What is Negative Confirmation?
A negative confirmation occurs when entities that have a relationship with an auditor's client indicate they have financial discrepancies or disagreements regarding their accounts with the client.
How Does Negative Confirmation Work?
For example, let's assume Company XYZ is working on its year-end audit. Its auditor contacts a random sample of Company XYZ's vendors and asks them to reply only if they have discrepancies with Company XYZ regarding accounts payable or receivable.
Company ABC receives the negative confirmation request from Company XYZ's auditor. It looks through its recorded transactions with Company XYZ and tells the auditor that Company XYZ has not paid one of its invoices due to a conflict regarding contract language. Company ABC believes Company XYZ owes the money and thus has recorded the amount as a receivable. Company XYZ does not believe it owes the money and thus has not recorded a corresponding payable, leaving a discrepancy. Company ABC communicates this to the auditor in its response to the negative confirmation request.
When auditors receive negative confirmations, they investigate the discrepancies and also look for patterns among any related misstatements. It is important to note, however, that some recipients may not have the ability or interest to respond, which skews the degree to which negative confirmations reflect on a company's accounting.
It is important to note that negative confirmation requests require the recipients to respond only if there is a discrepancy. Thus, auditors hope for no responses (and no discrepancies).
Why Does Negative Confirmation Matter?
Overall, negative confirmations are designed to reduce audit risk, particularly when a client has a lot of small payable and receivable balances and its financial records are generally in good condition. After all, auditors are paid to look hard for discrepancies in companies' financial statements. For companies that have very few errors, auditors often request negative confirmations from vendors, customers and other entities with which a company has a relationship to double-check their numbers.