External Confirmation is a tool used in substantive procedures.

Lahore School of Economics
External Confirmation is a tool used in
substantive procedures.
Topic 6
Ayesha Majid
Asad Tariq
Maheen Akhram
Mishael Khalil
Sajeel Azam
Syed Hassan Shah
10-5-2017

External Confirmation is a tool used in substantive procedures. 1
Table of Contents
Importance of external confirmation for audit: (Sajeel Azam) 3
Procedures for sending confirmation: (Mishael Khalil) 5
Possible Reasons for the difference in balance as per bank statement and as per bank confirmation:
(Syed Hassan Shah) 8
Possible solutions for avoiding and correcting misstatement in the balances: (M.Asad Tariq) 13
Results of the External Confirmation Procedures: (Maheen Akram) 14
Case Study: (Ayesha Majid) 16
Conclusion: (Ayesha Majid) 18

Introduction:
External confirmation – Audit evidence obtained as a direct written response to the auditor
from a third party (the confirming party), in paper form, or by electronic or other medium.
Substantive procedures (or substantive tests) are those activities performed by the auditor
to detect material misstatement or fraud at the assertion level.
Substantive procedures (or substantive tests) are those activities performed by the auditor
to detect material misstatement or fraud at the assertion level.
The different assertions of balances are:
existence,
rights and obligations,
validity, and
completeness.
Those for transactions are:
occurrence
completeness,
accuracy,
authorization,
cut-off,
classification.

Importance of external confirmation for audit: (Sajeel Azam)
External confirmation is a process through which audit evidence can be received. It is a direct
written response to the auditor by a third outside party, also known as the confirmation party.
It can be in paper form, electronic form or any other medium.
External confirmation is a commonly used procedure for confirmation of financial reports in
audit. In order to understand external confirmation it is important to understand what audit
evidence is. Audit evidence the information that an auditor needs in order to arrive at the
conclusions on which he gives his final opinion.
ISA 500 explains what constitutes audit evidence in an audit of financial statements and deals
with the auditor’s responsibility to design and perform audit procedures to obtain sufficient
appropriate audit evidence to be able to draw reasonable conclusions on which to base the
auditor’s opinion.
ISA 500 indicates that the reliability of audit evidence is influenced by its source and by its
nature, and is dependent on the individual circumstances under which it is obtained.
External confirmation is given more importance as to gather audit evidence in ISA, as:
Audit evidence is more reliable when it is obtained from independent sources
outside the entity.
Audit evidence obtained directly by the auditor is more reliable than audit evidence
obtained indirectly or by inference.
Audit evidence is more reliable when it exists in documentary form, whether
paper, electronic or other medium.
Accordingly, depending on the circumstances of the audit the auditor may send external
confirmation to gather audit evidence. The audit evidence is received by the auditor from the

confirming party which is more reliable than the evidence generated internally by the entity
that is being audited.
Other ISA’s also recognize the importance of external confirmation as audit evidence. ISA
330 indicates that external confirmation procedures may assist the auditor in obtaining audit
evidence with the high level of reliability that the auditor requires to respond to significant
risks of material misstatement, whether due to fraud or error.
ISA 240 indicates that the auditor may design confirmation requests to obtain additional
corroborative information as a response to address the assessed risks of material
misstatement due to fraud at the assertion level.
Different confirmations that the auditor may send for audit:
External Confirmation – It is the audit evidence that the auditor receives from a third
party/outside entity for confirmation in paper or electronic form, or by any other form.
Positive Confirmation request – Positive confirmation is when a third party/outside entity
responds directly to auditor whether they agree or disagree with the specific information that
has been requested, or give information regarding the query.
Negative Confirmation request – Negative confirmation is when a third party responds to the
auditor only in the situation where they disagree with the information provided in the request.
Non-response – When a third party/outside entity fails to respond or fully respond to a
positive confirmation request or when a confirmation request is returned undelivered.
Exception – It is the discrepancy between what the auditor has asked from the confirmation
party, or the information in the entity’s book and what the confirmation party has sent.

