When used with other audit procedures, external confirmations can be an effective audit tool in detecting fraud in accounts. In addition, to obtain sufficient appropriate audit evidence, debtor and creditor confirmations assist the auditor in discovering exceptions in the accounts. Audit evidence is more reliable when:

  • Received from independent sources outside the entity. (i.e. originally intended confirming party e.g. Bank balance confirmation, debtor balance confirmations, creditor balance confirmation)
  • Received directly by the auditor (as there will be less chance of its alteration or modification)
  • Exists in documentary form

Q-1 How external evidence helps in detecting fraud?

Exceptions noted in responses to confirmation requests may indicate either:

  • misstatements or potential misstatements in financial statements or in accounts or
  • differences may be due to timing, measurement, or clerical error in the external confirmation procedures.

If auditor identifies factors that give rise to doubts about the reliability of the response to a confirmation request, the auditor shall obtain further evidence to resolve those doubts.

Let us now examine how external evidences assist in revealing frauds in accounts with below mentioned example –

Suppression of cash receipt by an accountant using teeming and lading can be easily identified with debtors balance confirmation. Teeming and lading, a fraud scheme, where cash received from debtor is misappropriated either for personal use or to favor other debtors.

Example: Money received from A against his dues, is misappropriated. Later, when someone notices overdue balance in A’s account, the fraudster credits an amount received from another party B to A’s account. Similarly, little after that, when a third party C clear his dues, his amount is credited to B’s account. This chain continues until the accountant is not get caught, or balance reconciliation of above mentioned parties is not done by the company.

This scheme can also be used by an accountant to favor a debtor, where debtor’s balance has become overdue and account can be put on hold because of which debtor will not be able to receive any further order raised by him.  This is done by an accountant either to get some favor or commission in return from that debtor or to personally benefit a debtor who is a relative of that accountant.

*Proper segregation of duties can curb above practice up to great extent. The person carrying out this reconciliation should not be the person who accounted the income.

1. In a case, a company lost $230000 due to lack of adequate control procedures, and not performing customer circularization in order to verify account balances.

Q-2 What procedures to be apply for non-response to confirmation?

If any party does not respond to the confirmation sent to him, subsequent examination of the account can be done by the auditor.

  • Auditor may perform alternate audit procedures. For example:
  • For accounts receivable balances – examining specific subsequent cash receipts, shipping documentation, and sales near the period end.
  • For accounts payable balances – examining subsequent cash disbursements or correspondence from third parties, and other records, such as goods received notes.
  • For instance, a long outstanding balance in trade payable account, for which no confirmation has been received may lead to the case of hidden income in previous year/s (as we have discussed in last BRS article). Proper evidence should be obtained through alternate audit procedures.
  • Another useful method, where responses have not been received from certain parties, could be, checking customer status whether in existence or not. Since it may happen, to suppress income or to show high profit, entity can show bogus transactions of purchases and sales which results in disclosures of party accounts in financials having no valid existence. This could lead to further investigation of transactions in those accounts.

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Qualification: CA in Practice
Company: Kanika Mittal & Associates
Location: Meerut, Uttar Pradesh, IN
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