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You are on page 1of 13

by Kim Smith

01 May 1999

This article deals with the audit methodologies of audit sampling and other selective

testing procedures from both theoretical and practical perspectives. The paper 6, Audit

Framework Teaching Guide includes:

• comparison of judgement and statistical sampling;

• attribute sampling for tests of controls;

• variables sampling for substantive procedures; and

• professional guidance.

This is assumed knowledge at paper 10, Accounting and Audit Practice, where students

should be able to “explain the use of audit sampling in the conduct of an audit”.

On the theoretical side, the professional guidance referred to is SAS 430, Auditing

Sampling (UK Stream) and ISA 530, Audit Sampling and Other Selective Testing

Procedures (International Stream).

On the practical side, audit efficiency relies on obtaining the minimum audit evidence,

sufficient to form the audit opinion, as cost effectively as possible. To this end,

formalised audit sampling procedures have been developed and become commonplace

in the majority of audit firms. The use of audit sampling, on all audit assignments, offers

innumerable benefits to all auditors. These include:

• providing a framework within which sufficient audit evidence is obtained;

• forcing clarification of audit thinking in determining how the audit objectives

will be met;

• minimising the risk of over-auditing; and

• facilitating more expeditious review of working papers.

Nature of sampling

Audit evidence is obtained by carrying out audit tests which may be classified as ‘non-

sampling’ or ‘sampling’.

A definition — Audit sampling is the testing of less than 100% of the items within a population to

obtain and evaluate evidence about some characteristic of that population, in order to form a

conclusion concerning the population.

It is crucial that the items selected should be representative, in order to be able to form a

conclusion on the entire population. For if a test is applied only to those items which

have a specific feature (e.g., all customer’s balances exceeding $20,000) this constitutes

100% examination of a sub-population (or selective testing of high-value items) and the

results cannot be projected to the whole population.

Both statements of standards concern audit sampling in general i.e., both statistical and

non-statistical sampling. (It is a common misconception that these standards concern

only statistical sampling.) However, the ISA considers selective testing other than audit

sampling in more detail than the SAS.

The ISA definition of audit sampling specifically states that “all sampling units have a

chance of selection”. Thus, 100% examination and selecting specific items are clearly

non-sampling procedures.

• analytical procedures;

• tests in total (also called proofs in total or logic tests) i.e., calculations of

reasonableness based on independently verified data;

• ‘walk-through’ tests, i.e., tracing a few transactions in order to obtain knowledge

and understanding of the design and operation of accounting and internal control

systems; and

• other selective testing of specific items, e.g., high-value, key and unusual (but

not representative) items.

of detection risk which determines the required level of substantive procedures (see

“Audit strategy”, G. Cosserat, Students’ Newsletter, February 1999). The other

component of detection risk is then non-sampling risk.

A definition — Sampling risk is the risk that the sample is not representative of the population

from which it is drawn and thus the auditor’s conclusion is different to that which would be

reached if the whole population was examined.

(a) ‘the risk of incorrect rejection’ (also called Alpha risk) which arises when the sample

indicates a higher level of errors than is actually the case. This situation is usually

resolved by additional audit work being performed. This risk affects audit efficiency but

should not affect the validity of the resulting audit conclusion;

(b)‘the risk of incorrect acceptance’ (also called Beta risk) when material error is not

detected in a population because the sample failed to select sufficient items containing

errors. This risk, which affects audit effectiveness, can be quantified using statistical

sampling techniques. Although it is possible that an unqualified auditors’ report could be

issued inappropriately, such errors should be detected by other complementary audit

procedures (assuming that the sample size is appropriate to the level of detection risk).

Non-sampling risk is the component of detection risk that is not due to examining only a

portion of the data. Examples of sources of non-sampling risk include:

reliance on analytical procedures; and

• placing reliance on management representations as a substitute for other audit

evidence that could reasonably be expected to be available.

Selective testing which does not constitute audit sampling (e.g., selection of risk-prone

items) is also subject to non-sampling risk. ISA 530 defines non-sampling risk as the

risk which “arises from factors that cause the auditor to reach an erroneous conclusion

for any reason not related to the size of the sample”. Thus non-sampling risk can also

arise, for example, if the auditor fails to recognise an error in an individual item in a

sample. The auditor seeks to minimise the risk of erroneous conclusions by proper

planning, supervision and review.

20 chance of material error going undetected (this is the risk accepted by many audit

firms for any specific audit tests). Risk can also be expressed in terms of confidence

levels (assurance required) and reliability factors.

A confidence level is the degree of assurance that material error does not exist; it is the

converse of risk.

Reliability (R-) factors are derived from the Poisson sampling distribution (a distribution

of ‘rare events’) and are related to risk percentages as shown in Figure 1. Note the

‘inverse’ nature of the relationship between R-factors and risk and that a confidence

level is the mathematical complement of risk.

