(a) an audit of a financial report for a financial year, or an audit of a financial report for a half-year, in accordance with Part 2M.3 of the Corporations Act 2001; and
(b) an audit of a financial report for any other purpose.
2 This Auditing Standard also applies, as appropriate, to an audit of other financial information.
Operative Date
3 This Auditing Standard is operative for financial reporting periods commencing on or after 1 July 2006.
Introduction
4 The purpose of this Auditing Standard is to establish mandatory requirements and to provide explanatory guidance on the auditor’s use of external confirmations as a means of obtaining audit evidence.
5 The auditor shall determine whether the use of external confirmations is necessary to obtain sufficient appropriate audit evidence at the assertion level. In making this determination, the auditor shall consider the assessed risk of material misstatement at the assertion level and how the audit evidence from other planned audit procedures will reduce the risk of material misstatement at the assertion level to an acceptably low level.
6 ASA 500 Audit Evidence, states 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. It indicates that, while recognising exceptions may exist, the following generalisations about the reliability of audit evidence may be useful:
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.
Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or facsimiles.
Accordingly, audit evidence in the form of original written responses to confirmation requests received directly by the auditor from third parties who are not related to the entity being audited, when considered individually or cumulatively with audit evidence from other audit procedures, may assist in reducing the risk of material misstatement for the related assertions to an acceptably low level.
7 External confirmation is the process of obtaining and evaluating audit evidence through a representation of information or an existing condition directly from a third party in response to a request for information about a particular item affecting assertions in the financial report or related disclosures. In deciding to what extent to use external confirmations, the auditor ordinarily considers the characteristics of the environment in which the entity being audited operates and the practice of potential respondents in dealing with requests for direct confirmation.
8 External confirmations are frequently used in relation to account balances and their components, but need not be restricted to these items. For example, the auditor may request external confirmation of the terms of agreements or transactions an entity has with third parties. The confirmation request is designed to ask if any modifications have been made to the agreement, and if so what the relevant details are. External confirmations may also be used to obtain audit evidence about the absence of certain conditions, for example, the absence of a “side agreement” that may influence revenue recognition. Other examples of situations where external confirmations may be used include the following:
Bank balances and other information from bankers.
Accounts receivable balances.
Inventory held by third parties at bonded warehouses for processing or on consignment.
Property title deeds held by lawyers or financiers for safe custody or as security.
Investments purchased from stockbrokers but not received at balance date.
Loans from lenders.
Accounts payable balances.
9 The reliability of the audit evidence obtained by external confirmations depends, among other factors, upon the auditor applying appropriate audit procedures in designing the external confirmation requests, performing the external confirmation procedures, and evaluating the results of the external confirmation procedures. Factors affecting the reliability of confirmations include the control the auditor exercises over confirmation requests and responses, the characteristics of the respondents, and any restrictions included in the response or imposed by those charged with governance or management.
Relationship of External Confirmation Procedures to the Auditor’s Assessments of the Risks of Material Misstatement
10 ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, discusses the auditor’s responsibility to obtain an understanding of the entity and its environment including its internal control, and to assess the risks of material misstatement. It outlines the audit procedures performed to assess the risks of material misstatement of the financial report sufficient to design and perform further audit procedures.
11 ASA 330 The Auditor’s Procedures In Response to Assessed Risks, discusses the auditor’s responsibility to determine overall responses and to design and perform further audit procedures whose nature, timing and extent are responsive to the assessed risks of material misstatement at the financial report and assertion levels. In particular, ASA 330 indicates that the auditor determines the nature and extent of audit evidence to be obtained from the performance of substantive audit procedures in response to the related assessment of the risk of material misstatement and that, irrespective of the assessed risk of material misstatement, the auditor designs and performs substantive audit procedures for each material class of transactions, account balance and disclosure. These substantive audit procedures may include the use of external confirmations for certain assertions.
12 ASA 330 indicates that the higher the auditor’s assessment of risk, the more reliable and relevant is the audit evidence sought by the auditor from substantive audit procedures. Consequently, as the assessed risk of material misstatement increases, ordinarily, the auditor designs substantive audit procedures to obtain more reliable and relevant audit evidence, or more persuasive audit evidence, at the assertion level. In these situations, the use of confirmation procedures may be effective in providing sufficient appropriate audit evidence.
