Audit Confirmation: Positive vs Negative

I believe many of you  guys already familiar with “audit confirmation”, but some of you might still confuse with the differences between positive and negative confirmation. In this post we would like to discuss more about “audit confirmation”.

Definition:

Confirmation—the auditor’ s receipt of a direct written or electronic response from a third party verifying the accuracy of information requested.
Confirmation procedures can be used to confirm the balance of receivable, payable, contigent liabilities, bank account, inventories and securities in custody, or to confirm the transaction of sales invoice, side agreement, purchases.

Objective:

The purpose of accounts / transactions confirmation is to meet the Existence, Accuracy, and Cutoff objectives.

Form of Confirmation: Positive and Negative

Positive Confirmation
A positive confirmation =  correct or incorrect, the recipient is requested to reply/ confirm with the stated amount/ information. Included as positive confirmation are:

• A blank confirmation.
• An invoice confirmation.
• Sales involve special terms or side-agreements confirmation.

Negative Confirmation
A negative confirmation = the recipient is requested to reply only when the recipient disagrees with the stated amount.

Difference:

1. Failure to reply:
   
   • Positive Confirmation
   Auditor should perform follow up procedures if the debtor does not reply. See the follow procedures below.
   
   • Negative Confirmation
   Regarded as a correct response, even though the debtor may have ignored the confirmation request.


2. Cost of confirmation:
   Negative Confirmation is less expensive than positive confirmation, because there will be no second confirmation request and no follow-up procedures.


3. Criteria to Use:
   For using Negative Confirmation, all of the following circumstances are present:
   
   1. The auditor has assessed the risk of material misstatement as low and has obtained sufficient evidence regarding the design and operating effectiveness of controls.
   2. The population of items is made up of a large number of small, homogenous account balances, transactions, or other items.
   3. The auditor expects a low exception rate.
   4. The auditor reasonably believes that recipients will give the requests adequate consideration. Adequate consideration exist when there are high response rates on audits in previous year or of similar clients.
   Typically, when negative confirmations are used, the auditor puts considerable emphasis on the effectiveness of internal controls, substantive tests of transactions, and analytical procedures as evidence of the fairness of accounts receivable, and assumes that the large majority of the recipients will provide a conscientious reading and response to the confirmation request.


4. Common Pratical Use
   Negative Confirmation is common used practically for audits of hospitals, retail stores, banks, and other industries in which the receivables are due from the general public.

Follow-Up on Nonresponses

If a positive confirmations are not returned by the customer, auditing standards require follow-up procedures. Usually, auditors would send second and some times even third requests for confirmations. With these efforts, but some customers do not return the confirmation, so auditors should follow up with alternative procedures. The objective of alternative procedures is to confince the auditor whether the nonconfirmed account existed and was properly stated at the confirmation date. For any positive confirmation not returned, auditors can examine the following documentation to verify the existence and accuracy of individual sales transactions making up the ending balance in accounts receivable:

• Subsequent Cash Receipts
Evidence of the receipt of cash subsequent to the confirmation date includes examining remittance advices, entries in the cash receipts records, or perhaps even subsequent credits in the accounts receivable master file. On the one hand, the examination of evidence of subsequent cash receipts is a highly useful alternative procedure because it is reasonable to assume that a customer would not have made a payment unless it was an existing receivable. On the other hand, payment does not establish whether an obligation existed on the date of the confirmation. In addition, auditors should take care to match each unpaid sales transaction with evidence of its subsequent payment as a test for disputes or disagreements over individual outstanding invoices.

• Duplicate Sales Invoices
These are useful in verifying the actual issuance of a sales invoice and the actual date of the billing.

• Shipping Documents
These are important in establishing whether the shipment was actually made and as a test of cutoff.

• Correspondence with the Client
Usually, the auditor does not need to review correspondence as a part of alternative procedures, but correspondence can be used to disclose disputed and questionable receivables not uncovered by other means.

Case: FALSE AUDIT CONFIRMATIONS HIDE FRAUD AT U.S. SUBSIDIARY

Confirmations are normally considered highly reliable evidence because they come from independent third parties. However, in some cases customers have colluded with audit clients and returned false audit confirmations. Such was the case at U.S. Foodservice, Inc., a U.S. subsidi ary of Royal Ahold, a company headquartered in The Netherlands. The SEC complaints charged that U.S. Foodservice inflated promotional allowances from vendors by at least $700 million for fiscal years 2001 and 2002 in order to meet earnings targets. U.S Foodservice personnel contacted vendors and pressured them to return false confirmati on letters to the auditors. In two separate complaints, the SEC charged 16 individuals who were employees of or agents for vendors that supplied U.S. Foodservice.