A Common Peer Review Problem
Confirmation of accounts receivable has been a nearly sacrosanct auditing procedure for over 50 years. Before most of today's practicing CPAs were even born, the AICPA issued Statement on Auditing Procedure no. 1, Extensions of Auditing Procedure, requiring auditors to confirm accounts receivable whenever they were material to the financial statements. SAS no. 67, The Confirmation Process, followed in 1991 with significant changes in procedure. Despite those pronouncements and the publication in 1995 of the AICPA Auditing Procedure Study Confirmation of Accounts Receivable, problems continued to crop up. In fact, the Institute's peer review division (now the practice monitoring division) released a 1995 report in the Practicing CPA citing fundamental violations of the provisions of SAS no. 67. Even though the principle of confirmation is long-standing, perhaps these peer review deficiencies reflect auditors' inadequate understanding of the requirements. Audit quality will be enhanced if practitioners have a sound understanding of the provisions of SAS no. 67. The flowchart on pages 40--41 portrays the major aspects of the confirmation process. Additionally, this article emphasizes those commonly identified peer review confirmation deficiencies. Pitfall 1 KNOW WHAT IS NECESSARY SAS no. 67 provides that confirmations are not required if any one of three conditions is met: * Accounts receivable are immaterial. * The use of confirmations would be ineffective. * Combined inherent risk and control risk are low (assuming that evidence from analytical procedures or other substantive tests would achieve acceptably low levels of audit risk). Practice observations, as noted in the 1995 report, led to this change from SAP no. 1. One of these observations was the concern with recipient "say yes" behavior in which the confirmation is signed and returned without actual verification. "Say yes" behavior may be suggested from the results of other related substantive testing and observations when the recipient does not adequately investigate the accuracy of balances being confirmed. The AICPA also observed that recipients might lack the financial sophistication to provide reliable responses or might simply ignore the requests. For example, auditors often don't confirm hospital receivables, because response rates are usually inadequate. Similarly, the federal government and some companies have a policy of not responding to confirmation requests. Because the current standard makes clear the presumption that auditors need to confirm accounts receivable, practitioners must document carefully when they have not sent confirmations. Auditors should consider other auditing procedures when they do not confirm accounts receivable, especially when the balances are material. SAS no. 67 offers no specific guidance, but auditors can apply the following two substantive tests: 1. Examination of subsequent cash collections to corroborate the valuation assertion. 2. Examination of relevant documentation that the sales took place for most other key assertions. In a manufacturing or distribution company, for example, the documentation includes examination of customer purchase orders (POs), client invoice copies, shipping documents and third-party evidence of delivery. Audit problems that might be found in such documentation include, for example, evidence in customer POs of consignment arrangements rather than sales, as well as shipping documents indicating improper sales cutoffs. Additionally, auditors using the examination of subsequent cash collections as a primary substantive procedure might consider performing procedures to provide evidence that the source of the payment was the customer. The ZZZZ Best fraud clearly taught this lesson. Pitfall 2 CHOOSE THE RIGHT REQUESTS Auditors have to decide whether they can use negative accounts receivable requests. …