The use of R-factors (and related methods) is popular. It makes determination of sample

size easy, avoids the need to carry statistical tables and is compatible with the Audit

Risk Model as illustrated in Figure 2. In this illustration, the risk of errors arising

(inherent risk) is high, but assurance is planned to be obtained from tests of control. The

auditor’s tests of detail will therefore be planned at a level corresponding to sampling

risk of not more than 14% (see Figure 4 later).

Deciding to sample

When planning the audit procedures to be adopted, the decision to sample account

balances and transactions is influenced by:

• inherent risk (of errors arising);

• relevance and reliability of evidence available through non-sampling procedures;

and

• costs and time involved.

sampling and non-sampling procedures should be determined. Audit sampling

procedures are effected in four stages:

1 sample design;

2 sample selection;

3 testing (i.e., performing the audit procedure); and

4 evaluation.

1 Sample design

Sample design, which may be set out in a sample plan, includes consideration of:

• population from which the sample is to be drawn;

• sampling unit;

• results or conditions that will be regarded as errors or deviations;

• sample size.

Population

A definition – Population is the entire set of data from which a sample is selected and about

which the auditor wishes to draw a conclusion.

A population may be ‘stratified’, that is, divided up into sub-populations. Each sub-

population is a group of sampling units having similar characteristics. For example,

current debts, debts 1–3 months overdue, debts 3–6 months overdue and debts more than

6 months overdue.

For tests of control the population must have the same control characteristics. So, for

example, supplier’s invoices for raw materials will be distinct from supplier’s invoices

for services because the former should evidence the receipt of goods.

For substantive procedures the population could be a list of ledger balances or debit

entries to individual ledger accounts or all transactions of a particular type (e.g., weekly

wages).

Sampling unit

For example, an account balance, a debit (or credit) entry on a bank statement, a goods

received note or a monetary unit (i.e., £ or $).

control deviation. It is vital that what constitutes an error be determined (as incorrect

identification is an example of non-sampling risk). For example, in following up a direct

confirmation of accounts receivable to confirm the amounts owed, a non-reply will not

(of itself) constitute an error. If a balance is disagreed but the reason for the difference is

cash or goods-in-transit that is not an error (providing cut-off in the books being audited

is correct). If a balance is in dispute but is settled by the issue of a credit note after the

year end, that is not an error unless an allowance (i.e., provision) has not been made for

it.

Sample size

• assurance required;

• tolerable and expected error (or deviation rate); and

• stratification.

Absolute assurance cannot be achieved through sampling procedures. The lower the

assurance required, the smaller the required sample size. The tolerable error (or

deviation rate) is also called precision. It is the maximum error (or deviation rate) that

can be accepted to conclude that the audit objective has been achieved. (The combined

tolerable error for all audit tests is sometimes called gauge.)

For substantive tests, precision may be expressed as a monetary amount (which is less

than overall materiality) or a percentage of population value. For tests of control,

precision is the maximum rate of failure of an internal control that can be accepted in

order to place reliance on it (and is therefore likely to be small).

Errors increase the imprecision of results from sampling. Therefore, if they are expected,

a larger sample size is required.

Stratification

which the variation in characteristics is expected to be small, enables more time to be

devoted to items considered most vulnerable to material error. It is used mainly in

substantive testing.

In conclusion to this section, a sample plan for a substantive test is set out in Figure 3.

Figure 4 illustrates a sample plan for a test of controls.

2 Sample selection

The aim of audit sampling is to form a conclusion about the population from which a

sample is obtained. It is, therefore, necessary to ensure that the method of sample

selection can be expected to produce a representative sample with each item in the

population having a chance of being selected.

The distinction between statistical and non-statistical sampling should be made clear

before considering the methods of selection.

Statistical sampling

• measure sampling risk.

The two main types of statistical sampling are Attribute sampling and Variables

sampling.

Attribute sampling is concerned with testing items which can have only two possible

values (e.g., 0 or 1) or attributes (e.g., correct or incorrect). It is used to provide

information about rates of occurrence of events or characteristics. It is most widely used

in tests of control (to determine rates of non-compliance within control procedures) and

Monetary Unit Sampling (see later).

Variables sampling is concerned with testing items which can take any value within a

continuous range and is therefore used in substantive tests of details.

Non-statistical sampling

Any approach to sampling which does not fulfil all the characteristics set out above for

statistical sampling. Such approaches are often referred to as judgement sampling.

However, as statistical sampling

samples for audit sampling:

• random number;

• systematic;

• haphazard.

Random number selection — every item in a population has the same statistical

probability of being selected as every other item. Random numbers are selected using a

computer program or random number tables.

obtained by dividing the population by the sample size. E.g, if 50 items are to be

selected from a population of 600 every 12th item will be selected from a randomly

selected starting point (within the sampling interval). This method is suitable for both

tests of controls and substantive tests and particularly useful for sampling from non-

monetary populations as illustrated in Figure 5. However, care must be taken to ensure

that the population is not structured in such a way that the sampling interval corresponds

to a pattern in the population. For example, if cash book payments are written up by

cheques in date order with all the bank statement entries (direct debits, bank charges,

etc.,) being recorded at each month end, a sample could be biased towards a particular

transaction type.

