Audit of the Sales and Collection

Cycle: Tests of Controls and

Substantive Tests of Transactions
Chapter 14

Learning Objective 1
Identify the accounts and the classes of
transactions in the sales and collection cycle.

Accounts in the Sales and Collection

Cycle

Learning Objective 2
Describe the business functions and the related
documents and records in the sales and
collection cycle.

Sales Transaction
Accounts

Sales
Accounts
receivable

Business Functions Documents and Records

Processing
customer orders
Granting credit
Shipping goods
Billing customers
and recording
sales

Customer order
Sales order
Customer order or
sales order
Shipping document
Sales invoice
Sales transaction file
Sales journal or listing
Accounts receivable
master file
Accounts receivable
trial balance
Monthly statements

Cash Receipts Transaction

Accounts

Cash in bank
(debits from
cash receipts)
Accounts
receivable

Business Functions Documents and Records

Processing and
recording cash
receipts

Remittance advice
Prelisting of cash
receipts
Cash receipts
transaction file
Cash receipts journal
or listing

Sales Returns and Allowances

Transaction
Accounts

Sales returns
and
allowances
Accounts
receivable

Business Functions Documents and Records

Processing and
recording sales
returns and
allowances

Credit memo
Sales and returns and
allowances journal

Write-off of Uncollectible Accounts

Transaction
Accounts

Accounts
receivable
Allowance for
uncollectible
accounts

Business Functions Documents and Records

Writing off
uncollectible
accounts
receivable

Uncollectible account
authorization form
General journal

Bad Debt Expense Transaction

Accounts

Bad debt
expense
Allowance for
uncollectible
accounts

Business Functions Documents and Records

Providing for bad

debts

General journal

Processing Customer Orders

Customer Order:
A request for merchandise by a customer
Sales Order:
A document describing the goods ordered
by a customer

Granting Credit
Before goods are shipped, a properly
authorized person must approve credit
to the customer for sales on account

Shipping Goods
This is the first point in the cycle
at which the company gives up assets.
One type of shipping document is a
bill of lading.
Bills of lading are often transmitted once
goods have been shipping

Billing Customers and Recording Sales

Sales
transaction
file

Accounts
receivable
file

Accounts
receivable
trial balance

Sales
journal

Processing and Recording Cash

Receipts

Remittance advice

Prelisting
of
Cash
receipts

Cash receipts
transaction
file
Cash receipts listing

Processing and Recording Sales

Returns and Allowances
Credit memo
Sales returns and allowances journal

Writing Off Uncollectible

Accounts Receivable
Uncollectible account authorization form

This is a document used internally to

indicate authority to write an account
receivable off as uncollectible

Providing for Bad Debts

This provision represents a residual,
resulting from managements
end-of-period adjustment of the
allowance for uncollectible accounts

Learning Objective 3
Understand internal control, and design and
perform tests of controls and substantive tests
of transactions for sales.

Methodology for Designing Controls and

Substantive Tests
Understand internal control sales
Assess planned control risk sales
Determine extent of testing controls
Design tests of controls and
substantive tests of transactions
for sales to meet transactionrelated audit objectives

Audit procedures
Sample size
Items to select
Timing

Understand Internal Control Sales

Study the clients flowcharts, prepare
an internal control questionnaire, and
perform walk-through tests of sales.

Assess Planned Control Risk Sales

1. Framework for assessing control risk
2. Identify key internal controls and deficiencies
3. Associate controls and deficiencies with the
objectives
4. Assess control risk for each objective

Assess Planned Control Risk Sales

Adequate separation of duties
Proper authorization
Adequate documents and records
Pre-numbered documents
Monthly statements
Internal verification procedures

Determine Extent of Testing Controls

Control
effectiveness
Control
risk

Direction of Tests for Sales

Transaction-related Audit
Objectives for Sales
Occurrence:
Recorded sales are for shipments actually made.
Completeness:
Existing sales transactions are recorded.
Accuracy:
Recorded sales are for the
amount shipped.

