Question

Bank confirmations are critical to the cash audit. What information does the auditor obtain by sending bank confirmations? Explain the different types of bank confirmations and what assertions each type addresses. How do you determine which is the best bank confirmation type to use

Answer 1

A bank confirmation letter (BCL) is a letter from a bank or financial institution confirming the existence of a loan or a line of credit that has been extended to a borrower. The letter officially vouches for the fact that the borrower—typically an individual, company, or organization—is eligible to borrow a specified amount of funds for a specified purpose.

A bank confirmation letter's purpose is to assure a third party, generally a seller, that the borrower has access to sufficient financial resources to complete a transaction, such as the purchase of goods. The confirmation letter—sometimes known as a comfort letter—is not a guarantee of payment, but only an assurance of the borrower's financial resources to make payment.

Since a letter of confirmation is issued in regard to a particular transaction or project, it's not transferable to a different transaction or project. If the bank's customer decides to enter into a different deal or purchase, the customer usually is required to obtain a new letter of confirmation. For example, a prospective home buyer decides to buy a different home than the one specified in the bank confirmation letter; a new BCL would be needed.

Regulations vary from country to country in terms of whether and to what extent a letter of confirmation must state the specific purpose for which a loan or line of credit is being extended to the borrower.

Bank confirmation letters are most commonly prepared for a business customer of the bank, vouching for the existence of a specified line of credit. The letters often serve to reassure sellers of a large number of goods. They may also be issued for a company that is entering into a joint venture project with another company. While the letter does not guarantee payment or provision of funds, it does provide an assurance of a high probability of the company receiving payment from the bank's customer.

The most common use of a bank confirmation letter by an individual is during the purchase of a home or land. In such cases, the letter provides confirmation to a seller or realtor that the bank's customer is approved for a mortgage up to a specified amount for a proposed purchase. The letter is not a commitment to buy the property; it is merely a reassurance that the bank’s customer has access to funds to complete a purchase.

TYPES OF BANK CONFIRMATION

The most common types of confirmations are for cash accounts, debt, accounts receivable and accounts payable, though confirmations can be customized to confirm almost any financial statement assertion that is made.

There are two common types of confirmations used for confirming accounts receivable: “positive”confirmations and “negative”confirmations. A positive confirmationis a letter, addressed to the debtor, requesting that the recipient indicate directly on the letter whether the stated account balance is correct or incorrect and, if incorrect, by what amount. A negative confirmationis also a letter, addressed to the debtor, but it requests a response only if the recipient disagrees with the amount of the stated account balance. A positive confirmation is more reliable evidence because the auditor can perform follow-up procedures if a response is not received from the debtor. With a negative confirmation, failure to reply must be regarded as a correct response, even though the debtor may have ignored the confirmation request. Offsetting the reliability disadvantage, negative confirmations are less expensive to send than positive confirmations, and thus more of them can be distributed for the same total cost. The determination of which type of confirmation to be sent is an auditor’s decision, and it should be based on the facts in the audit.