Haphazard selection — this method attempts to give all items in a population a chance

of selection by choosing items haphazardly. To avoid conscious bias it is necessary to

avoid: favouring middle items, ignoring first and last items, selection of unusual items,

etc. Sometimes it is the only practical method (in terms of time and cost) of selecting a

sample from a population which cannot be accessed using a numerical sequence.

Though sometimes used for non-statistical sampling it is not sufficiently rigorous for

statistical sampling.

Value weighted selection — this systematic selection method uses currency unit values,

rather than the items, as the sampling population. Each individual pound is given an

equal chance of selection. Since these cannot be examined, the item in which a pound

selected lies is tested. Using this method, high-value items have a greater chance of

being selected. Random number selection could be employed but usually the method

involves cumulative totalling of currency values (which can be time consuming unless

computer-assisted). This is illustrated in Figure 6. The determination of Cumulative

Monetary Amounts (CMA) is frequently used in Monetary Unit Sampling (MUS). MUS

is a statistical sampling technique used for substantive testing which tests each $1 (or

£1) to see if it is correct or incorrect (i.e., a form of attribute sampling).

Value weighted selection can also be used in non-statistical sampling. For example, by

stratifying the population and selecting more items from a particular strata. An example

of this is the ‘two strata’ sampling method which combines 100% selection of high-

value (key) items with the sampling of items from two strata in the remaining

population. The boundary between the two strata may be calculated as (for example)

twice the average population value. The sample selected from the two strata is then

weighted towards the higher value stratum items.

Block sampling — consists of the selection ‘en bloc’ of adjacent transactions or items.

(i) a block selected may not be typical of the characteristics in the population as a whole;

and

(ii) relatively few blocks may be selected. It is, therefore, unlikely that a reasonable

conclusion can be drawn.

Nevertheless significant cost savings in audit time can result and practical considerations

may dictate its use. For example, when conducting an audit over numerous branches, it

may be appropriate to select just one week’s payroll or one month’s postings to the

general ledger or all customer accounts beginning with the same letter.

available, alternative procedures to provide equivalent evidence should be adopted. If

this is not possible the effect of assuming it to be an error (or deviation) should be

considered. If a test is inconclusive alternative evidence should be sought from other

tests.

The errors or deviations detected should be analysed and used to estimate the total error

or deviation rate in the population. The risk, that the actual error or deviation rate may

exceed the tolerable error, should be assessed.

When analysing the errors or deviations (as defined when planning the sample) their

nature, cause and possible impact on other audit areas and the financial statements as a

whole should be considered. If they have a common and potentially significant feature a

sub-population of items possessing that feature may be identified for further testing.

For substantive tests there are two quantitative methods of error projection. Their use

depends on whether or not the error relates closely (i.e., is proportional) to the size of the

item.

Ratio method

This method is used if errors relate closely to the size of the items (i.e., small errors in

small balances, large errors in large balances). For example, if sales invoices for the first

week of January were all priced at December prices.

The projected error is estimated as:

sample x value

Sample

value

This is illustrated in Figure 7. To this must be added the actual errors in items examined

100% (if any) to give a total estimate of error. (Refinements of this method, for example,

using ‘error taintings’, ‘rankings’ and ‘precision-gap widening’ are beyond the scope of

this article, the professional guidance and the ACCA’s examination syllabuses!)

Difference method

This method is used if errors do not relate closely to the size of items but are relatively

constant for all items. A simple example would be if a credit card company charged a

renewal fee of $21 per account instead of $12 per account.

Such errors can be projected by multiplying the average difference between audited (i.e.,

correct) and recorded (i.e., incorrect) amounts (i.e., $9 in the preceding example) by the

total number of items in the population. This amounts to calculating:

Number of

Error found in

items in

sample x

population

Number of

items in

sample

For tests of control the number of observed deviations divided by the sample size is the

best estimate of the deviation rate in the population from which it was selected, as

illustrated in Figure 8.

Projected errors are not precise measures of the actual errors present in the population.

When using statistical sampling confidence intervals may be calculated to indicate the

likely range of possible error. Alternatively, and more commonly, judgement is used to

draw a reasonable conclusion.

• Audit sampling is testing less than 100% of items that have a chance of selection.

• Sampling risk is the risk that a sample is not representative.

• Non-sampling risk arises from factors that cause the auditor to reach an incorrect

conclusion (for any reason unrelated to sample size).

• Four stages in audit sampling are design, selection, testing and evaluation.

• Statistical sampling requires random sample selection and use of probability

theory.

• Three methods of selecting representative samples are random number,

systematic and haphazard.

• Results are evaluated qualitatively and quantitatively.

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