Procedures for sending confirmation: (Mishael Khalil)
External confirmation is sent though the following procedure.
Determining the Information to Be Confirmed or Requested:
External confirmation procedures frequently are performed to confirm or request information
regarding account balances and their elements. They may likewise be utilized to affirm terms
of understandings, contracts, or exchanges between an element and different gatherings, or
to affirm the nonappearance of specific conditions, for example, a "side agreement."
Selecting the Appropriate Confirming Party:
Responses to confirmation requests give more relevant and reliable audit evidence when
confirmation requests are sent to a confirming party the auditor believes is knowledgeable
about the information to be confirmed. For example, a financial institution official who is
knowledgeable about the transactions or arrangements for which confirmation is
requested may be the most appropriate person at the financial institution from whom to
request confirmation.
Designing Confirmation Requests:
The design of a confirmation request may specifically influence the confirmation
response rate, its reliability and the nature of the audit evidence.
Thus some factors need to be considered before designing the request, e.g.:
The assertions being addressed.
Specific identified risks of material misstatement, including fraud risks.
The layout and presentation of the confirmation request.
Prior experience on the audit or similar engagements.

The method of communication (for example, in paper form, or by electronic or
other medium).
Management’s authorization or encouragement to the confirming parties to respond to the
auditor. Confirming parties may only be willing to respond to a confirmation request
containing management’s authorization.
The ability of the intended confirming party to confirm or provide the requested
information.
A positive external confirmation asks for requests that the affirming party answer to the
auditor in all cases, either by demonstrating the affirming gathering's concurrence with the
given data, or by requesting that the affirming party give data. A reaction to a positive
confirmation ask for request is anticipated that would give reliable audit evidence. There is a
risk, nonetheless, that a confirming party may answer to the confirmation request without
confirming that the data is correct. The auditor can reduce the risk by designing the
confirmation request that don't express the sum (or other data) on the affirmation ask for,
and request that the affirming party fill in the sum or other data. Then again, using this kind
of "blank” confirmation request may bring about lower reaction rates in light of the fact that
extra exertion is required of the affirming parties.
Follow-Up on Confirmation Request:
The auditor may send an additional confirmation request when an answer to a past
demand has not answered within a reasonable time. For instance, the auditor may, having
re-confirmed the precision of the first address, send an extra or follow-up demand.

What items are usually confirmed in external bank confirmation:
Bank balances and other
information
Existence of amount Highly relevant because the bank responds directly to the
auditor confirming the bank balance
Completeness of Less relevant because confirming a bank balance does not
recording of transactions address recording of specific transactions, although they may
reveal discrepancies in recording of transactions
Transactions have been Less relevant because a bank confirmation does not provide
recorded in the correct cut-off information that the auditor can use to verify the
period recording of transactions in the correct period
Presentation and Highly relevant because a bank confirmation may identify the
disclosure existence of contingent liabilities, collateral lodged as security
and other items that require disclosure in the financial
statements

Possible Reasons for the difference in balance as per bank statement and as per bank
confirmation (Syed Hassan Shah)
There may be several reasons for the difference in balances as per bank statements and as per
bank confirmation. Described below are some of the reasons for the difference:
(i) Cheques issued but not yet presented for payment:
When a cheque is issued, the accountant of the enterprise record this transaction on the
credit side of the cash book under the bank column immediately. The effect of this recording
is that the bank balance in cash book will be reduced by the amount issued.
The bank on the other hand debits the account of the business enterprise only when the
concerned party presents the cheque for payment. It should be noted that there is an
expected gap between the date of issuance of cheque and the date of appearance of cheque
to the issuing bank. Sometimes the party intentionally presents the cheque after a
considerable delay for instance, after two months.
In this prevailing period, the bank statement issued by the bank shows a higher bank balance
than the balance shown by the bank column of cash book. On the other hand, the balance
shown by the bank column of cash book would be lower than the balance shown by the bank
statement to the extent of cheques not presented for payment.
(ii) Cheques paid into the Bank but not yet collected by the Bank:
The business enterprise immediately debits the bank column of the cash book after
depositing the cheques with bank. But the account of the business enterprise will be credited
by the bank only after these cheques have been collected through the clearing process.
Usually, two to three working days are taken in clearing of local cheques and in the case of
outstation cheques it takes four to five working days for clearing the cheques.