13 The lower the assessed risk of material misstatement, the less assurance the auditor ordinarily needs from substantive audit procedures to form a conclusion about an assertion. For example, an entity may have a loan that it is repaying according to an agreed schedule, the terms of which the auditor has confirmed in previous years. If the other work carried out by the auditor (including such tests of controls as are necessary) indicates that the terms of the loan have not changed and has led to the risk of material misstatement over the balance of the loan outstanding being assessed as low, the auditor might limit substantive audit procedures to testing details of the payments made, rather than again confirming the balance directly with the lender.
14 When the auditor has identified a risk as being significant, see ASA 315, the auditor may give particular consideration to whether confirmations of certain matters may be an appropriate way of reducing the risk of misstatement. For example, unusual or complex transactions may be associated with higher assessed risk than simple transactions. If the entity has entered into an unusual or complex transaction that results in a higher assessed risk of material misstatement, the auditor ordinarily considers confirming the terms of the transaction with the other parties in addition to examining documentation held by the entity.
Assertions Addressed by External Confirmations
15 ASA 500 requires the use of assertions in assessing risks and designing and performing audit procedures in response to the assessed risks. ASA 500 categorises the assertions into those relating to classes of transactions, account balances and disclosures. While external confirmations may provide audit evidence regarding these assertions, the ability of an external confirmation to provide audit evidence relevant to a particular assertion varies.
16 External confirmation of an account receivable provides reliable and relevant audit evidence regarding the existence of the account as at a certain date. Confirmation also provides audit evidence regarding the operation of cut-off procedures. However, such confirmation does not ordinarily provide all the necessary audit evidence relating to the valuation assertion, since it is not practicable to ask the debtor to confirm detailed information relating to its ability to pay the account.
17 Similarly, in the case of goods held on consignment, external confirmation is likely to provide reliable and relevant audit evidence to support the existence and the rights and obligations assertions, but might not provide audit evidence that supports the valuation assertion.
18 The relevance of external confirmations to auditing a particular assertion is also affected by the objective of the auditor in selecting information for confirmation. For example, when auditing the completeness assertion for accounts payable, the auditor needs to obtain audit evidence that there is no material unrecorded liability. Accordingly, sending confirmation requests to an entity’s principal suppliers asking them to provide copies of their statements of account directly to the auditor, even if the records show no amount currently owing to them, will usually be more effective in detecting unrecorded liabilities than selecting accounts for confirmation based on the larger amounts recorded in the accounts payable subsidiary ledger.
19 ASA 500 provides explanatory guidance on other audit procedures to complement confirmation procedures or to be used instead of confirmation procedures when obtaining audit evidence for assertions is not adequately addressed by confirmations.
Design of the External Confirmation Request
20 The auditor shall tailor external confirmation requests to the specific audit objective.
21 When designing the request, under paragraph 20 of this Auditing Standard, the auditor needs to consider the assertions being addressed. The auditor ordinarily considers the factors that are likely to affect the reliability of the confirmations. Factors such as the form of the external confirmation request, prior experience on the audit or similar engagements, the nature of the information being confirmed, and the intended respondent, affect the design of the requests because these factors have a direct effect on the reliability of the evidence obtained through external confirmation procedures.
22 Also, in designing the request, ordinarily the auditor considers the type of information respondents will be able to confirm readily since this may affect the response rate and the nature of the audit evidence obtained. For example, certain respondents’ information systems may facilitate the external confirmation of single transactions rather than of entire account balances. In addition, respondents may not always be able to confirm certain types of information, such as the overall accounts receivable balance, but may be able to confirm individual invoice amounts within the total balance.
23 Confirmation requests ordinarily include management’s authorisation to the respondent to disclose the information to the auditor. Respondents may be more willing to respond to a confirmation request containing management’s authorisation, and in some cases may be unable to respond unless the request contains management’s authorisation.
Use of Positive and Negative Confirmations
24 The auditor may use positive or negative external confirmation requests or a combination of both.
25 A positive external confirmation request asks the respondent to reply to the auditor in all cases either by indicating the respondent’s agreement with the given information, or by asking the respondent to fill in information. A response to a positive confirmation request is ordinarily expected to provide reliable audit evidence. There is a risk, however, that a respondent may reply to the confirmation request without verifying that the information is correct. The auditor is not ordinarily able to detect whether this has occurred. The auditor may reduce this risk, however, by using positive confirmation requests that do not state the amount (or other information) on the confirmation request, but ask the respondent to fill in the amount or furnish other information. On the other hand, use of this type of “blank” confirmation request may result in lower response rates because additional effort is required of the respondents.