Transaction-related Audit
Objectives for Sales
Posting and summarization:
Sales transactions are correctly included
in the accounts receivable master file.
Classification:
Sales transactions are correctly classified.
Timing:
Sales are recorded on the
correct dates.

COSO Report Identifies Revenue

Misstatement Techniques
Sham sales

Improper
% of completion

Improper
sales cutoff

Fraudulent
Techniques

Premature
revenue
recognition
Unauthorized
shipments

Bill and hold

Conditional sales
Round-tripping
loans as sales

Consignment
sales

Summary of Methodology
for Sales
Identify key transaction-related audit objectives
Determine key existing controls
Design tests of controls to verify effectiveness
Evaluate any control deficiencies
Determine extent of substantive tests
of transactions

Learning Objective 4
Apply the methodology for controls over sales
transactions to controls over sales returns
and allowances.

Sales Returns and Allowances

The transaction-related audit objectives and
clients methods of controlling misstatements
are essentially the same for processing credit
memos as those described for sales.

Sales Returns and Allowances

There are, however, two important differences:

Materiality

Emphasis
on
objectives

Learning Objective 5
Understand internal control, and design and
perform tests of controls and substantive
tests of transactions for cash receipts.

Tests of Controls and Substantive Tests of

Transactions for Cash Receipts
Determine whether cash received was recorded
Prepare proof of cash receipts*
Test to discover lapping of accounts receivable*

* Only performed when fraud is suspected

Learning Objective 6
Apply the methodology for controls over the
sales and collection cycle to write-offs of
uncollectible accounts receivable.

Audit Tests for the Write-Off

of Uncollectible Accounts
Occurrence transaction-related audit objective
Proper authorization of the write-off of
uncollectible accounts
Verification of accounts written off

Effect of Results of Controls and Substantive

Tests of Transactions
The parts of the audit most affected by the
tests for the sales and collection cycle are:

Allowance for
doubtful accounts

Accounts
receivable

Bad debt expense

Cash

Types of Audit Tests for the Sales and

Collection Cycle
Sales

Accounts
Cash in
Receivable
Bank
Sales
Cash receipts
transactions
transactions

Audited by
TOC, STOT, and AP

Ending
balance

Audited by
TOC, STOT, and AP

Ending
balance

Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient appropriate evidence

End of Chapter 14

Completing the Tests

in the Sales and Collection Cycle:
Accounts Receivable
Chapter 16

Learning Objective 1
Describe the methodology for designing tests of
details of balances using the audit
risk model.

Accounts Receivable Balance-related

Audit Objectives
Detail tie-in
Rights

Existence

Completeness

A/R
Audit
Objectives

Realizable value

Cutoff

Accuracy
Classification

Methodology for Designing Tests

of Details of Balances for A/R
Phase I

Identify client
business risks
affecting
Accounts
Receivable

Set tolerable
misstatement
and assess
inherent risk
for accounts
receivable

Assess
control risk
for sales and
collection
cycle

Methodology for Designing Tests

of Details of Balances for A/R
Phase II

Design and perform tests of controls and

substantive tests of transactions
for the sales and collection cycle

Methodology for Designing Tests

of Details of Balances for A/R
Phase III
Design and perform
analytical procedures
for accounts
receivable
Audit
procedures

Sample
size

Design tests of details of

accounts receivable
balance to satisfy balancerelated objectives

Items to
select

Timing

Occurrence
Completeness
Accuracy
Posting and
summarization
Classification
Timing

Rights

Realizable
value

Cutoff

Classification

Accuracy

Sales

Completeness

Translation-related
audit objectives

Existence

ACCOUNTS RECEIVABLE
BALANCE-RELATED
AUDIT OBJECTIVES

Detail tie-in

Relationship Between Sales and

Accounts Receivable

Occurrence
Completeness
Accuracy
Posting and
summarization
Classification
Timing

Rights

Realizable
value

Cutoff

Classification

Accuracy

Cash receipts

Completeness

Translation-related
audit objectives

Existence

ACCOUNTS RECEIVABLE
BALANCE-RELATED
AUDIT OBJECTIVES

Detail tie-in

Relationship Between Sales and

Accounts Receivable

Learning Objective 2
Design and perform analytical procedures for
accounts in the sales and collection cycle.