In this intervening period, the bank statement issued by the bank definitely shows lower bank
balance than the balance shown by the bank column of cash book. In other words, the balance
shown by the bank column of the cash book would be higher than the balance shown by the
bank statement to the extent of amount of cheques not cleared or collected.
(iii) Interest and Dividends Received by the Bank:
Sometimes, the interest on debentures or dividends on shares is given by the companies
directly to the accounts of debenture holders or shareholders as the case may be. This system
is called Electronic Clearing System (ECS). In this case, the advice regarding the interest or
dividend credited by bank has not been communicated to the business enterprise. So, there
will be a difference because the bank has credited the amount to the customer’s account but
it has not yet been recorded in bank column of cash book.
In this intervening period, the bank statement issued by the bank definitely shows higher
bank balance than the balance shown by the bank column of cash book. In other words, the
balance shown by the bank column of cash book would be lower than the balance shown
by the bank statement to the extent of interest and dividend directly received by the bank.
(iv) Direct Deposits Made by the Parties:
Direct payment in the bank account of the business enterprise can be made by the debtors or
the customers. As the business enterprise may not be aware of this receipt, so in this case,
only bank balance will increase by the amount of direct deposits made by the parties. There
will be a difference because the bank has credited the amount to the customer’s account but
it has not yet been recorded in bank column of cash book.
In this intervening period, the bank statement issued by the bank definitely shows higher bank
balance than the balance shown by the bank column of cash book. In other words, the

by the bank statement to the extent of direct payments received by the bank.
(v) Direct Payments Made by the Bank:
Under the ECS (Electronic Clearing System), bank on behalf of its customers pays a certain
payment to the third party. Usually, payment for an insurance premium, periodical
membership fees, or any Equated Monthly Installment (EMI) for repaying the loan amount
etc. can be made as and when the payment becomes due.
In this case, the bank will debit the party’s account immediately but the business enterprise
will record these transactions in the cash book only when the business enterprise receives
updated bank statement.
balance shown by the bank column of cash book would be higher than the balance shown by
the bank statement to the extent of direct payments made by the bank.
(vi) Credit Given by the Bank on Account of Interest:
The bank allows interest on the deposits made by the business enterprise periodically and
credit the bank account immediately on the date on which interest is due. However, the
business enterprise will record this transaction only on receipt of such advice from the bank.
In this intervening period, the bank statement issued by the bank definitely shows higher
bank balance than the balance shown by the bank column of cash book. In other words, the
by the bank statement to the extent of amount of interest credited by the bank.

(vii) Debit Given by the Bank on Account of Interest on Overdraft and Bank Charges
etc.:
For the services rendered to the customers, the bank charges some amount in the shape of
interest on overdraft and commission etc. These bank charges are debited to the customer’s
account from time to time. However, the business enterprise records these charges in the
bank column of the cash book only after receiving advice from the bank in this regard or after
obtaining updated bank statement.
The balance of cash book and balance of pass book will differ. In this intervening period;
the bank statement issued by the bank definitely shows lower bank balance than the balance
shown by the bank column of cash book. In other words, the balance shown by the bank
column of cash book would be higher than the balance shown by the bank statement to the
extent of amount of debit given by the bank.
(viii) Bills Collected by the Bank:
The bank on behalf of its customers can collect the amount due on bills as and when
the payment becomes due. The business enterprise record this transaction only on
receiving intimation from the bank in this regard.
The balances shown by the bank column of cash book and bank statement in the intervening
period will differ. The bank statement issued by the bank definitely shows higher bank
balance shown by the bank column of cash book would be lower than the balance shown by
the bank statement to the extent of amount of bills collected by the bank.

