CHAP.

s 8 & 9- AUDIT SAMPLING: AN APPLICATION TO TESTS OF CONTROLS & SUBSTANTIVE TESTINGS

What is Sampling? AUDIT SAMPLING is the application of an audit procedure to less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or transaction (ISA 530) Applying audit procedure (testing) to less than 100% of the items
1

The importance of Sampling

Timing, cost, extent and scope of audit To provide reasonable (based on sample) not absolute (population) assurance Sufficient evidence to support conclusions and audit opinion Appropriate means in gathering and evaluating audit evidence since it is impractical to do 100% of transactions in accounts.

AUDIT RISK
SAMPLING RISK Samples taken may not be representative of the population tested. Overcome: to increase number or sample size. NON-SAMPLING RISK Error in conclusion not due to sample size but to nature of evidence that is persuasive rather than conclusive. i.e. inappropriate audit procedures,
misinterpret evidence, or failure in recognizing the error.

Overcome: by proper planning, supervision and review.

3

TYPE I AND TYPE II RISK

TEST OF CONTROL Type I Risk = The risk auditor will conclude that the control risk is higher than it actually is (assessed CR too high) Type II Risk= The risk of assessing control risk too low SUBSTANTIVE TESTING Type I Risk = Risk auditor will conclude that material error exists when in fact it does not. Type II Risk = Risk auditor conclude that material error does not exists when in fact it 4 does exist.

THAT DO NOT INVOLVE AUDIT SAMPLING

Inquiry and observation Analytical procedures Procedures applied to every item in the population (100% examination) Classes of transactions or account balances not tested
Pg. 275 Table 8-1 Evidence where audit sampling is usually used.

AUDIT PROCEDURES

TYPES OF AUDIT SAMPLING

Non-statistical versus statistical sampling Non-statistical (or judgmental): use of professional judgment in designing the sample size. Statistical: selection at random or use of law of probability theory Advantages: 1. Design efficient sample 2. Sufficient evidence obtained 3. Quantify sampling risk Disadvantage 1. Additional costs incurred for training on proper sampling techniques 6

Non-statistical Sample Selection Methods

Item selection based on auditor judgmental criteria
Selecting 100% items from population

Test entire population Constitute large number of large value items

Directed Sample Selection

Items most likely to contain misstatements Items containing selected population characteristics Large dollar coverage
7

Types of Statistical Sampling Techniques

Attribute Sampling - to estimate proportion of population that have specified characteristics (egs. non-compliance battery). Monetary Unit Sampling - to estimate the amount (in RM) of misstatement for a class of transaction or accounts balances Classical Variable Sampling -use of typical statistical method in making estimates
8

ATTRIBUTE SAMPLING APPLIED TO TESTS OF CONTROLS

Attribute sampling is a statistical method used to estimate the proportion of a characteristic in a population.

The auditor is normally attempting to determine the operating effectiveness of a control procedure in terms of deviations from the prescribed internal control policy.

Attributes Sampling
Example: Audit test on how often a credit check is not performed on customer orders before shipment - sampling unit = customer order forms how often an invoice is not sent after shipment is made - sampling unit = invoice or shipping documents? Common use of attribute sampling test 10 of controls

Monetary-unit Sampling (MUS)

MUS uses attribute sampling theory and techniques to estimate the amount (in RM or other currency unit) of misstatement for a class of transactions or an account balance. Sampling unit = in monetary terms

Focus on monetary value rather than rate of occurrences. To test overstatement (high value items).

11

Audit Sample Selection- continue

Statistical Sampling Simple Random Sample (random number table/audit software) Systematic Sample Selection (random/stratified random) Random Select every nth elements in the sample Stratified the population is divided into strata, then sample is drawn from each strata.
12

NEEDS FOR SAMPLING

SUBSTANTIVE TESTINGS To estimate the characteristic in a population. Attempting to determine the deviations from the prescribed accounting system in ensuring the audit objectives are achieved. To provide reasonable assurance. Sufficient evidence to support conclusion & audit opinion. Means of gathering and evaluating evidence.
13

PHASES IN SAMPLING APPLICATION

Planning
Performance Evaluation

14

SPECIAL SITUATIONS IN PERFORMING THE AUDIT PROCEDURES

Voided documents. Unused or inapplicable documents. Missing documents.