Analytical Procedures for the Sales and

Collection Cycle
Compare by product line:

Gross margin percentage with

previous years

Sales by month over time

Sales returns and allowances

as a percentage of gross sales
with previous years

Analytical Procedures for the Sales and

Collection Cycle
Compare with previous years:

Individual customer balances over

a stated amount

Bad debt expense as a percentage

of gross sales

Days that accounts receivable

are outstanding

Analytical Procedures for the Sales and

Collection Cycle
Compare with previous years:

Aging category as a percentage

of receivables

Allowance for uncollectible accounts as

a percentage of accounts receivable

Write-off of uncollectible accounts as a

percentage of total accounts receivable

Selected Comparative Information

Percent
Percent
change
12/31/11 change 12/31/10 2009- 12/31/09
($000) 2010-11 ($000) 2010
($000)
Sales
Gross margin
Accounts receivable
Bad debt expense
Total current assets
Total assets
Net earnings
Number of accounts
receivable
Number of accts. rec. with
balances over $100,000

144,328
39,845
20,197
3,323
51,027
61,367
5,681

9.0 132,421 7.0 123,737

36,350 7.0 33,961
9.6
18,827 14.1 16,505
7.3
3,162
3,394 7.3
(2.1)
44,779 6.6 41,989
14.0
(7.0) 66,021 8.0 61,147
3,351
4,659 39.0
21.9

258

16.7

221

5.7

209

37

15.6

32

6.7

30

Analytical Procedures: Sales and

Collection Cycle

Design and Perform Tests of Details of A/R

Balance (Phase III)
Planned detection risk for each
objective is an auditor decision
Combining the factors that determine
planned detection risk is complex

Learning Objective 3
Design and perform tests of details of balances
for accounts receivable.

Designing Tests of Detail

of Balances
Accounts receivable are correctly added and
agree with the Master File and the General
Ledger (aged trial balance).
Recorded accounts receivable exist
Existing accounts receivable are included

Designing Tests of Detail

of Balances
Accounts receivable are accurate
Accounts receivable are properly classified
Cutoff for accounts receivable is correct

Designing Tests of Detail

of Balances
Accounts receivable is stated at
realizable value
The client has rights to accounts receivable
Accounts receivable presentation and
disclosure

Learning Objective 4
Obtain and evaluate accounts receivable
confirmations.

Confirmation Requirements
Auditing Standards
United States

International

Required Except
when:

Confirmations not
required

Expected low
response rate
Low inherent &
control risks

Alternate
Procedures

Type of Confirmation
Positive confirmation
Blank confirmation form
Invoice confirmation
Negative confirmation

Positive Confirmation

Negative Confirmation Requirements

Risk of material misstatement is low
Large number of small account balances
Expected low exception rate
Expect adequate consideration from
recipients

Negative Confirmation

Timing
The most reliable evidence from confirmations
is obtained when they are sent as close to the
balance sheet date as possible.

Sampling Decisions
Tolerable
misstatement
Inherent Risk

Control Risk

Sample
Size factors
Type of
Confirmation

Achieved
Detection
risk from
other tests

Verifying Addresses and Maintaining

Control
The auditor should perform procedures to
verify the addresses or email addresses
used for confirmation.
Auditors must be responsible for mailing
the confirmations and maintaining control
of the confirmations until they are returned
from the customer.

Follow-up on Nonresponses
When positive confirmations are used,
AU 330 requires follow-up procedures
for confirmations not returned by
the customer.
Alternate Procedures

Subsequent
cash receipts

Duplicate
sales invoices

Shipping
documents

Analysis of Differences
Payment-in-transit
Shipment-in-transit
The goods have been returned
Errors and disputes

Drawing Conclusions
Reevaluate internal control
Evaluate the qualitative nature of
misstatements
Determine whether sufficient evidence
was obtained

Learning Objective 5
Design audit procedures for the audit of
accounts receivable, using an evidence
planning worksheet as a guide.

