Which Assertions Are Proved by Accounts Receivable Confirmations?
For small businesses that sell on credit, accounts receivable can make up a substantial portion of the balance sheet. During the annual audit, auditors will check to see if your claims regarding the accounts receivable balance can be proved. These claims are known as assertions. The most common audit procedure related to accounts receivable is confirmation, in which the auditor will ask your customers to confirm their account balance. Knowing which assertions can be proved by confirmation can help you understand why your auditor asks for multiple audit procedures on the same account.
Accounts receivable confirmations mainly serve to prove the existence assertion. The existence assertion is management's claim that the accounts receivable that are recorded on the balance sheet are real. The logic is that if a customer will readily admit to owing a balance to your firm, the account receivable probably exists. If the customer disputes the balance, more work is done to determine where the discrepancy lies. Sometimes the customer will not respond to the confirmation request. In this case, the auditor will need additional information that proves the obligation was outstanding at the balance sheet date.
The rights assertion is management's contention that the accounts receivable belong to the company. In most companies, this isn't an issue. However, this assertion gets called into question if the company has a factoring arrangement, by which it sells receivables to another company, known as the factor, at a discount. The factor gets a discount, but the company doesn't have to worry about collecting from customers. In some of these arrangements, title to the receivables passes to the factor; the accounts receivable no longer belong to the company, so the company should not carry the receivables on the balance sheet. Accounts receivable confirmations provide almost no ability to detect factoring arrangements. In many cases, customers do not know that their receivables have been factored. As such, they will indicate that the balance is owed to the original company. Therefore, auditors will look for these arrangements by talking with management and examining cash receipts for factor payments.
Completeness is the quality that the financial statements contain all transactions that actually occurred. This is most often thought of in terms of unrecorded liabilities. However, accounts receivable may be incomplete if the company has not recorded sales so it can fraudulently reduce income tax liability. Confirmations do not provide much assurance related to the completeness assertion. However, if the auditor sends a blank confirmation, asking a customer to list all balances owed, any balances not recorded may be uncovered. Because this does not address any customers with no balances recorded, auditors will also look at cash receipts after the year-end date. These cash inflows should be traceable to sales after year-end or recorded receivables.
The valuation assertion tells financial statement users that the numbers on the front of the statement are correct. That is, the correct numeric value is stated. Accounts receivable have two main valuation concerns. First, you must record the correct balance in the first place. Accounts receivable confirmations help determine if this is the case. Generally accepted accounting principles, however, require that accounts receivable are presented on the financial statements minus a reduction for accounts that will turn out to be uncollectible. This estimate is made by looking at the company's collection history. The auditor will determine if an appropriate allowance has been made by examining the inputs to this estimate and determining if the calculations and methodology make sense.