What Auditors Ask For: Confirmations and Stocktakes

At a glance

What is actually requested is determined by the auditor under the Hong Kong Standards on Auditing and according to the company’s circumstances.

Why external evidence?

Because the essence of an audit is independent verification.

The bank statement you hand over could be a photocopy; the invoice you hand over could be one you typed. The auditor is not assuming you are falsifying anything — professional standards require them to obtain evidence from an independent source for significant items.

So: the cash balance is confirmed by the bank directly, significant balances are confirmed by the counterparty directly, and stock has to have been physically counted by someone.

Once that logic is clear, every other request makes more sense.

Bank confirmations: the most common cause of delay

The auditor writes to the bank directly to confirm account balances, loans, guarantees, charges and authorised signatories.

Four practical points:

One: they need your authorisation first. A bank will not release information just because an auditor asks; you have to sign an authority. Without that step the confirmation cannot even go out.

Two: list every account. Including the one you consider unimportant, foreign currency accounts, and accounts closed during the year. Miss one and the auditor will send a second request when they find it, and the wait starts again.

Three: there is a wait. How fast the bank replies is not within your control, which is why this step belongs at the very start of the audit.

Four: some banks charge. Confirmations carry a fee, set by the bank.

The stocktake: the one thing that cannot be recreated

If you carry stock, count it on the year end date, or as close to it as possible.

Record the item, quantity and unit cost, along with the date of the count and who carried it out.

The characteristic of this one is that once the date has passed, there is no fixing it. Saying in March that “there was roughly this much at the end of December” has no evidential basis behind it, and the auditor can only issue a qualified opinion.

For a larger operation, the auditor may want to attend the count in person. So agree a date with them before the year end rather than telling them on the day.

The management representation letter: not a formality

This is a document plenty of owners sign without reading. It carries more weight than that.

In substance, the directors confirm in writing that: all relevant information has been provided, nothing significant has been withheld, there are no undisclosed proceedings or guarantees, all related party transactions have been disclosed, and the judgements behind significant estimates are reasonable.

Signing it makes it your responsibility. If something later turns out not to have been mentioned, “I didn’t know” is a very difficult answer to run — because you confirmed it in writing.

So read it line by line before signing. Anything unmentioned — a verbal guarantee, an unrecorded claim, an arrangement between related companies — say it before you sign, not afterwards.

Litigation and subsequent events

Litigation enquiries — if the company has an ongoing or potential legal dispute, the auditor will ask, and may want your solicitors to confirm the position. This affects the disclosure of contingent liabilities.

Subsequent events — significant events after the year end but before the report is signed (a major customer failing, significant litigation, a disposal) may require an adjustment or a disclosure.

Plenty of owners treat both as “nothing to do with the year end” and say nothing. In fact the standards require coverage up to the date the report is signed — so if something significant happens during the audit, raise it with the auditor.

What happens if you don’t provide it?

Two layers.

Minor — they will chase. Which drags out the timetable and raises the fee.

Serious — it affects the opinion. Where sufficient evidence cannot be obtained for a significant item, the auditor can only issue a qualified opinion or a disclaimer of opinion. On what those do with banks, investors and the IRD, see the article on audit opinions.

Which is to say that not cooperating does not make the problem disappear; it writes the problem into your audit report.

Three things to do before the year end

One: list every bank account (including closed ones) and be ready to sign the authority.

Two: fix the date of the stocktake, and carry it out on the year end date.

Three: clear up current accounts and unrecorded items, and write down what they were.

Between them, those three cover most of what goes wrong in an audit. A week beforehand beats three months of chasing afterwards.

The same preparation is the core of the checklist for your accountant.

We do bookkeeping and company secretarial work, which includes getting this material ready before the year end and handling the auditor’s queries. The audit procedures themselves are performed independently by a licensed accountant under professional standards.

Want someone to line up the pre-year-end preparation for you? Talk to us, or get started.

This is general information and does not constitute audit or accounting advice. The audit procedures performed and the information required are determined by the auditor under the Hong Kong Standards on Auditing and according to the individual company’s circumstances.