LET SEE AND GET INFORMATION FROM IT

1. Auditing – Study Notes Chapter 14 External Confirmation
CHAPTER FOURTEEN
EXTERNAL CONFIRMATION
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*Explanation of Reference:
First digit in Study Text’s Reference represents chapter number, second and third digits represents
section and sub-section number. Contents in brackets (if any) represent part of the sub-section
which is covered by the learning objective.
Coverage from Question Bank:
After completion of this chapter, you will be able to attempt following questions in ICAP's Question
Bank:
Question # in ICAP’s
Question Bank
Type of Question
Question # in ICAP’s
Question Bank
Type of Question
Q. # 32c (Zakir Co) Concept Review Question Q. # 72 (ISA 500) Concept Review Question
Q. # 45 (Direct confirmations 1) Concept Review Question Q. # 79c,di (Sahito Co) Concept Review Question
Q. # 51 (Direct confirmations 2) Concept Review Question Q. # 79dii (Sahito Co) Case Study
Q. # 60 (MWL) Case Study
2

2. Auditing – Study Notes Chapter 14 External Confirmation
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Definition:
External confirmation is a process of obtaining evidence by auditor directly from a third party in
written (on paper, electronic or other medium).
Examples of situations where external confirmation is used:
Usually, confirmation procedure is used to confirm information from Debtors, Creditors, Banks,
Lawyers, Inventories held by third parties, and investments held by brokers.
Objective of using External Confirmation:
External confirmation provides highly reliable evidence (being written, external and direct
evidence) about:
 information (e.g. account balances, specific transactions, and other terms and
conditions)and
 assertions (e.g. Existence, Rights and Obligation, Completeness, and Cut-off).
However, confirmation provides weak evidence about Valuation and Allocation.
Whether or not to use Confirmation in obtaining Audit Evidence:
External confirmation is a frequently used audit procedure. However, it is not a required procedure
and auditor may omit it in following situations:
i. When Inherent Risk and Control Risk both are assessed as low.
ii. When balance is not material.
iii. When response is not expected to be adequate or reliable (e.g. if confirming party does
not have ability, objectivity or willingness to respond).
iv. When sufficient appropriate evidence can be obtained from other substantive
procedures.
v. When management requests auditor not to send confirmation request and there is a
reasonable justification for this.
Deciding Timing of Confirmation:
Confirmation is usually sent at year end. However, it may also be used at interim date. If
confirmation is used at interim-date, following further procedures are performed at year end to
ensure that intervening transactions are not materially misstated:
1. Obtain break-up of balances (i.e. party wise detail) at year end along with summary of
transactions with each party between interim date and final date.
2. Agree sum of individual transactions with control account.
3. Compare individual balances as on year end with balances as on interim date, and
investigate unusual variations.
4. Select a sample of sales and receipts and perform tests of controls to ensure operating
effectiveness of control after interim period.
5. Select a sample of material sales and receipts and vouch them with supporting documents.
Exam Tip
Be careful for difference between following situations:
 Auditor decides not to use confirmation in obtaining evidence.
 Client insists auditor not to send confirmation.
 Confirming party does not reply to a confirmation request.
2 By Muhammad Asif, ACA

3. Auditing – Study Notes Chapter 14 External Confirmation
6. Perform cut-off test at year end.
7. Check subsequent recovery of year-end balances.
CONCEPT REVIEW QUESTION
Define external confirmations. Explain the purpose of using external confirmations by the auditors during an audit of
financial statements and also identify any four (04) situations where auditor can use direct confirmations. (06 marks)
(ICMAP - February 2014)
You are the Manager on the audit of Ghazi Power Limited (GPL), a gas transmission and distribution company, for the
year ending 31 October 2011. On the company’s request, your firm has agreed to complete the audit by 20 November
2011.
What audit procedures should be performed at the year end, if requests for confirmation of balances are sent on 31
August 2011? (07 marks)
(CA Inter, Autumn 2011)
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If auditor decides to use external confirmation to obtain evidence, auditor shall consider following
matters:
1. Decide timing of confirmation (i.e. whether to be used at interim date or at final date).
2. Select appropriate confirming parties (for this purpose population should be stratified, and
a suitable sample should be selected considering each category).
3. Design confirmation request to be sent i.e.
 Decide the information and assertion to be confirmed.
 Decide method of confirmation (i.e. whether positive or negative)
 Obtain Authorized signature of CFO (or other responsible official).
 Request confirming party to send reply directly to auditor.
4. Appropriate procedures should be performed (depending on reply) on replies received.
CONCEPT REVIEW QUESTION
Direct confirmations of balances due from customers are obtained to satisfy the objective of ensuring that the customer
exists and owes the specified amount to the company at a certain date.
Required:
(a) State the circumstances in which an auditor may decide not to circulate the requests for direct confirmation.
(05 marks)
(b) What are the factors that an auditor considers while designing the requests for direct confirmation? (05 marks)
(c) Describe the alternative audit procedures which may be conducted if the customer does not reply to a request for
confirmation. (06 marks)
(CA Inter, Spring 2010)
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Broadly, there are two types of confirmation requests which are used by auditors i.e.
1. Positive Confirmation Request and
2. Negative Confirmation Request
Positive Confirmation Request:
Definition:
A positive confirmation request asks confirming party to reply auditor in all cases whether he
agrees or disagrees with the information provided in the request.
3 By Muhammad Asif, ACA

