AUDITING CHAPTER 9

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AUDITINGCHAPTER 9

• Audit Sampling
• By
• David N. Ricchiute

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TOPICS

• Use of sampling in audit engagements
• Role of sampling, nonsampling risk
• Risk of assessing control risk too high, too low
• Risks of incorrect rejection, acceptance
• Distinction between statistical, nonstatistical
  sampling
• Audit sampling for tests of controls and
  substantive tests of details
• Attribute estimation, sequential sampling
• Probability-proportional-to-size (PPS)

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SAMPLINGDefinitions

• Sampling examining less than 100 of items in a
  population
• Population all items within a class of
  transactions
• Sampling plan procedures to test a sample
• Attributes sampling tests rate of deviation from
  a prescribed control procedure
• Variables sampling tests whether recorded
  account balances are fairly stated

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AUDIT RISK

• Risk that auditor may unknowingly fail to modify
  opinion on materially misstated financial
  statements
• 2 parts
• Risk that errors will occur uncontrollable
• Inherent risk control risk
• Risk that material errors will not be detected
  controllable
• Detection risk

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UNCERTAINTIES

• Sampling risk
• Risk that sample may contain disproportionately
  more/less error than exists in population
• Nonsampling risk
• Aspects of audit risk not attributable to
  sampling such as human error

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CONTROL RISK ASSESSMENT Too High

• Inefficient
• Assessing control risk at maximum when it should
  be lower
• Concluding control not effective when it is

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CONTROL RISK ASSESSMENT Too Low

• Ineffective
• Lowering control risk when should be set at
  maximum
• Concluding control is effective when it isnt

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STATISTICAL SAMPLING

• Apply the laws of probability to
• Design efficient sample
• Measure sufficiency of sample
• Evaluate sample results
• Measures sampling risk quantitatively

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NONSTATISTICAL SAMPLING

• Relies exclusively on judgment to
• Determine sample size
• Evaluate sample results
• Cannot measure sampling risk quantitatively

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(NON)STATISTICAL SAMPLING CHOICE

• Choice based on relative costs benefits
• Independent of audit procedures

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ATTRIBUTES DEVIATIONS

• Attribute
• A characteristic of control
• Deviation
• Absence of the attribute

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ATTRIBUTE ESTIMATION SAMPLING

• Used to test controls that leave an audit trail
• Determine objectives, attributes, deviation
  conditions
• Define population
• Define sample size
• Perform sampling plan
• Evaluate sample results

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ATTRIBUTE ESTIMATION SAMPLING Objectives

• Whether controls for class of transactions
  sufficiently effective to lower control risk
  below maximum
• Trail of observable documented evidence
• Does not rely primarily on segregation of duties

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ATTRIBUTE ESTIMATION SAMPLING Sample Size

• Sample size components
• Acceptable risk of assessing control risk too low
• Inverse relationship with sample size
• Tolerable rate of deviation
• Maximum population rate of deviation from control
• Expected population deviation rate
• Estimated from prior year or pilot sample

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SAMPLE SELECTION METHODS

• Random-number sampling
• Systematic sampling
• Block sampling
• Haphazard sampling
• Stratified

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SAMPLE SELECTION METHODS Random Number

• Uses computer-generated numbers to select
  sampling units
• Match number to prenumbered documents
• Appropriate for both statistical nonstatistical
  sampling

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SAMPLE SELECTION METHODS Systematic Sampling

• Selecting every nth item from population of
  sequentially ordered items
• Useful when identification numbers lacking
• Appropriate for both statistical nonstatistical
  sampling

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SAMPLE SELECTION METHODS Block Sampling

• A group of items arranged contiguously within a
  larger grouping
• Inefficient not generalizable
• Should not be used for statistical or
  nonstatistical sampling without care in
  controlling sampling risk

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SAMPLE SELECTION METHODS Haphazard Sampling

• Sampling units selected without special reason or
  conscious bias
• Inappropriate for statistical sampling
• Useful for nonstatistical sampling

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SAMPLE SELECTION METHODS Stratified Sampling

• Subdivide population into homogeneous strata
• Select separate sample for each strata by one of
  prior methods

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OTHER TECHNIQUES Sequential Sampling

• Stop-or-go
• Performed in stages
• Auditor decides to stop or continue sampling
  after each stage

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OTHER TECHNIQUES Nonstatistical Sampling

• Used when costs outweigh benefits of statistical
  sampling
• Auditor judgment guided by
• Experience
• Prior knowledge
• Current information

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SUBSTANTIVE SAMPLING RISK 2 Sources

• Risk of incorrect rejection
• Risk that audit sample suggests account balance
  is materially misstated when it is fairly stated
• Risk of incorrect acceptance
• Risk that sample suggests account balance is
  fairly stated when it is materially misstated

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VARIABLES SAMPLING PLAN

• Determine objectives of test
• Define population
• Choose sampling technique
• Determine sample size
• Determine method of sample selection
• Perform sampling plan
• Evaluate sample results

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OBJECTIVES OF TEST

• To estimate account balance that is not recorded
• To test reasonableness of recorded account balance

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DEFINING POPULATION

• Audit population
• All items constituting an account balance or
  class of transactions defined by auditors
  characteristic of interest
• Sampling unit
• Any individual elements of a population

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AUDIT SAMPLING

• Sampling used only for those accounts where it is
  appropriate
• When large number transactions within one account
• Techniques
• Probability proportional to size (PPS)
• Nonstatistical sampling
• Classical variables sampling (appendix)

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SAMPLING DECISIONS

• Choice between statistical nonstatistical
  sampling based on
• Costs
• Effectiveness
• Need for quantitative estimate of sampling risk

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PROBABILITY-PROPORTIONAL-TO-SIZE (PPS)

• Derived from attributes sampling theory
• Appropriate when 1 or a few errors expected
• Characteristics
• Automatically stratifies an audit population
• Appropriate for testing for overstatement
• Useful for testing assets revenues

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PPSAn Example

• Define population for accounts receivable
• All customer debit balances testing overstatement
  or
• All customer balances, including 0 negative
• Requires special consideration
• Dollar is sample unit

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PPS SAMPLE SIZE ELEMENTS

• Determine
• Reliability factor for overstatement errors based
  on
• Expected number overstatement errors
• Risk of incorrect acceptance
• Tolerable (acceptable) error
• Anticipated error expansion factor

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PPS SAMPLE SIZE MODEL

• n RF x B
• TE (AE x EF)
• where
• RF reliability factor (from table)
• B book value (from client)
• TE tolerable error (auditor judgment)
• AE anticipated error (auditor judgment)
• EF expansion factor (from table)

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PPS SAMPLE SELECTION

• Used for statistical sampling methods
• Random number
• Systematic sampling

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EVALUATING RESULTSPPS Decision Rule

• If the upper error limit is less than or equal to
  the tolerable error, the account is fairly
  presented

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NONSTATISTICAL SAMPLING

• Used when
• No apparent need to quantify sampling risk
• Cost of statistical sampling exceeds benefits
• Cost to select sampling units exceeds benefits

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SAMPLE SIZE IN NONSTATISTICAL SAMPLING

• Requires
• Degree audit assurance
• Substantial, moderate, little
• Assurance factor
• Estimated tolerable error

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EVALUATING SAMPLE RESULTS

• When likely error is estimated, auditor has 4
  choices
• Accept clients book value
• Propose audit adjustment
• Perform additional substantives tests
• Request client to revalue entire population