4.4 External Confirmations for Bank, Receivables & Payables

External Confirmations for Bank, Receivables & Payables

1. Overview of External Confirmations (ISA 505)

ISA 505 (External Confirmations) deals with the auditor's use of external confirmation procedures to obtain audit evidence in accordance with the requirements of ISA 500 and ISA 330.

An external confirmation is defined as 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. External confirmations are exceptionally persuasive because evidence obtained from independent external sources is inherently more reliable than internally generated client documentation.

Primary Account Balances Tested via Confirmation

• Bank Balances and Credit Facilities: Confirming cash balances, loans, overdrafts, guarantees, and collateral.
• Trade Receivables (Debtors Circularization): Confirming customer balances to test existence and rights and obligations.
• Trade Payables (Creditors Circularization): Confirming supplier balances to test completeness and valuation/cut-off.
• Inventories Held by Third Parties: Confirming stock held in public bonded warehouses or on consignment.
• Legal Claims and Contingencies: Confirming pending litigation details directly with external legal counsel.

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2. Positive vs. Negative Confirmation Requests

ISA 505 categorizes confirmation requests into two formats:

1. Positive Confirmation Request

A request that the confirming party respond directly to the auditor indicating whether the confirming party agrees or disagrees with the information in the request, or providing the requested information.

• Blank Form Positive Confirmation: The confirming party is asked to fill in the balance or details (e.g., "Please state your outstanding balance as of 31 December"). This provides higher reliability because the recipient cannot simply sign off without checking, but it risks lower response rates.
• Stated Balance Positive Confirmation: The request specifies the recorded figure (e.g., "Our records show BDT 500,000 due from you; please confirm if correct"). Higher response rate, but risk that recipients sign without verification.

2. Negative Confirmation Request

A request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided in the request.

Strict ISA 505 Restrictions: Negative confirmations provide significantly less persuasive audit evidence than positive confirmations. ISA 505 explicitly forbids relying solely on negative confirmations unless ALL FOUR of the following conditions are met:

1. The auditor has assessed the risk of material misstatement as low and has obtained sufficient appropriate evidence regarding operating effectiveness of relevant controls.
2. The population of items subject to negative confirmation comprises a large number of small, homogeneous account balances or transactions.
3. A very low exception rate is expected.
4. The auditor is not aware of circumstances or conditions that would cause recipients of negative confirmation requests to disregard such requests.

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3. Bank Confirmation Procedures

In Bangladesh, bank confirmations are considered a critical mandatory audit step. Under ICAB and Bangladesh Bank guidance, auditors issue standard bank confirmation requests to all financial institutions with which the client has conducted business during the financial year—including accounts closed during the year.

Information Requested in Bank Confirmations

• Balances on all current, savings, and fixed-deposit accounts.
• Details of all loan facilities, term loans, and overdraft limits.
• Outstanding Letters of Credit (LC), bank guarantees, and performance bonds.
• Assets pledged as collateral or mortgage charges registered against facilities.
• Authorized signatories and joint-operation mandates.
• Accrued interest receivable or payable and foreign currency forward contracts.

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4. Confirmation of Trade Receivables (Circularization)

Assertions Tested

Direct confirmation of receivables primarily tests Existence and Rights and Obligations. It does not provide full evidence for Valuation, because a customer confirming that they owe money does not guarantee they have the financial capacity to pay it!

Sampling and Timing

Auditors select customer accounts for circularization based on high monetary value, overdue balances, accounts with zero or credit balances, and related-party balances. Confirmation is ideally performed as of the financial statement date (year-end), but may be performed at an interim date if control risk is low and roll-forward procedures are applied.

Exception Analysis

When customers respond indicating a balance different from the client's ledger, the auditor must investigate whether the exception is due to:

• Timing Differences: Goods in transit (sent before year-end, received after year-end) or Cash in transit (paid by customer before year-end, received by client after year-end).
• Processing Errors / Disputes: Unrecorded credit notes, defective goods returned, price disputes, or misposted payments.
• Actual Misstatement: Omission of transactions or fraudulent recording.

Alternative Audit Procedures for Non-Responses

When no response is received for a positive confirmation request, the auditor must perform alternative substantive audit procedures:

1. Inspecting Subsequent Cash Receipts: Checking bank statements and official receipts post-year-end to verify that the specific customer paid the outstanding invoice.
2. Inspecting Shipping / Dispatch Documentation: Verifying goods received notes (GRN), bills of lading, and signed customer delivery notes dated prior to year-end.
3. Inspecting Sales Contracts & Approved Orders: Confirming contractual terms and authorization.

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5. Confirmation of Trade Payables

Key Tactical Difference from Receivables

While receivable circularization focuses on overstatement (Existence), payable confirmation focuses on understatement and Completeness.

Therefore, selection of trade payables for confirmation differs significantly:

• Auditors select major active suppliers (suppliers with large purchasing volumes during the year), regardless of their year-end recorded balance—including suppliers with zero balances at year-end!
• The confirmation request is usually sent in blank form or accompanied by a request for the supplier's monthly statement of account as of year-end to reconcile unrecorded liabilities.

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6. Management Refusal to Allow Confirmations

If management refuses to allow the auditor to send an external confirmation request, the auditor must:

Management Refusal -> Inquire Reasons -> Evaluate Risk Impact -> Perform Alternative Procedures -> Escalate to TCWG

1. Inquire as to Management's Reasons: Seek audit evidence as to the validity and reasonableness of the refusal (e.g., ongoing legal dispute with supplier).
2. Evaluate Implications: Assess the impact of refusal on assessed risks of material misstatement (including fraud risk) and the nature, timing, and extent of other procedures.
3. Perform Alternative Audit Procedures: Designed to obtain sufficient appropriate audit evidence.
4. Escalate to TCWG & Evaluate Report Impact: If management's refusal is unreasonable, or the auditor is unable to obtain relevant evidence from alternative procedures, the auditor shall communicate with Those Charged with Governance (TCWG) and evaluate the implications for the audit opinion under ISA 705 (Scope Limitation).