4. Auditing – Study Notes Chapter 14 External Confirmation
Risk in positive confirmation:
There is a risk in positive confirmation that confirming party may reply without due verification or
may not identify a disagreement which is in his favor.
This risk can be reduced by sending a blank confirmation (i.e. a confirmation without amount or
information; confirming party is asked to fill it himself).
Negative Confirmation Request:
Definition:
A negative confirmation request asks confirming party to reply auditor only if he disagrees with the
information provided in the request.
Risk in negative confirmation:
Negative confirmation is less reliable because there is no explicit evidence that confirming party
received and verified confirmation. Confirmation may be lost or disregarded by party.
Therefore, negative confirmation is used in combination with positive confirmation. However, it can
be used as sole substantive procedure only when all of following conditions are met:
1. Relevant population consists of large number of small balances or transactions.
2. Inherent risk and control risk are low, and auditor has obtained evidence about operating
effectiveness of controls.
3. A very low exception rate is expected, and
4. Auditor is not aware of any circumstances that confirming party will disregard such
requests.
CONCEPT REVIEW QUESTION
Direct confirmations from third parties provide independent audit evidence that certain account balances and items in
the financial statements are properly recorded and disclosed.
Required:
(a) Distinguish between positive and negative confirmations. (02 marks)
(b) Briefly describe the risks associated with each of the above type of confirmation and the steps that an auditor usually
takes to avert such risks. (05 marks)
(c) Explain why and under what circumstances an auditor may decide to use negative confirmation requests. Also,
identify the circumstances where the auditor may use a combination of positive and negative confirmations. (06 marks)
(CA Inter, Autumn 2008)
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When evaluating the results of external confirmation requests, the auditor may categorize such
results as follows:
a) A response indicating agreement
b) A response indicating Exception
c) A non-response of positive confirmation.
A response indicating agreement:
If response indicates agreement, it forms sufficient appropriate audit evidence. No further work is
required.
4 By Muhammad Asif, ACA

5. Auditing – Study Notes Chapter 14 External Confirmation
A response indicating Exception/Disagreement:
If there is an exception (i.e. difference between information requested to be confirmed and
information provided by the confirming party), auditor shall ask client to reconcile the balances in
its records with the balances confirmed by the parties.
Reconciliation prepared by client should be checked to determine whether this exception is
because of:
− timing difference (i.e. cash in transit or goods are in transit) or
− errors in record of customer or
− misstatement in accounts of client
If there is a misstatement in accounts of client, auditor shall also consider:
 whether it is indicative of fraud or deficiencies in internal control, and
 if so, whether there is need to revise his risk assessment.
A non-response of positive confirmation:
In cases of non-response of positive confirmation within a reasonable time, follow-up procedures
should be initiated (e.g. sending 2nd request letter, or asking client to contact party and ask for
reply). If response is still not received, auditor shall perform following alternative audit procedures
to obtain evidence e.g.
Situation Alternative Audit Procedures
If confirmation
from accounts
receivable is not
received
1. Examine cash received from customer after the balance sheet date.
2. If cash is not received or partly received from customer, auditor shall:
 inspect customer signed sales orders, sales invoices, Goods Dispatch
Notes and other documents acknowledged by customer.
 obtain explanation for cash not received within credit period.
3. Perform cut-off test by examining sales near balance sheet date.
4. If any amount is disputed, examine correspondence with receivable,
lawyer opinion, appropriateness of provision.
If confirmation
from accounts
payable is not
received
1. Examine cash paid to supplier after the balance sheet date.
2. If cash is not paid or partly paid to supplier, auditor shall:
 inspect supplier signed purchase orders, suppliers’ invoices, Goods
Received Notes and other documents.
 obtain explanation for cash not paid within credit period.
3. Perform cut-off test by examining purchases near balance sheet date.
CONCEPT REVIEW QUESTION
In the course of verification of ‘trade creditors’ of Mirpur Limited, you sent fifteen positive confirmations to the suppliers.
The results have been summarized as under:
(i) Three suppliers confirmed the balance. You came to know that bulk of the sales of these suppliers is made to Mirpur
Limited.
(ii) Five suppliers confirmed the balances over telephone.
(iii) No replies have been received from the remaining suppliers.
Briefly discuss how you would deal with each of the above situations. (09 marks)
(CA Inter, Autumn 2006)
5 By Muhammad Asif, ACA