(ix) Dishonor of a Bill Discounted with the Bank:
Bank facilitates to discount the bill before its maturity. If the bill discounted by the bank is
dishonored on its due date, the bank will debit the customer’s account with the amount of
total bill. The business enterprise will record this transaction only on receiving intimation
from the bank in this regard.
balance than the balance shown by the bank column of cash book. In other words, the balance
shown by the bank column of cash book would be higher than the balance shown by the bank
statement to the extent of amount of bill dishonored.
(x) Dishonor of Cheque Deposited with the Bank:
If the cheque deposited with the bank is dishonored on presentation, the bank will debit the
customer’s account with the total amount of cheque. The business enterprise will record
this transaction only on receiving intimation from the bank in this regard.
balance shown by the bank column of cash book would be higher than the balance shown by
the bank statement to the extent of amount of dishonored cheque.
(xi) Errors and Omissions:
The difference between the bank balance shown by the cash book and the balance shown by
the bank pass book can also be caused due to error or omission either on the part of the
customer or the bank. Till the error/omission is detected, the difference on this ground
cannot be eliminated.

Customer may commit an error such as recording of a cheque twice in the cash book.
Sometimes, banks may also commit errors, e.g., wrongly debiting the customer’s account or
charging bank charges twice etc. In these cases, the balances appearing in both the books are
not the same.
Banks reports for audit purposes (bank confirmation) ¬ Consist of confirmation of bank
balances and other matters from the client’s bankers at the period end. ¬ Standard letters are
used to confirm information with the bank where the client has dealings.
Reasons for auditors to seek bank confirmation is that the bank confirmation provides
evidence in respect of existence, ownership, and accuracy. It is a third party, written in
relation to the balance sheet of assets and liabilities.
Possible solutions for avoiding and correcting misstatement in the balances (M.Asad
Tariq)
Verification and monitoring of bank reconciliations are key detective controls for cash and
banking operations. There are usually differences between the bank statement and accounting
records due to the timing differences when the data is recorded in the accounting books and
at the bank. The purpose of bank reconciliation is to check whether the differences are due to
timing rather than error. It is important that sufficient verification and monitoring takes place
so that immediate action can be taken on accounting errors or unusual transactions.
Policy should require the bank reconciliation to be submitted within ten working days of
the closing of the financial period.
Use appropriate means to headquarters to send the statement. Methods of submission, such
as sending scanned copies followed by originals.

Financial Operations, International (SMFF) should provide effective oversight of the
bank reconciliation process to ensure, to the extent possible, that errors, omissions, and
malfeasance are detected, by:
Developing, documenting, and implementing a monitoring plan for reliable assessments.
Ensuring that all bank reconciliations are completed and submitted as required.
Correct the current situation balances. Enforcing policies and
procedures Improve monitoring
Remind employees at missions with delegated authority under Sections 33 and 34 of the
importance of complying with the Financial Administration Act (FAA).
Awareness sessions should be
considered. Redesign the Record
Eliminate ambiguity.
To reduce risk by reducing the use of cash e.g Make payments using electronic funds
transfers when possible.
Results of the External Confirmation Procedures
Reliability of Responses to Confirmation Requests
(Maheen Akram)
The secure delivery of responses to confirmation requests is a very sensitive topic and
requires intensive care to be ensured. Since the introduction of the internet and electronic
mail services, e-mails have been widely used as a form to communicate, even in matters of
business, such as the response to confirmation requests. But this method of communication
may prove to be dangerous in this regard. The actual identity of the sender of an e-mail can
be easily disguised and receivers may fall prey to responses not sent by the actual authority.

Therefore, the proof of origin is a big issue in using this method of communication for
communicating responses. Also, there is a risk of information falling into the wrong hands.
Third parties may gain access to such information that may prove to be sensitive in one case
or another, through malware or even hacking. Even if the origin of the e-mail is determined
to be accurate, the response provided may still be inaccurate. The data can still be subject to
changes over the online distribution channel it goes through. However, using a safe and
secure network for the transfer of information may reduce the chances of such problems
taking place and also reduce the chances of any inaccuracies, making the response obtained
as reliable as it could be. The auditor should make sure that such a system is established
which ensures the security of such confidential information. A number of techniques can be
used to ensure this transfer of information may take place effectively. The use of data-
encryption and firewalls prevents hackers from obtaining access to the information. The use
of anti-spyware software on both the sending and receiving computer systems involved also
reduces the risk. Electronic digital signatures and the security provided to verify and
authenticate websites such as SSL (Secure Sack Layer) also help in taking care of this
problem. According to ISA 500, the auditor is supposed to determine either the modification
or addition of procedures to resolve doubts regarding the authenticity of information that is
used for audit evidence. The auditor can contact the confirming party in order to ensure the
authenticity of both the source and the information. An example of this is when a response is
sent by the confirming party over electronic mail, a telephone call may suffice to confirm if it
originated from the confirming party or not. Also, if the response is obtained indirectly,
through the entity who was sent the response accidentally, a request of the response to be
delivered in writing can be sent to make sure of the authenticity.