Evidence Planning Worksheet

End of Chapter 16

Audit Sampling for Tests of Controls and

Substantive Tests of Transactions
Chapter 15

Learning Objective 1
Explain the concept of representative sampling.

Representative Samples
A representative sample is one in which
the characteristics in the sample of audit
interest are approximately the same as
those of the population.
In practice, an auditor can increase the
likelihood of a representative sample by
using care in designing the sampling
process and selection, and evaluating
the results.

Sampling Risks
Sampling risk is the risk that an auditor
reaches an incorrect conclusion because
the sample is not representative of the
population.
Nonsampling risk is the risk that audit
tests do not uncover existing exceptions
in the sample.

Minimizing Sampling Risk

Sampling Risk Meter

Step 1

Adjust
sample size

Step 2

Use
appropriate
sample
selection
method

Learning Objective 2
Distinguish between statistical and nonstatistical
sampling and between probabilistic and
nonprobabilistic sample selection.

Statistical Versus Nonstatistical

Sampling
Similarities of both approaches:
Step 2
Step 1

Plan the
sample

Select the
sample and
perform the
tests

Step 3

Evaluate the
results

Statistical Versus Nonstatistical

Sampling
Differences in approach:
Statistical sampling allows the quantification
of sampling risk in planning the sample (Step 1)
and evaluating the results (Step 3)
In nonstatistical sam pling those items that
the auditor believes will provide the most
useful information are selected

Probabilistic Versus Nonprobabilistic Sample

Selection
P robabilistic sam ple selection is a method
of selecting a sample such that each
population item has a known probability
of being included in the sample.

Nonprobabilistic sample selection is a

method in which the auditor uses professional
judgment rather than probabilistic methods.

Probabilistic Versus Nonprobabilistic Sample

Selection
Nonprobabilistic selection methods:
1. Directed sample selection
2. Block sample selection
3. Haphazard sample selection

Probabilistic Versus Nonprobabilistic Sample

Selection
Probabilistic selection methods:
1. Simple random sample selection
2. Systematic sample selection
3. Probability proportional to size sample selection
4. Stratified sample selection

Nonprobabilistic Sample
Selection Methods
Directed sam ple selection is the selection of

each item based on auditors judgmental criteria.

Items most likely to contain misstatements
Items containing selected population characteristics
Large dollar coverage

Nonprobabilistic Sample
Selection Methods
Block sample selection is the selection
of several items in sequence.
Haphazard sample selection is the
selection of items without any conscious
bias on the part of the auditor.

Learning Objective 3
Select representative samples.

Probabilistic Sample Selection

Methods
A simple random sample is one in which
every possible combination of elements
in the population has an equal chance
of constituting the sample.
Random number tables
Computer generation of random numbers
offers several advantages
time savings
reduced risk of error
automatic documentation

Random Sample Selection Tools

Random number tables
Computer generation of random
numbers offers several advantages
time savings
reduced risk of error
automatic documentation

Probabilistic Sample Selection

Methods
Systematic sample selection:
The auditor calculates an interval and
then selects the items for the sample
based on the size of the interval.
The interval is determined by dividing
the population size by the number of
sample items desired.

Probabilistic Sample Selection

Methods
Probability proportional to size:
A sample is taken where the probability
of selecting any individual population item
is proportional to its recorded amount (PPS).

Learning Objective 4
Define and describe audit sampling for
exception rates.

Sampling for Exception Rates

The occurrence rate, or exception rate,
is the percent of items in the population
containing the characteristic or specific
attribute of interest to the total number
of population items.

Sampling for Exception Rates

Following are types of exceptions in
populations of accounting data:
1. Deviations from clients established controls
2. Monetary misstatements in populations
of transaction data
3. Monetary misstatements in populations of
account balance details

Learning Objective 5
Use nonstatistical sampling in tests of controls
and substantive tests of transactions.