26 A negative external confirmation request asks the respondent to reply only in the event of disagreement with the information provided in the request. However, when no response has been received to a negative confirmation request, there will be no explicit audit evidence that intended third parties have received the confirmation requests and verified that the information contained therein is correct. Accordingly, the use of negative confirmation requests ordinarily provides less reliable audit evidence than the use of positive confirmation requests, and the auditor ordinarily considers performing other substantive audit procedures to supplement the use of negative confirmations.
27 Negative confirmation requests may be used to reduce the risk of material misstatement to an acceptable level when:
the assessed risk of material misstatement is low;
a large number of small balances is involved;
a substantial number of errors is not expected; and
the auditor has no reason to believe that respondents will disregard these requests.
28 A combination of positive and negative external confirmations may be used. For example, where the total accounts receivable balance comprises a small number of large balances and a large number of small balances, the auditor may decide that it is appropriate to confirm all or a sample of the large balances with positive confirmation requests and a sample of the small balances using negative confirmation requests.
Requests by Those Charged with Governance and Management
29 When the auditor seeks to confirm certain balances or other information, and those charged with governance or management request the auditor not to do so, the auditor shall consider whether there are valid grounds for such a request and obtain audit evidence to support the validity of such request. If the auditor agrees to a request by those charged with governance or management not to seek external confirmation regarding a particular matter, the auditor shall apply alternative audit procedures to obtain sufficient appropriate audit evidence regarding that matter.
30 If the auditor does not accept the validity of a request by those charged with governance or management and is prevented from carrying out the confirmations, there has been a limitation on the scope of the auditor’s work and the auditor shall consider the possible impact on the auditor’s report.
31 When considering the reasons provided by those charged with governance or management, the auditor applies an attitude of professional scepticism and considers whether the request:
(a) has any implications regarding the integrity of those charged with governance or management; and
(b) may indicate the possible existence of fraud or error.
ASA 240 The Auditor’s Responsibility to Consider Fraud in an Audit of a Financial Report, and ASA 250 Considerations of Laws and Regulations in an Audit of a Financial Report, provide mandatory requirements and explanatory guidance in circumstances where the auditor believes that fraud or error exists. Under ASA 500, the auditor needs to consider whether the alternative audit procedures will provide sufficient appropriate audit evidence regarding that matter.
Characteristics of Respondents
32 The reliability of audit evidence provided by a confirmation is affected by the respondent’s competence, independence, authority to respond, knowledge of the matter being confirmed, and objectivity. For this reason, ordinarily the auditor attempts to ensure, where practicable, that the confirmation request is directed to an appropriate individual. For example, when confirming that a covenant related to an entity’s long-term debt has been waived, the auditor directs the request to an official of the creditor who has knowledge about the waiver and has the authority to provide the information.
33 Ordinarily, the auditor assesses whether certain parties may not provide an objective or unbiased response to a confirmation request. Information about the respondent’s competence, knowledge, motivation, ability or willingness to respond may come to the auditor’s attention. Ordinarily, the auditor considers the effect of such information on designing the confirmation request and evaluating the results, including determining whether additional audit procedures are necessary. Ordinarily, the auditor considers whether there is sufficient basis for concluding that the confirmation request is being sent to a respondent from whom the auditor can expect a response that will provide sufficient appropriate audit evidence. For example, the auditor may encounter significant unusual year-end transactions that have a material effect on the financial report, the transactions being with a third party that is economically dependent upon the entity. In such circumstances, ordinarily the auditor considers whether the third party may be motivated to provide an inaccurate response.
The External Confirmation Process
34 When performing confirmation procedures, the auditor shall maintain control over the process of selecting those to whom a request will be sent, the preparation and sending of confirmation requests, and the responses to those requests.
35 Control is maintained over communication between the intended recipient and the auditor to minimise the possibility that the results of the confirmation process will be biased because of the interception and alteration of confirmation requests or responses. Under paragraph 34 of this Auditing Standard, the auditor needs to ensure that it is the auditor who sends out the confirmation requests, that the requests are properly addressed, and that it is requested that all replies are sent directly to the auditor. The auditor ordinarily considers whether replies have come from the purported sender.