6. Auditing – Study Notes Chapter 14 External Confirmation
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CCOONNFFIIRRMMAATTIIOONN RREEQQUUEESSTT TTOO AA PPAARRTTYY::
If management refuses to allow the auditor to send a confirmation request, the auditor shall inquire
reason for refusal (e.g. it may be a legal dispute or ongoing negotiation) and seek evidence for
validity and reasonableness of request.
If refusal is reasonable:
Auditor shall perform alternative audit procedures (discussed above) to obtain evidence. If
evidence cannot be obtained, it will be a scope limitation. Auditor shall communicate the matter to
TCWG and shall determine its implication on auditor’s report (i.e. qualified opinion or disclaimer of
opinion depending on effect of matter).
If refusal is not reasonable:
It will be considered inappropriate scope limitation by management. Auditor shall communicate the
matter to TCWG and shall determine its implication:
 on auditor’s report (i.e. qualified opinion or disclaimer of opinion depending on effect of
matter) if he is unable to obtain evidence from alternative procedures, and
 on audit (e.g. increase in risk of fraud, modification in audit procedures, withdrawal from
engagement).
CONCEPT REVIEW QUESTION
(a) What is the auditors’ duty in case of balances for which the management has requested for not sending the
confirmation? (03 marks)
(b) What is the duty of the auditor if response of a negative confirmation has not been received? (02 marks)
(CA Inter, Autumn 2004)
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Following information is normally requested by the auditor in a bank confirmation request:
Information regarding bank accounts:
1. Full Title and account number of all bank accounts held in the name or joint name of client, along with balances
therein, as on year end.
2. For all accounts closed during the period, full titles and dates of closure.
3. The separate amounts of interest credited/charged during the period
4. Details of unpaid bank charges.
5. If there is any restriction on bank accounts, information regarding nature and extent of restriction.
Information regarding overdrafts/loans:
1. Details of overdrafts and loans.
2. Details of any assets held as security by bank including type of charge, (e.g. pledge, hypothecation, mortgage)
3. Terms of Interest/Markup.
4. Repayment Schedule.
Information regarding contingent liabilities:
1. Details of contingent liabilities (e.g. bills discounted)
2. Total of Letter of Guarantees.
3. Total of letters of credits.
Additional Information:
A list of other banks, or branches of your bank, where you are aware that a relationship has been established during the
period.
CONCEPT REVIEW QUESTION
Identify any eight types of information which you would verify from the confirmations received directly from the bank.
(08 marks)
(CA Inter, Autumn 2010)
6 By Muhammad Asif, ACA

