Negative Confirmation

What Is A Negative Confirmation?

A negative confirmation involves seeking confirmation from the recipient only if they disagree with the content, providing the auditor with a method to obtain valid evidence and verify the legitimacy of documents presented by the management.

Audit forms an integral part of the corporate world. The auditors scrutinize and evaluate a company's financial health to find out whether the company in question reported the financial statements truly and fairly to interested parties.

Since auditors independently scrutinize companies on behalf of the company’s shareholders, they seek validation from the right sources to prove the legitimacy of the supporting evidence presented by the company’s management.

One tactic to obtain the right information is negative confirmation. Through this article, we’ll delve deeper by understanding its meaning, nature, use, etc. 

Understanding Negative Confirmation 

Negative confirmation stands out for its efficiency in time and resource utilization. The auditor can validate the legitimacy of documents presented by the management without unnecessary delays or resource expenditure unless the recipient raises concerns about the evidence.

A negative confirmation is one of the approaches highlighting the auditor’s practice of professional skepticism. Due to this, without solid physical evidence, an auditor cannot accept the information as legitimate evidence, especially if it is via word of mouth by the management.

The confirmation can be in the form of letters, taxes, documents, or even emails. As long as the medium of communication allows the auditor to connect with the recipient of the event related to the evidence of the management, it is a legitimate confirmation.

Typically, it is sent out by the auditor when the company has strong accounting controls and measures, thereby enabling the company to have fewer errors or chances of fraudulent activities historically.

Thus, it involves sending documents, including financial data, requesting the recipient to respond to the request only if they find any discrepancies in their records and the records of the company being audited, or the request can be ignored.

Why Should An Auditor Use Negative Confirmations? 

An auditor should use negative confirmations for an efficient and effective flow of the audit procedures without overutilizing time and resources in one audit area. In a nutshell, an auditor should only get stuck waiting for a response with a valid reason.

Therefore, an auditor can only rely on the management’s controls and procedures when they are based on historical performance and efficiencies. Below are some effective uses of negative confirmation for an auditor:

1. Efficiency: The negative confirmation approach allows the auditor to instill trust in the credibility of the management’s controls and procedures. Thus, the auditor can move forward with the audit procedures without delay.
2. Cost-Effective: This confirmation approach shows efficiency on a cost basis. When dealing with a large audience, it is measurably less expensive to an inquiry than a positive confirmation, especially when auditors detect risks.
3. Less Intrusive: The negative confirmation method is arguably less intrusive compared to the positive confirmation approach, which pressures recipients to respond regardless of their agreement with the inquiry.
4. Applicable to Low-Risk items: Since the confirmation is measurably affordable to reach audiences for inquiries based on risk detection levels, this method is also effective for low-risk components. It reduces the waiting period and wasted productivity, unlike the positive confirmation. 
5. Reduction of Confirmation Bias: Engaging with large audiences reduces the chance of confirmation bias among the subjected population. If management engages in fraud, it is highly unlikely that all related external sources are complicit in it, therefore allowing the auditor to filter the white noise of bias.
6. Applicability to Large Audience: A negative confirmation approach, with its cost-effectiveness, allows the same total cost budget as a positive confirmation to reach and distribute inquiries to larger populations in a shorter time period.  

Understanding The Assumptions Of Negative Confirmation

An auditor performs audits with utmost professional skepticism, which preserves their independence and qualifies the audit. With that in mind, choosing the right approach will depend on the level of audit risk an auditor is willing to take regarding material misstatement.

To reduce risks such as to a minimum, an auditor must employ judgment to choose the right approach, which is analytical, systematic, and objective. Therefore, before an auditor accepts the clarification from external sources, an auditor must ensure that the third party

• Relevance to the Event
• Independence
• Familiarity with the Account
• Clarity on Transaction Intention

If the auditor can ensure the validity of the above points, then the value of the confirmation is legitimate and deemed to enable the next procedures, as the confirmation of the account balances with the external sources explains managerial assertions for the specific transaction.

The auditor can ensure the transactions are per prevailing accounting standards such as GAAP (US) and IFRS (International) by conducting external reconciliations, along with applying audit standards such as GAAS (US) and ISA (International).

These procedures help reduce the chances of fraud and ensure security for the users of the company’s financial statements. 

Other Types Of Audit Confirmation 

An auditor has several options for confirmation with external sources, but choosing the right one is an important task. It is important to weigh each confirmation’s advantages and disadvantages.

There are three ways an auditor can approach recipients on the confirmation of the account. Types other than negative confirmation include the two following.

Positive Confirmation 

In a positive confirmation approach, the auditor sends a confirmation request via any form of communication to the recipients, requiring them to express the accuracy of the accounts by a direct confirmation.

If any discrepancies are found, retrieve explanations and update the systems. But if there are no discrepancies, the recipient should provide a response confirming the accuracy. 

Blank Confirmation form

The blank confirmation form is a variation approach of the positive confirmation, where the recipients are required to return a letter or evidence of the detailed accounts balance confirming the accuracy of the accounts on both sides of the companies by conducting cross-checks. 

When To Use Negative Confirmation? 

Negative confirmation proves advantageous when the auditor can confidently rely on the company's established controls and procedures.

This significantly reduces the burden on the auditor and enhances overall productivity, making it a mutually beneficial approach for the auditor and client to efficiently conclude the audit.

Another case of use would be deployed depending upon the level of material misstatement risk involved, and an experienced auditor can pinpoint the level of involved control and inherent risks. 

The effectiveness of the confirmation heightens based on the circumstances below: 

• Low level of material misstatement risk.
• Low probability of discrepancies between the recorded figures of both the company and the external parties. 
• The account in question is similar to the external sources and relatively smaller in balance. 
• The recipient expects to acknowledge the request and respond if there are any discrepancies.

Practical Application Of The Negative Confirmation

Assuming audit risk remains constant, a decrease in material misstatement can increase detection risk. Due to this, an auditor perceives less risk of the company’s internal controls and operations, so an auditor willingly accepts a higher chance of detection risk. 

Therefore, an auditor uses negative confirmation during tests of controls to procure audit evidence for the account balances, especially when the business model is B2C (Business-to-Consumer) where the recipients are large, i.e., the general public.

Financial institutions, public authorities, stores, restaurants, etc, are all part of the B2C category, where the primary customer base is the general public. Therefore, an auditor can assess the quality of the service provided by confirming with the customers.

The factors affecting the confirmation decision of an auditor are

• Size and scale of individual accounts. 
• Inherent and Control risks. 
• Availability of substantive audit evidence.
• Materiality levels of account in question.
• Effectiveness of the deployed technique for confirmation.

Researched and authored by Muhammed Ishfaque Ishaque | LinkedIn 

Reviewed and edited by Parul Gupta | LinkedIn

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