Terms Used in Audit Sampling

Terms related to planning:
Characteristic or attribute
Acceptable risk of assessing control risk too
low (ARACR)
Tolerable exception rate (TER)
Estimated population exception rate (EPER)
Initial sample size

Terms Used in Audit Sampling

Terms related to evaluating results:
Exception
Sample exception rate (SER)
Computed upper exception rate (CUER)

I: Plan the Sample

Step 1

Step 2

Step 3

State the
objectives
of the
audit test.

Decide
whether
audit
sampling
applies.

Define
attributes
and
exception
conditions

Step 4

Define the
population

Step 5

Define the
sampling unit

I: Plan the Sample

Step 7

Step 6

Specify the
tolerable
exception
rate.
Step 8

Estimate the
population
exception
rate.

Specify
acceptable
risk of
assessing
control risk
too low
Step 9

Determine
the initial
sample size

II: Select the Sample and Perform the

Audit Procedures
Step10

Select the
sample

Step 11

Perform the
audit
procedures

III: Evaluate the Results

Step 12

Generalize
from the
sample to
the
population

Step 13

Analyze
exceptions

Step 14

Decide the
acceptability
of the
population

Guidelines for ARACR and TER Tests of

Controls

Guidelines for ARACR and TER Tests of

Transactions

Effect on Sample Size of Changing

Factors
Type of change

Effect on initial
sample size

Increase acceptable risk of

assessing control risk too low
Increase tolerable risk rate
Increase estimated population
exception rate
Increase population size

(minor)

Actions When Population is

Not Acceptable
Revise TER or ARACR
Expand the sample size
Revise assessed control risk
Communicate with the audit
committee or management

Summary of Audit Sampling Steps

Compare

To/From
Step 6

Plan the sample

(Steps 1-9)

Computed
upper
exception
rate

From
Step 12

Select the sample

(Step 10)

To Step 14

Perform the tests

(Step 11)
Evaluate the results
(Steps 12-14)

Number of
exceptions
in sample
and actual
sample size
To Step 12

Learning Objective 6
Define and describe attributes sampling and a
sampling distribution.

Statistical Audit Sampling

The statistical sampling method most
commonly used for tests of controls
and substantive tests of transactions
is attributes sampling.

Sampling Distribution
It is a frequency distribution of the results
of all possible samples of a specified size
that could be obtained from a population
containing some specific parameters.
Attributes sampling is based on the
binomial distribution.

Sampling Distribution

Learning Objective 7
Use attributes sampling in tests of controls and
substantive tests of transactions.

Application of Attributes Sampling

Use of the tables:
i.
ii.
iii.
iv.

Select the table corresponding to the ARACR

Locate the TER on the top of the table
Locate the EPER in the far left column
Read down the appropriate TER column until
it intersects with the appropriate EPER row
in order to get the initial sample size

Application of Attributes Sampling

Effect of population size:
Population size is a minor consideration
in determining sample size
Representativeness is ensured by the sample
selection process more than by sample size

Application of Attributes Sampling

Select the sample
Perform the audit procedures
Evaluate the results

End of Chapter 15

Audit Sampling for Tests of Details of

Balances
Chapter 17

Learning Objective 1
Differentiate audit sampling for tests of details
of balances and for tests of controls and
substantive tests of transactions.

Tests of Details of Balances

and Controls, and Substantive
Tests of Transactions
Differences among tests
Type of Test

What It Measures

Controls

Effectiveness of
controls

Transactions

Monetary correctness
of transactions

Balances

Existence of material
misstatements

Learning Objective 2
Apply nonstatistical sampling to tests of details
of balances.

Nonstatistical Sampling
14 steps required in audit sampling for
tests of details of balances.
Steps parallel the sampling approach
used to test controls and/or test
transactions.
There are a few differences because
of the different objectives of the tests.

