Bringing Audit Confirmations into the 21st Century

Auditors routinely send out confirmation letters through the U.S. Postal Service to their audit clients’ customers and lenders to verify year end balances in such items as cash, receivables and loans. The Public Company Accounting Oversight Board (PCAOB) recently revived its 2010 proposal Release No. 2010-003, Confirmation, which would make some changes to the audit confirmation process. Although managers and auditors generally welcome a modernized process, the proposal received criticism during its initial comment period. After being sidelined for five years, the proposal may be given new life in 2015.

Traditional confirmation procedures

Confirmation is the process of obtaining and evaluating a direct communication from a third party in response to a request for information about a particular item on the financial statements. Auditors send two types of confirmation requests:  

1. Positive forms. Some positive forms ask the respondent to indicate agreement with the information stated on the request. Other positive forms, referred to as “blank” forms, don’t state the amount (or other information) on the confirmation request, but request that the recipient fill in the balance or furnish other information.
2. Negative forms. A negative form requests that the recipient respond only if he or she disagrees with the information stated on the request.

Auditors must maintain control over confirmation procedures to minimize the possibility that the results will be biased because of interception and alteration of the confirmation requests or responses. The entity being audited generally isn’t directly involved in the confirmation process.

To maintain control, auditors typically send paper confirmation letters through standard U.S. Postal Service mail in accordance with Interim Auditing Standard (AU) Section 330, The Confirmation Process. This can be time-consuming, especially if recipients fail to respond to positive forms.

A need for change

AU Sec. 330 went into effect in 1992. In addition to mailed confirmation responses, it refers to confirmation responses received orally or via facsimile — but not to electronic communications or online records.

If an auditor wants to verify outstanding invoices and loan balances in today’s world, it seems logical for them to be allowed to send e-mail confirmations or to access customer accounts or bank records online. So, in 2010, the PCAOB issued Release No. 2010-003, a proposal that, among other changes, defined a confirmation response to include electronic or other media. The expanded definition of a confirmation response would make the confirmation process more efficient — although auditors would need to take into account the risks associated with electronic confirmation responses.

Possible changes in the works

Release No. 2010-003 was intended to replace AU Sec. 330. In addition to revising the definition of confirmation responses, it called for auditors to perform confirmation procedures for receivables, including those resulting from sales that rely on financing, loans and other transactions, to provide audit evidence to address the risk of financial fraud. 

The proposal also required an auditor to confirm cash and other relationships with financial institutions — such as lines of credit, the balances banks require corporate accounts to keep to get free services, possible legal liabilities and financial guarantees. Moreover, the original proposal required auditors to confirm risks and responses to some of the risks. 

Comment letters from auditors and companies in response to the 2010 version of the proposal criticized it for relying too heavily on specific requirements and expressed a preference for a more principles-based standard. Auditors also wanted the confirmation standard to be more consistent with the eight risk assessment standards that range from Auditing Standard (AS) No. 8, Audit Risk, to AS 15, Audit Evidence.

Several years in the making

After its initial comment period, Release No. 2010-003 was sidelined for much of the subsequent five years while the PCAOB pursued an ambitious agenda to have auditors disclose more information to shareholders. Now it’s being revived, although the exact timing of a revised confirmation proposal isn’t clear.

© 2015