Definition
A third party's reply may differ from the entity's records. Under AU-C 505 the auditor investigates exceptions to find out whether they indicate a misstatement, including the possibility of fraud. Many are timing differences, such as a payment in transit on year end, or disputes that are already known. Others are real errors, such as billing mistakes or invalid balances.
Why it matters in an audit or review
An exception is useful because it shows where the books and the outside party differ. Misstatements found are accumulated and, in a sample, projected. If a pattern appears, the auditor may need to change the risk assessment, extend testing or reconsider the reliability of the client's records.
Example
Of 25 positive receivable confirmations (illustrative), 3 differ. One customer paid $14,000 on December 30, and the check was deposited January 3, which is a timing difference supported by the bank deposit. One disputes a $9,500 charge for returned goods, which is an error if the credit memo was issued late. One reply has an unverified email sender and is treated as unreliable.
Common mistakes
- Accepting the client's explanation without checking it to an external or independent document.
- Treating every exception as timing.
- Not logging exceptions on the confirmation control log.
FAQ
Does an exception always mean an adjustment?
No. Only exceptions that are real misstatements lead to adjustment.
Sources
- AICPA, AU-C Section 505, External Confirmations
- AICPA, AU-C Section 530, Audit Sampling (projecting misstatements)
- AICPA, AU-C Section 450, Evaluation of Misstatements Identified During the Audit
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error