No Response to a Positive Confirmation Request
36 The auditor shall perform alternative audit procedures where no response is received to a positive external confirmation request. The alternative audit procedures shall be such as to provide audit evidence about the assertions that the confirmation request was intended to provide.
37 Where no response is received, the auditor ordinarily contacts the recipient of the request to elicit a response. Where the auditor is unable to obtain a response, under paragraph 36 of this Auditing Standard, the auditor needs to use alternative audit procedures. The nature of alternative audit procedures varies according to the account and assertion in question. In the examination of accounts receivable, alternative audit procedures may include examination of subsequent cash receipts, examination of shipping documentation or other client documentation to provide audit evidence for the existence assertion, and examination of sales near the period-end to provide audit evidence for the cut-off assertion. In the examination of accounts payable, alternative audit procedures may include examination of subsequent cash disbursements or correspondence from third parties to provide audit evidence of the existence assertion and examination of other records, such as goods received notes, to provide audit evidence of the completeness assertion.
Reliability of Responses Received
38 Ordinarily, the auditor considers whether there is any indication that external confirmations received may not be reliable. Ordinarily, the auditor considers the response’s authenticity and performs audit procedures to dispel any concern. The auditor may choose to verify the source and contents of a response in a telephone call to the purported sender. In addition, the auditor, under paragraph 34 of this Auditing Standard, needs to request the purported sender to mail the original confirmation directly to the auditor. With ever-increasing use of technology, the auditor ordinarily considers validating the source of replies received in electronic format (for example, fax or electronic mail). Under ASA 230 Audit Documentation, the auditor needs to document oral confirmations in the work papers. If the information in the oral confirmations is significant, the auditor ordinarily requests the parties involved to submit written confirmation of the specific information directly to the auditor.
Causes and Frequency of Exceptions
39 When the auditor forms a conclusion that the confirmation process and alternative audit procedures have not provided sufficient appropriate audit evidence regarding an assertion, the auditor shall perform additional audit procedures to obtain sufficient appropriate audit evidence.
40 In forming the conclusion, ordinarily the auditor considers the:
reliability of the confirmations and alternative audit procedures;
nature of any exceptions, including the implications, both quantitative and qualitative of those exceptions; and
audit evidence provided by other audit procedures.
Based on this evaluation and under paragraph 39 of this Auditing Standard, the auditor needs to determine whether additional audit procedures are needed to obtain sufficient appropriate audit evidence.
41 Ordinarily, the auditor considers the causes and frequency of exceptions reported by respondents. An exception may indicate a misstatement in the entity’s records, in which case, under ASA 320 Materiality and Audit Adjustments, and ASA 530 Audit Sampling and Other Means of Testing, the auditor needs to determine the reasons for the misstatement and assesses whether it has a material effect on the financial report. If an exception indicates a misstatement, under paragraph 39 of this Auditing Standard, the auditor needs to reconsider the nature, timing and extent of audit procedures necessary to provide the audit evidence required.
Evaluating the Results of the Confirmation Process
42 The auditor shall evaluate whether the results of the external confirmations process together with the results from any other audit procedures performed, provide sufficient appropriate audit evidence regarding the assertion being audited.
43 See ASA 330 and ASA 530 for mandatory requirements and explanatory guidance in conducting this evaluation.
External Confirmations Prior to the Year-End
44 When the auditor uses confirmation as at a date prior to the balance date to obtain audit evidence to support an assertion, under ASA 500, the auditor needs to obtain sufficient appropriate audit evidence that transactions relevant to the assertion in the intervening period have not been materially misstated. Depending on the assessed risk of material misstatement, the auditor may decide to confirm balances at a date other than the period end, for example, when the audit is to be completed within a short time after the balance date. As with all types of pre-year-end work, under ASA 330, the auditor needs to consider the need to obtain further audit evidence relating to the remainder of the period. ASA 330 provides additional explanatory guidance when audit procedures are performed at an interim date.
Conformity with International Standards on Auditing
45 This Auditing Standard conforms with International Standard on Auditing ISA 505 External Confirmations, issued by the International Auditing and Assurance Standards Board of the International Federation of Accountants.
Compliance with this Auditing Standard enables compliance with ISA 505.