Confirmations are not Sent
What audit procedure should be performed if confirmations are not sent? Usually, the auditor will examine cash collections after the period-end. Care must be taken to ensure that the subsequent collections examined relate to receivables that existed at period-end and not to sales occurring after period-end.
Required Documentation When Confirmations are not Sent
AU-C 330.31 states that “the auditor should include in the audit documentation the basis for any determination not to use external confirmation procedures for accounts receivable when the account balance is material.” So, it is not sufficient to simply state that the use of confirmations is ineffective. We should state that we tried to confirm receivables in a prior year without effective results or that we tried to confirm receivables for clients in a similar industry, but without effective results.
The auditor should include a memo to the file or add comments on the receivables work paper explaining why confirmations were not sent.
See my post: Auditing Receivables and Revenues.