## **Learning Outcomes**

After reading this article, you will be able to explain the use and process of external confirmation for trade receivables, identify circumstances where confirmations may be unreliable or inappropriate, and recommend effective alternative procedures. You will also understand common pitfalls in receivable audit evidence and be able to apply best-practice substantive tests to meet ACCA AA exam requirements.

## **ACCA Audit and Assurance (AA) Syllabus**

For ACCA Audit and Assurance (AA), you are required to understand how external confirmations are used as audit evidence for receivables and the alternatives available when confirmations are ineffective or impractical. Focus your revision on:

- The objectives, nature, and process for obtaining external confirmations for receivables. _(ISA 505)_
- The strengths and weaknesses of confirmation evidence and when it is appropriate.
- The auditor’s response if a confirmation is unreliable, refused, or impractical—key alternative substantive procedures.
- Designing effective substantive procedures for existence, rights and obligations, and valuation of trade receivables.
- Scenarios where confirmation is not sufficient or cannot be performed, and issues such as management refusal.
- How to address non-replies, discrepancies, and risk indicators during receivable audit testing.

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Why is external confirmation often considered strong evidence for the existence of trade receivables?
2. List two situations where confirmation of receivables may not be appropriate or reliable.
3. If a customer fails to reply to a positive confirmation request, what should the auditor do?
4. Name three alternative substantive procedures that can provide evidence over the valuation of trade receivables.

## **Introduction**

External confirmation of receivables is one of the most widely used and effective forms of audit evidence. However, confirmation is not always possible or reliable. The auditor must understand the purpose, process, and potential limitations of receivable confirmation, as well as alternative approaches available when confirmation evidence cannot be obtained or is insufficient.

> **Key Term: external confirmation**
> Audit evidence obtained directly by the auditor from a third party, usually by requesting confirmation of account balances or transactions.

## External Confirmation of Receivables

Sending external confirmation requests to customers is a key substantive procedure for testing the existence of trade receivables. Confirmations may be positive (requesting a response in all cases) or negative (asking for a response only if the recipient disagrees with the stated balance).

### When to Use Confirmation

Confirmation is appropriate when:

- Existence and rights over receivables are key assertions.
- Internal control over receivables is weak or fraud risk is high.
- The receivable amount is material or overdue.

Confirmation is less useful if:

- The risk is low and reliable evidence is available from other audit procedures.
- Receivables are numerous, immaterial, or related-party balances.

> **Key Term: positive confirmation**
> A confirmation request asking a third party to respond in all cases, whether they agree or disagree with the auditor’s stated balance.
>
> **Key Term: negative confirmation**
> A confirmation request asking a third party to respond only if they disagree with the balance presented by the auditor.

### The Confirmation Process

1. Auditor selects a sample of customer balances for confirmation, including large, old, unusual, and disputed items.
2. Confirmation letters are prepared on the client’s headed paper, signed by client management, but sent and controlled by the auditor.
3. Replies are requested to be sent directly to the auditor for integrity.
4. Where there is no response to a positive confirmation, the auditor follows up with reminders or considers alternative procedures.

### **Worked Example 1.1**

A firm audits Alpha Ltd, which has 200 trade receivables at year-end. The auditor selects a sample including the ten largest balances, those over 90 days overdue, and randomly chooses 15 others. Positive confirmation letters are sent on company letterhead. Five customers fail to reply.

**Question:**  
What should the auditor do for the five non-replies?

> **Answer:**  
> The auditor should perform alternative procedures on the balances with no reply (e.g., review subsequent cash receipts, inspect sales invoices and goods dispatch notes, check correspondence) to obtain sufficient evidence over existence and valuation.

## Limitations and Reliability of Confirmation

While confirmation provides strong external evidence, it is not infallible.

### Situations Where Confirmation Is Unreliable or Impractical

- The client’s customers are unlikely to respond (e.g., due to illiteracy, hostility, or foreign language barriers).
- There is a suspicion that management may have colluded with debtors.
- The confirmation process could be manipulated (e.g., “window-dressing” or spurious circularisation).
- The population is too large and balances too small for replies to be expected.
- Legal or practical obstacles prevent contacting customers.

