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The purpose of Practice Notes issued by the Hong Kong Institute of Certified Public Accountants is to assist auditors in applying
Statements of Auditing Standards (SASs) and Standards on Assurance Engagements (SAEs) of general application to
particular circumstances and industries.
They are persuasive rather than prescriptive. However they are indicative of good practice and have similar status
to the explanatory material in SASs and SAEs, even though they may be developed without the full process of consultation
and exposure used for SASs and SAEs. Auditors should be prepared to explain departures when called upon to do so. |
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Introduction |
1. |
The purpose of this Practice Note (PN) is to provide assistance on inter-bank confirmation procedures to the external
independent auditors and also to bank management, such as internal auditors or inspectors. The guidance contained
in this PN contributes to the effectiveness of inter-bank confirmation procedures and to the efficiency of processing
replies. For the purpose of this PN, reference to banks also include deposit-taking companies registered under
the Banking Ordinance. |
2. |
An important audit step in the examination of bank financial statements and related information is to request direct
confirmation from other banks of both balances and other amounts which appear in the balance sheet and other information
which may not be shown on the face of the balance sheet but which may be disclosed in the notes to the financial
statements. Off balance sheet items requiring confirmation include, such items as guarantees, forward purchase
and sale commitments, repurchase options, and offset arrangements. This type of audit evidence is valuable because
it comes directly from an independent source and, therefore, provides greater assurance of reliability than that
obtained solely from the bank's own records. |
3. |
The auditors, in seeking to obtain inter-bank confirmations, may encounter difficulties in relation to language,
terminology, consistent interpretation and scope of matters covered by the reply. Frequently, these difficulties
result from the use of different kinds of confirmation requests or misunderstandings about what they are intended
to cover. |
4. |
Audit procedures may differ from country to country, and consequently local practices will have relevance to the
way in which inter-bank confirmation procedures are applied. While this PN does not purport to describe a comprehensive
set of audit procedures, nevertheless, it does emphasize some important steps which would be followed in the use
of a confirmation request. |
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The Need for Confirmation |
5. |
An essential feature of management control over business relations, with individuals or groups of financial institutions,
is the ability to obtain confirmation of transactions with those institutions and of the resulting positions. The
requirement for bank confirmation arises from the need of the bank's management and its auditors to confirm the
financial and business relationships between the following: |
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a. |
the bank and other banks within the same country; |
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b. |
the bank and other banks in different countries; and |
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c. |
the bank and its non-bank customers. |
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While inter-bank relationships are similar in nature to those between the bank and a non-bank customer, there may
be special significance in some inter-bank relationships, for example, in connection with certain types of "off
balance sheet" transactions, such as contingencies, forward transactions, commitments and offset agreements. |
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Use of Confirmation Requests |
6. |
The guidance set out in the following paragraphs is designed to assist banks and their auditors to obtain independent
confirmation of financial and business relationships within other banks. However, there may be occasions on which
the approach described within this PN may also be appropriate to confirmation procedures between the bank and its
non-bank customers. The procedures described are not relevant to the routine inter-bank confirmation procedures
which are carried out in respect to the day to day commercial transactions conducted between banks. |
7. |
The auditors would decide from which bank or banks to request confirmation, have regard to such matters as size
of balances, volume of activity, degree of reliance on internal controls, and materiality within the context of
the financial statements. Tests of particular activities of the bank may be structured in different ways and confirmation
requests may, therefore, be limited solely to enquiries about those activities. Requests for confirmation of individual
transactions may either form part of the test of a bank's system of internal control or be a means of verifying
balances appearing in a bank's financial statements at a particular date. Therefore, confirmation requests would
need to be designed to meet the particular purpose for which they are required. |
8. |
The auditors would determine which one of the following approaches is the most appropriate in seeking confirmation
of balances or other information from another bank: |
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a. |
listing balances and other information, and requesting confirmation of their accuracy and completeness, or |
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b. |
requesting details of balances and other information, which can then be compared with the requesting bank's records. |
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In determining which one of the above approaches is the most appropriate, the auditors would weigh the quality
of audit evidence they require in the particular circumstances against the practicality of obtaining a reply from
the confirming bank. |
9. |
Difficulty may be encountered in obtaining a satisfactory response even where the requesting bank submits information
for confirmation to the confirming bank. It is important that a response be sought for all confirmation requests.
