Introduction
External Confirmation under SA 505 means asking someone outside the company to confirm information directly to the auditor.
when an auditor checks a company’s accounts, they do not only trust what the company says. Instead, they also contact third parties — like customers, suppliers, banks, or lenders — to verify whether the figures shown in the books are correct.
2. Considerations Before Using External Confirmations
Before using external confirmations, the auditor considers the following factors:
- Materiality of the item
- Assessed level of inherent risk
- Assessed level of control risk
- Nature of the item to be confirmed
- Whether evidence from other planned audit procedures will reduce audit risk to an acceptably low level
Therefore, the auditor evaluates whether external confirmation will effectively address assessed risks.
3. Use of External Confirmation Procedures
The auditor employs external confirmation procedures after consulting with management. However, the auditor maintains full control over the confirmation process.
Generally, auditors seek confirmations for:
- Account balances
- Components of account balances
- Terms of agreements
- Transactions with third parties
However, the auditor does not restrict confirmations only to account balances.
4. Effectiveness of Confirmation Procedures
The auditor uses confirmation procedures when he determines a higher level of assessed inherent and control risk. In such situations, confirmations provide sufficient and appropriate audit evidence.
Moreover, confirmations become particularly important when fraud risk exists or when internal controls appear weak.
5. Timing of Confirmation Requests
The auditor makes confirmation requests either:
- At the date of financial statements, or
- At a date close to the reporting date
Additionally, the auditor designs confirmation requests to meet specific audit objectives.
6. Understanding Client’s Arrangements
The auditor understands the client’s arrangements and transactions with third parties. This understanding helps the auditor determine:
- The nature of information to confirm
- The appropriate confirming party
- The method of confirmation (including electronic confirmations, where applicable)
Consequently, proper understanding improves the reliability of evidence obtained.
7. Types of External Confirmation Requests
The auditor may use:
(a) Positive Confirmation Request
The auditor requests the third party to respond whether they agree or disagree with the information provided.
(b) Negative Confirmation Request
The auditor requests the third party to respond only if they disagree with the information.
(c) Combination of Both
The auditor may use a combination of positive and negative confirmations depending on risk assessment.
8. Evaluation of Reliability
After receiving confirmations, the auditor evaluates whether:
- The responses are reliable
- The replies come directly from the intended respondent
- Any contradictions exist between confirmation results and other audit evidence
Furthermore, if doubts arise regarding reliability, the auditor performs additional audit procedures.
9. When Management Refuses Confirmation
If management requests the auditor not to send a confirmation request, the auditor:
- Inquires about the reasons
- Evaluates whether the reasons are valid
- Obtains audit evidence to support management’s explanation
- Performs alternative audit procedures
However, if management’s refusal lacks valid grounds, the auditor considers the implications for the audit opinion.
Conclusion
In conclusion, SA 505 requires the auditor to obtain direct third-party evidence while maintaining strict control over the confirmation process. By properly designing, sending, and evaluating confirmations, the auditor reduces audit risk and strengthens the reliability of audit evidence.