Accounts receivable confirmation definition
/What is an Accounts Receivable Confirmation?
When an auditor is examining the accounting records of a client company, a primary technique for verifying the existence of accounts receivable is to confirm them with the company's customers. The auditor does so with an accounts receivable confirmation. This is a letter signed by a company officer (but mailed by the auditor) to customers selected by the auditors from the company's accounts receivable aging report. The letter requests that customers contact the auditors directly with the total amount of accounts receivable from the company that was on their books as of the date specified in the confirmation letter. The auditor typically selects customers for confirmation that have large outstanding receivable balances, with secondary consideration given to overdue receivables, followed by a random selection of customers having smaller receivable balances.
Since the information obtained through confirmations comes from a third party, it is considered to be of higher quality than any information that an auditor could have obtained from the client company's internal records.
Sample Accounts Receivable Confirmation
A sample accounts receivable confirmation appears in the following exhibit. Note that the confirmation clearly states that it is not a dunning letter (which is used for collections).
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The Difference Between Positive and Negative Confirmations
There are two forms of confirmation, which are noted below.
Positive Confirmation
A positive confirmation is a request to provide a response to the auditor, whether or not the customer agrees with the receivable information listed in the confirmation. For example, an auditor might send a letter to a client’s customer, stating the balance owed as of a certain date, along with a request that the customer either confirms it is correct or provides the correct amount if it is not. This method provides stronger audit evidence because it requires a response in all cases, making it especially useful when the auditor suspects that errors are present, or when internal controls appear to be weak.
Negative Confirmation
A negative confirmation is a request to contact the auditor only if the customer has an issue with the accounts receivable information contained within the confirmation. This is a less robust form of evidence, since there is an inclination by customers to not contact the auditor, which leads to the presumption by the auditor that customers agree with the presented accounts receivable information.
Alternative Audit Procedures
If customers do not return confirmations to the auditor, the auditor may go to considerable lengths to obtain the confirmations, given the high quality of this form of evidence. If there is no way to obtain a confirmation, then the auditor's next step is to investigate subsequent cash receipts, to see if customers have paid for those invoices that were not confirmed. This is a strong secondary form of evidence that the accounts receivable outstanding at the end of the reporting period being audited were in existence at that time.
Dealing with Confirmation Variances
If the information received from a customer varies from the receivable amount listed in the company's receivable report, there are several steps that an auditor can take, which include the following:
Investigate the variance. Determine whether the variance is due to timing differences, errors, or disputes. For example, a payment made near year-end may not have been recorded by the respondent yet. Understanding the cause helps assess whether it impacts financial statement accuracy.
Discuss the variance with management. Share the discrepancy with the client’s management to get their explanation. They may provide documentation such as receipts, invoices, or reconciliations to support their position. The auditor should evaluate the credibility and sufficiency of this explanation.
Obtain supporting documentation. Gather relevant supporting documents from both the client and the confirming party (if necessary). This might include shipping records, cash receipts, bank statements, or contract terms. The auditor uses this evidence to determine whether the client’s balance or the confirmation response is more reliable.
Assess materiality. Consider whether the variance is material either individually or when aggregated with other findings. Evaluate whether it indicates a control weakness, misstatement, or fraud risk. This assessment may influence the auditor’s opinion or lead to expanded testing.
Consider recommending adjustments. If the client’s explanation is reasonable and backed by evidence, no adjustment may be needed. If the variance reflects a true error or misstatement, recommend an adjustment to the financial statements. Document the entire evaluation process in the audit working papers for support during review.