It is not usual practice to request a response only if the information submitted is incorrect or incomplete. |
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Preparation and Dispatch of Requests and Receipt of Replies |
10. |
The auditors would determine the appropriate location to which the confirmation request should be sent, for example
a department, such as internal audit, inspection and other specialist department, which may be designated by the
confirming bank as responsible for replying to confirmation requests. It may be appropriate, therefore, to direct
confirmation requests to the head office of the bank (in which such departments are often located) rather than
to the location where balances and other relevant information are held. In other situations, the appropriate location
may be the local branch of the confirming bank. |
11. |
Whenever possible, the confirmation request would be prepared in the language of the confirming bank or in the
language normally used for business purposes. |
12. |
Control over the content and dispatch of confirmation requests is the responsibility of the auditors. However,
it will be necessary for the request to be authorized by the requesting bank. Replies are required to be returned
directly to the auditors and to facilitate such a reply, a pre-addressed envelope would be enclosed with the request. |
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Content of Confirmation Requests |
13. |
The form and content of a confirmation request letter will depend on the purpose for which it is required, on local
practices and on the requesting bank's account procedures, for example, whether or not it makes extensive use of
electronic data processing. |
14. |
The confirmation request would need to be prepared in a clear and concise manner to ensure ready comprehension
by the confirming bank. |
15. |
Not all information for which confirmation is usually sought will be required at the same time. Accordingly, request
letters may be sent at various times during the year dealing with particular aspects of the inter-bank relationship. |
16. |
The most commonly requested information is in respect of balances due to or from the requesting bank on current,
deposit, loan and other accounts. The request letter would provide the account description, number and the type
of currency for the account. It may also be advisable to request information about nil balances on correspondent
accounts, and correspondent accounts which were closed in the twelve months prior to the chosen confirmation date.
The requesting bank may ask for confirmation not only of the balances on accounts but also, where it may be helpful,
other information, such as the maturity and interest terms, unused facilities, lines of credit/standby facilities,
any offset or other rights or encumbrances, and details of any collateral given or received. |
17. |
An important part of banking business relates to the control of those transactions commonly designated as "off
balance sheet." Accordingly, the requesting bank and its auditors are likely to request confirmation of contingent
liabilities, such as those arising on guarantees, comfort letters and letters of undertaking, bills, own acceptances,
and endorsements. Confirmation may be sought both of the contingent liabilities of the requesting bank to the confirming
bank and of the confirming bank to the requesting bank. The details supplied or requested should describe the nature
of the contingent liabilities together with their currency and amount. |
18. |
Confirmation of asset repurchase and resale agreements and options outstanding at the relevant date would also
be sought. Such confirmation would need to describe the asset covered by the agreement, the date the transaction
was contracted, its maturity date, and the terms on which it was completed. |
19. |
Another category of information, for which independent confirmation is often requested at a date other than the
transaction date, concerns forward currency, bullion, securities and other outstanding contracts. It is well established
practice for banks to confirm transactions with other banks as they are made. However, it is the practice for audit
purposes to confirm independently a sample of transactions selected from a period of time or to confirm all the
unmatured transactions with a counterparty. The request would need to give details of each contract including its
number, the deal date, the maturity or value date, the price at which the deal was transacted and the currency
and amount of the contract bought and sold, to and from, the requesting bank. |
20. |
Banks often hold securities and other items in safe custody on behalf of customers. A request letter may thus ask
for confirmation of such items held by the confirming bank, at a specific date. The confirmation would need to
include a description of the items and the nature of any encumbrances or other rights over them. |
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Compatibility with International Auditing Practice Statements |
21. |
This Practice Note is, in all material respects, in accordance with International Auditing Practice Statement 1000
"Inter-Bank Confirmation Procedures". |
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Appendix - Glossary
This Appendix defines certain terms used in this PN. The list is not intended to include all terms used in
an inter-bank confirmation request. Definitions have been given within a banking context, although usage and legal
application may differ.
Collateral
Security given by a borrower to a lender as a pledge for repayment of a loan, rarely given in the case of inter-bank
business. Such lenders thus become secured creditors; in the event of default, such creditors are entitled to proceed
against collateral in settlement of their claim. Any kind of property may be employed as collateral. Examples of
collateral are: real estate, bonds, stocks, notes, acceptances, chattels, bills of lading, warehouse receipts and
assigned debts.
Contingent Liabilities
Potential liabilities, which only crystallize upon the fulfillment of or the failure to fulfill certain conditions.
They may arise from the sale, transfer, endorsement, or guarantee of negotiable instruments or from other financial
transactions. For example, they may result from:
- re-discount of notes receivable, trade and bank acceptances arising under commercial letters of credit;
- guarantees given; or
- letters of support or comfort.
Encumbrance
A claim or lien, such as a mortgage upon real property, which diminishes the owner's equity in the property.
Offset
The right of a bank, normally evidenced in writing, to take possession of any account balances that a guarantor
or debtor may have with it to cover the obligations to the bank of the guarantor, debtor or third party.
Options
The right to buy or sell or to both buy and sell securities or commodities at agreed prices, within a fixed duration
of time.
Repurchase (or Resale) Agreement
An agreement between seller and buyer that the seller (or buyer) will buy (or sell) back notes, securities, or
both property at the expiration of a period of time, or the completion of certain conditions, or both.
Safe Custody
A facility offered by banks to their customers to store valuable property for safe keeping.
Line of Credit/Standby Facility
An agreed maximum amount of funds which a bank has made or undertakes to make available over a specified period
of time.
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