7. Auditing – Case Studies Chapter 14 External Confirmation
CHAPTER FOURTEEN (CASE STUDIES)
EXTERNAL CONFIRMATION
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Structure of the Case:
In exam question, you may be given a population (e.g. of debtors) stratified in different categories (e.g. by value, by aging,
by product, by type of customer, or by geography), and you will be required to select parties for external confirmation
request.
Suggested Approach to Solve:
Remember that you have to select confirming parties from each category of stratification, even if it is small (because
immaterial misstatements may become material in aggregate).
Basis of selection for positive confirmation will be:
1. All high value items (to ensure evidence about existence is obtained on significant portion).
2. Overdue debts which are material (because these may not be collectible and may require provision)
3. Debtors with credit balance (to ensure that there are no omitted or misclassified transactions e.g. advance cash
recorded in debtors or cash recorded but relevant sales not recorded)
4. Major customers with small or zero balance. (to ensure that any transaction with major customers is not omitted
and balances are complete)
Basis of selection for negative confirmation will be:
1. Remaining population (after considering above)
Model Case Study From Examination Questions:
Case Study 1:
You are the Audit Incharge of Rehan Limited for the year ended 31 December 2015. While reviewing the working papers
and discussion with audit team, you have noted the following:
The audit team did not send balance confirmation requests for amounts below Rs. 100,000 because according to the
client, lot of efforts were required to follow up the customers and the balances were also not material.
Required:
(a) Discuss with reasons whether you agree with the approach adopted/conclusion drawn by the audit team.
(b) Provide brief guidance to the audit team in respect of each of the above situations.
(CA Inter - Spring 2016)
Solution:
(a)Approach of not sending confirmation requests to amounts below Rs. 100,000 is incorrect because there may be
omitted transactions in small balances, as well as small misstatements may become material when aggregated.
(b)Audit team should not accept client’s suggestion of not sending confirmation, because it is auditor’s decision whether
to use confirmation which cannot be omitted simply because it requires lot of efforts. If client refuses to send
confirmation requests, it will be considered inappropriate scope limitation. Auditor shall communicate this to TCWG and
shall determine its effect on audit and auditor’s report.
1 By Muhammad Asif, ACA

8. Auditing – Case Studies Chapter 14 External Confirmation
Case Study 2:
The aged receivables report produced by the computer is shown below:
In view of the deteriorating receivables situation, a direct confirmation of receivables will be performed this year.
Required:
Discuss which particular categories of receivables might be chosen for the sample. (05 marks)
(ACCA F8 - June 2008)
Solution:
All receivables ranging $50,001 or more:
to ensure that no material misstatement exists in significant part of population.
All receivables Less than 0:
to ensure that there are no omitted or misclassified transactions e.g. advance cash recorded in debtors or cash recorded
but relevant sales not recorded
Material receivables which are “1 to 2 months old” or “more than 2 months old”:
because these may not be collectible and may require provision
Other receivables:
Random sample will be selected from remaining population of categories “0 to 20,000” and “20,001 to 50.000) to provide
an overall view of the accuracy of receivable balance.
2 By Muhammad Asif, ACA

9. Auditing – Case Studies Chapter 14 External Confirmation
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Structure of the Case:
In exam question, you may be required to comment whether sending a negative confirmation is appropriate in a given
situation.
Suggested Approach to Solve:
First state that negative confirmation can only be used if all of following conditions are met:
1. Relevant population consists of large number of small transactions or balances.
2. Risk of material misstatement is low, and auditor has obtained evidence about operating effectiveness of
controls.
3. A very low exception rate is expected, and
4. Auditor is not aware of any circumstances that confirming party will disregard such requests.
Then, link conditions with information given in the question. If question contains information that any condition is not
being met, you will state negative confirmation will not be used. If question contains information that some of conditions
are being met but question is silent about other conditions, you will state that negative confirmation can be used
assuming other conditions are also met.
Model Case Study From Examination Questions:
Case Study 1:
You are the Manager on the audit of Ghazi Power Limited (GPL), a gas transmission and distribution company, for the
year ending 31 October 2011. On the company’s request, your firm has agreed to complete the audit by 20 November
2011.
In order to meet the audit deadline, you are considering various measures which include sending requests for negative
confirmations related to balances due on 31 August 2011. On 31 August 2011, total debtors aggregated Rs. 45 Million.
50% of the amount is due from 15 major debtors, whereas the total number of debtors is 2,450.
Your previous experience with the client and the results of initial risk assessment procedures suggest that the risk of
material misstatement is low.
Required:
Discuss whether it would be appropriate to use the negative confirmations procedure in the above situation. (06 marks)
(CA Inter - Autumn 2011)
Solution:
Population of debtors has been stratified between two categories i.e. 15 major debtors covering 50% of the amount and
remaining 2,435 debtors covering remaining 50% of amount.
Category 1: 2,435 debtors covering 50% of amount:
Negative confirmation is appropriate for this category because conditions for sending negative confirmation are being
met i.e.
1. Population consists of large number of small balances.
2. Risk of material misstatement is low.
In the absence of information it is assumed that following conditions are also met:
3. A very low exception rate is expected, and
4. Auditor is not aware of any circumstances that confirming party will disregard such requests.
Category 2: 15 debtors covering remaining 50% of amount:
Positive confirmation is appropriate for this category because population consists of small number of large balances.
3 By Muhammad Asif, ACA