Case Study (Ayesha Majid)
The purpose of the audit as per the case was to assess the adequacy of key controls of the
management control framework for accounts receivable and revenue management. The
objectives of this audit were to determine:
whether the management control framework is effectively designed and operating as
intended; and
the degree to which the Department is in compliance with the applicable
accounting regulations, policies and standards.
Accounts receivable and revenue management are core financial management and reporting
processes that constitute a significant level of materiality to the Department in this case of
Rs. 30 million. The scope of the audit consists of an examination of the processes, controls
and supporting documentation from fiscal year in this case. The audit methodology will
consist of:
reviewing relevant documentation;
conducting interviews with management and staff;
questioning Sector Financial Providers (SFPs)
conducting a gap analysis between regional departments of the company
or competitors
identifying and assessing key risks associated with accounts receivable and revenue
management; and
sampling accounts receivable transactions
Audit criteria are reasonable standards of performance and control used by the Audit Branch to
assess the adequacy of the Department’s accounts receivable and revenue management
practices. The audit criteria is to be derived from Departmental and Treasury Board policies

and procedures of the company. Actual performance is to be assessed against the audit criteria,
which will result in either a positive finding or the identification of an area for improvement.
Management prior to the commencement of the audit reviews the audit criteria.
In this case to results are to be obtained either reconciliation of accounts balances or failure
of management to provide a sufficient explanation.
If the reconciliation is satisfactory, the auditor will give a true and fair remark to the financial
statements. On the other hand if the management fails to satisfy the auditor during the audit
analysis there are high chances of fraud or misrepresentation. Improper recognition of revenue -
either prematurely or of fictitious revenue – is the most common form of fraudulent earnings
management which in this case would have led to overvaluation of accounts receivable from
debtor X Limited. Premature recognition should be distinguished from recognition of fictitious
revenue derived from false sales or to false customers in this case.
To analyse the genuity of sales to X limited at a certain time particular attention should be
focused upon terms governing
(i) payment and shipment,
(ii) delivery and acceptance,
(iii) risk of loss,
(iv) terms requiring future performance on the part of the seller before payment,
(v) payment of up-front fees, and
(vi) other contingencies.
The auditor must consider timing – particularly as it relates to the company’s quarter
and year-end periods.

Conclusion (Ayesha Majid)
An external confirmation is audit evidence obtained as a direct written response to the auditor
from a third party (the confirming party), in paper form, or through electronic or other
medium. Requesting external confirmations is a commonly used audit procedure in an audit
of financial statements. It can be useful in obtaining audit evidence about relevant financial
statement assertions regarding such items as receivables and payables, bank and other third
party deposits and liabilities, investments, inventory, guarantees, contingent liabilities,
significant transactions outside the normal course of business.
External is governed by ISA 500 as discussed previously and confirmation is dependent upon
audit evidence received by third party. External confirmation procedure are given is ISA 330
and 240. Each external confirmation has its own method of request defined in audit procedure
and most common is bank confirmation, which was discussed in detail in the report.
External confirmation procedures can be an effective tool in obtaining relevant and reliable
audit evidence when used properly. Circumstances may exist where it may be difficult to
obtain responses to external confirmation requests or all the information requested. While
such difficulty should not dissuade auditors from sending confirmation requests in
appropriate circumstances, the auditor may discover that confirming parties will not respond
or provide all the information requested by the auditor and, therefore, may need to plan
alternative or additional procedures.

External Confirmation is a tool used in substantive procedures.

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