Comparison of the 14 Steps

Audit sampling for tests
of details of balances
1. State the objectives
of the audit test.
2. Decide whether audit
sampling applies.

3. Define a m isstatem ent.

4. Define the population.
5. Define the sampling unit.

Audit sampling for tests of

controls and substantive
tests of transactions
1. State the objectives
of the audit test.
2. Decide whether audit
sampling applies.
3. Define attributes and
exception conditions.
4. Define the population.
5. Define the sampling unit.

Comparison of the 14 Steps

Audit sampling for tests
of details of balances

6. Specify tolerable
m isstatem ent .
7. Specify acceptable risk

of incorrect acceptance .

8. Estim ate m isstatem ents

in the population.
9. Determine the initial
sample size.

Audit sampling for tests of

controls and substantive
tests of transactions
6. Specify the tolerable
exception rate.
7. Specify acceptable risk
of assessing control
risk too low.
8. Estimate the population
exception rate.
9. Determine the initial
sample size.

Comparison of the 14 Steps

Audit sampling for tests of
Audit sampling for tests
controls and substantive
tests of transactions
of details of balances
10. Select the sample.
10. Select the sample.
11. Perform the audit
11. Perform the audit
procedures.
procedures.
12. Generalize from the
12. Generalize from the
sample to the population.
sample to the population.
13. Analyze the m isstatem ents. 13. Analyze the exceptions.
14. Decide the acceptability
14. Decide the acceptability
of the population.
of the population.

Action When a Population

Is Rejected

Take no action until tests of other audit areas

are completed
Perform expanded audit tests in specific areas
Increase the sample size
Adjust the account balance
Request the client to correct the population
Refuse to give an unqualified opinion

Learning Objective 3
Apply monetary unit sampling.

Monetary Unit Sampling

MUS is an innovation in statistical
sampling methodology that was
developed specifically for use
by auditors.

Differences between MUS

and Nonstatistical Sampling
The definition of the sampling unit
is an individual dollar.
The population size is the recorded
dollar population.
Preliminary judgment of materiality
is used for each account instead of
tolerable misstatement.

Differences between MUS

and Nonstatistical Sampling
Sample size is determined using a
statistical formula.
A formal decision rule is used for
deciding the acceptability
of the population.
Sample selection is done using
probability proportional to size
sample selection (PPS).

Differences between MUS

and Nonstatistical Sampling
The auditor generalizes from the
sample to the population using MUS
techniques.
Attribute sampling tables are used to
calculate results
Attribute results must be converted to
dollars
Make an assumption about the % of
misstatement for each item misstated
Determine misstatement bounds.

Generalizing from the Sample

to the Population
Assumption 1:
Population is $1,200,000
Sample size is 100 customer accounts
Overstatement amounts equal 100%.
Understatement amounts equal 100%.
Misstatement bounds at a 5% ARIA are:
Upper misstatement bound
= $1,200,000 3% 100% = $36,000
Lower misstatement bound
= $1,200,000 3% 100% = $36,000

Generalizing from the Sample

to the Population
The following two conditions both have to
exist before the $36,000 correctly reflects
the true overstatement amount:
1. All amounts have to be overstatements.
2. All population items misstated have to
be 100% misstated.

Generalizing from the Sample

to the Population
Assumption 2:
Overstatement amounts equal 10%.
Understatement amounts equal 10%.
Misstatement bounds at a 5% ARIA are:
Upper misstatement bound
= $1,200,000 3% 10% = $3,600
Lower misstatement bound
= $1,200,000 3% 10% = $3,600

Generalizing from the Sample

to the Population
Assumption 3:
Overstatement amounts equal 20%.
Understatement amounts equal 200%.
Misstatement bounds at a 5% ARIA are:
Upper misstatement bound
= $1,200,000 3% 20% = $7,200
Lower misstatement bound
= $1,200,000 3% 200% = $72,000

Appropriate Percent of Misstatement

Assumption
The appropriate assumption for the overall
percent of misstatement in those population
items containing a misstatement is an
auditors decision.