Stopping the test before completion. Egs. List of invoices from creditors to see if the accounts are paid.
15

Non-statistical sampling for Test of Accounts Balances (p. 322)

Identify individually significant items -These items will be tested 100% -The remaining items which insignificant is subjected to sampling.
Determine the sample size = Population Book Value* x Assurance Factor Tolerable Misstatement** * Exclude 100% test ** estimated during audit planning Calculate the sample results.
16

NONSTATISTICAL SAMPLING: DETERMINING SAMPLE SIZE

Population Book Value Sample Size = x Assurance Factor Tolerable Misstatement

Com bine d Assessment of Control Risk and Inherent Risk Maximum Slightly belo w maximum Mo derate Low

Risk that Other Su bstantive Proce dures will Fail to Detect Material Misstatements Maximum Slightly belo w maximum 2.7 2.4 2.1 1.6 Moderate Substantial

3.0 2.7 2.3 2.0

2.3 2.0 1.6 1.2

2.0 1.6 1.2 1.0

17

NONSTATISTICAL SAMPLING: CALCULATING SAMPLE RESULTS

The AICPA's guidance describes two acceptable methods for projecting the amount of misstatement found in a nonstatistical sample: Project the amount of misstatement by dividing the amount of misstatement by the percentage of the dollars of the population included in the sample. Project the average misstatement found in the sample to the population.

18

NONSTATISTICAL SAMPLING AN EXAMPLE - CALABRO

The senior in charge of the audit, Don Jones, has decided to design a nonstatistical sampling application to examine the accounts receivable balance of Calabro, Inc. at December 31, 2000. As of December 31, there were 11,800 accounts receivable accounts with a balance of $3,717,900 and the population is composed of the following strata: Number and Size of Accounts 15 accounts > $25,000 250 accounts >3,000 11,535 accounts < $3,000 Book Value of Strata $ 550,000 850,000 2,317,400
19

NONSTATISTICAL SAMPLING - CALABRO

Jones has made the following decisions: Based the results of the tests of controls, a low assessment is made for inherent & control risk. Tolerable misstatement allocated to accounts receivable is $40,000. The expected amount of misstatement is $15,000. There is moderate risk that other auditing procedures will fail to detect material misstatements. All customer account balances greater than $25,000 are to be audited.
20

NONSTATISTICAL SAMPLING: DETERMINING SAMPLE SIZE

Population Book Value Sample Size = x Assurance Factor Tolerable Misstatement

Com bine d Assessment of Control Risk and Inherent Risk Maximum Slightly belo w maximum Mo derate Low

Risk that Other Su bstantive Proce dures will Fail to Detect Material Misstatements Maximum Slightly belo w maximum 2.7 2.4 2.1 1.6 Moderate Substantial

3.0 2.7 2.3 2.0

2.3 2.0 1.6 1.2

2.0 1.6 1.2 1.0

21

NONSTATISTICAL SAMPLING AN EXAMPLE - CALABRO

Sample Size = ($3,167,900/$40,000) x 1.2 = 95* * Allocation of the 95 to the 2 strata (BV/Pop BV x SS)

Results
Strata > $25,000 > $3,000 < $3,000 Book Value of Strata $ 550,000 850,500 2,317,400 Book Value of Sam ple $ 550,000 425,000 92,000 Audit Value of Sample $ 549,500 423,000 91,750 Amount of Overstatement $ 500 2,000 250
22

NONSTATISTICAL SAMPLING AN EXAMPLE - CALABRO Projected Misstatement

2 ways to project (p. 325):

Ratio estimation - % of $ misstatement in sample population (Amount of misstatement relate to size of item)
Difference estimation The $ misstatement in sample items population (Misstatements to be relatively constant for all items)
23

Projected Misstatement
Strata > $25,000 > $3,000 < $3,000 Amount of Misstatement $ 500 2,000 250 Percentage of Strata Sampled 100% 425,000 850,500 = .50 92,000 2,317,400 = .073 Projected Misstatement $ 500 4,000 6,250 10,750
24

Total Projected Misstatement

CONCLUSION
If projected misstatements > tolerable misstatement, conclusion: there is unacceptably high risk that the account is misstated. If projected misstatements is considerably < tolerable misstatement; compare the projected misstatements to the expected misstatements. If projected misstatement is < expected misstatement, conclusion: there is acceptably low sampling risk that projected misstatement exceeds tolerable misstatements. If projected misstatement significantly > expected misstatements, conclusion: there is unacceptably high risk that true misstatement exceeds tolerable 25 misstatements.