> **Key Term: management refusal**
> When management instructs the auditor not to seek confirmation from certain customers, often for reasons they claim are sensitive or confidential.

### **Exam Warning**

> Common errors include relying solely on unreturned negative confirmations or accepting management’s explanations for non-responses. In such cases, always perform alternative procedures.

## Alternative Procedures When Confirmation Fails

Auditors must design substantive procedures to address existence, rights and obligations, and valuation if confirmation replies are not received or confirmation is inappropriate.

### Alternative Procedures

- Review post year-end bank statements for receipts from customers.
- Inspect original sales invoices, contracts, and delivery documents supporting the receivable.
- Examine correspondence with customers regarding unpaid balances or account disputes.
- Investigate credit notes or write-offs issued after the year-end.
- For overdue or disputed balances, discuss recoverability with credit control staff and management, considering allowance for doubtful debts.

### **Worked Example 1.2**

You audit Bravo Ltd. A customer with a material outstanding balance does not reply to repeated confirmation requests. Subsequent cash receipts show part payment; the remainder is long overdue. Inspection of correspondence indicates the balance is disputed.

**Question:**  
How should the auditor obtain sufficient appropriate evidence over this receivable?

> **Answer:**  
> The auditor should verify amounts received post year-end, review supporting documentation for the remaining balance, discuss the dispute with management, and consider an impairment allowance if recoverability is in doubt.

## Dealing With Non-Replies and Discrepancies

Non-replies and discrepancies between customer replies and client records must not be ignored.

- Investigate the reason for discrepancies (e.g., timing, errors, disputes, goods in transit).
- Adjust the client’s records if errors or omissions are found.
- Assess whether further misstatement is likely in the population.

If a large number of non-replies or errors occur, consider the risk of material misstatement and whether confirmation is an effective procedure for this client.

### **Worked Example 1.3**

While auditing Delta Co, several customer confirmations are returned stating that the outstanding balance is lower than the client’s records. Reviewing the balances reveals goods in transit at year-end.

**Question:**  
What assertion is most at risk here, and what procedures should you perform?

> **Answer:**  
> The completeness and cut-off assertions are at risk. The auditor should check shipping terms and cut-off procedures to ensure sales and receivables were recorded in the correct period. Misstatements should be corrected.

## When Management Refuses Confirmation

If management refuses confirmation of specific accounts:

- Obtain reasons for the refusal.
- Evaluate whether the refusal is reasonable (e.g., ongoing legal dispute, commercial sensitivity).
- Perform alternative procedures.
- Consider whether management’s refusal is itself a risk indicator (e.g., possible fraud).
- If sufficient appropriate evidence cannot be obtained, consider the impact on the audit opinion.

### **Revision Tip**

> Where confirmation is impractical or unreliable, plan your evidence mix early, using receipts, original documents, and correspondence. Document all work and management explanations in your working papers.

## **Summary**

Confirmation of receivables is a high-quality but not foolproof form of audit evidence. Understanding when and how to use this procedure, as well as when to rely on alternative substantive tests, is key to effective audit work. Always investigate non-replies, discrepancies, and management refusals thoroughly, and gather sufficient appropriate evidence for the assertion tested.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain the use of external confirmations for receivables and when they provide reliable evidence.
- Identify limitations or circumstances where confirmation is inappropriate or unreliable.
- Recommend alternative substantive procedures for receivables when confirmations are not effective.
- Evaluate the auditor’s responsibilities in cases of management refusal or non-responses.
- Investigate and document non-replies and discrepancies identified during the confirmation process.
- Ensure that sufficient, appropriate evidence is gathered over existence, rights, and valuation of receivables.

## **Key Terms and Concepts**

- external confirmation
- positive confirmation
- negative confirmation
- management refusal

Revenue and receivables - Receivable confirmations and alternatives