Generalizing When Misstatements Are

Found
1. Overstatement and understatement
amounts are dealt with separately
and then combined.
2. A different misstatement assumption
is made for each misstatement,
including the zero misstatements.

Generalizing When Misstatements Are

Found
3. The auditor must deal with layers of the
computed upper exception rate (CUER)
from the attributes sampling table.
4. Misstatement assumptions must be
associated with each layer.

Illustration of the Auditors Decision

Rule for MUS

Determining Sample Size Using

MUS
Materiality
Assumption of the average percent
of misstatement for population items
that contain a misstatement
Acceptable risk of incorrect acceptance
Recorded population value

Determining Sample Size Using

MUS
Estimate of the population exception rate
Relationship of the audit risk model
to sample size for MUS

P DR = AAR (I R CR )

Advantages of Using MUS

MUS increases the likelihood of selecting
high-dollar items
MUS often reduces the cost of audit testing
Easy to apply
MUS provides a statistical conclusion

Learning Objective 4
Describe variables sampling.

Frequency of values in percent

Frequency Distribution of Sample

Means

Value of x in dollars

Sampling Distributions
Three things shape the results of the
experiment of taking a large number of samples
from a known population:
1. The mean value of all the sample means
is equal to the population mean ( ).
X

Sampling Distributions
2. The shape of the frequency distribution
of the sample means is that of a normal
distribution (curve), as long as the sample
size is sufficiently large, regardless of the
distribution of the population .
3. The percentage of sample means between
any two values of the sampling
distribution is measurable.

Mean

Sampling
distribution
Normal
Population
distribution
Skewed

Value of

Frequency of values in percent

Sampling Distribution for

a Population Distribution

in dollars

Variables Methods
Difference estimation
Ratio estimation
Mean-per-unit estimation

Stratified Statistical Methods

All of the elements of the population are
divided into two or more subpopulations
Each subpopulation is independently tested
The calculations are then made for each
stratum and then combined into one overall
population estimate

Sampling Risks (ARIA and ARIR)

Actual audit decision

Actual state of the population

Materially
Not materially
misstated
misstated

Conclude that the

population is
materially misstated

Correct
conclusion
no risk

Incorrect
conclusion
risk is ARIR

Conclude that the

population is not
materially misstated

Incorrect
conclusion
risk is ARIA

Correct
conclusion
no risk

Learning Objective 5
Use difference estimation in tests of details of
balances.

Plan the Sample and Calculate

the Sample Size
State the objectives of the audit test
Decide whether audit sampling applies
Define misstatement conditions
Define the population
Define the sampling unit
Specify tolerable misstatement

Specify Acceptable Risk

ARIA

ARIR

Estimate Misstatement
in the Population
1. Estimate an expected point estimate
2.Make an advance population standard deviation
estimate variability of the population.

Calculate the Initial

Sample Size
n=
where:

SD*(ZA + ZR)N
(TM E *)

= initial sample size

SD* = advance estimate of the standard deviation
Z A = confidence coefficient for ARIA
Z R = confidence coefficient for ARIR
N
= population size
TM = tolerable misstatement for the population (materially)
E * = estimated point estimate of the population misstatemen

Select the Sample and Perform the

Procedures
The auditor must use one of the
probabilistic sample selection methods
to select the items for confirmation.
The auditor must use care in confirming
and performing alternative procedures.

Evaluate the Results

Generalize from the sample to the population
1. Compute the point estimate of the
total misstatement
2. Compute an estimate of the population
standard deviation
3. Compute the precision interval
4. Compute the confidence limits

Effect of Changing Each Factor

Type of change
Increase ARIA
Increase the point estimate
of the misstatements
Increase the standard dev.
Increase the sample size

Effect on the com puted

precision interval

Analyze the Misstatements

The auditor must evaluate misstatements to
determine the cause of each misstatement
and decide whether modification of the
audit risk model is needed.

Auditors Decision Rule for

Difference Estimation

End of Chapter 17