AUDITING CHAPTER 9

1. AUDITINGCHAPTER 9 Audit Sampling By David N. Ricchiute

2. 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) GBW 8th ed., Ch. 9

3. SAMPLING:Definitions • 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 GBW 8th ed., Ch. 9

4. 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 GBW 8th ed., Ch. 9

5. 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 GBW 8th ed., Ch. 9

6. CONTROL RISK ASSESSMENT: Too High Inefficient • Assessing control risk at maximum when it should be lower • Concluding control not effective when it is GBW 8th ed., Ch. 9

7. CONTROL RISK ASSESSMENT: Too Low Ineffective • Lowering control risk when should be set at maximum • Concluding control is effective when it isn’t GBW 8th ed., Ch. 9

8. STATISTICAL SAMPLING • Apply the laws of probability to • Design efficient sample • Measure sufficiency of sample • Evaluate sample results • Measures sampling risk quantitatively GBW 8th ed., Ch. 9

9. NONSTATISTICAL SAMPLING • Relies exclusively on judgment to • Determine sample size • Evaluate sample results • Cannot measure sampling risk quantitatively GBW 8th ed., Ch. 9

10. (NON)STATISTICAL SAMPLING CHOICE • Choice based on relative costs & benefits • Independent of audit procedures GBW 8th ed., Ch. 9

11. ATTRIBUTES & DEVIATIONS Attribute • A characteristic of control Deviation • Absence of the attribute GBW 8th ed., Ch. 9

12. 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 GBW 8th ed., Ch. 9

13. 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 GBW 8th ed., Ch. 9

14. 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 GBW 8th ed., Ch. 9

15. SAMPLE SELECTION METHODS • Random-number sampling • Systematic sampling • Block sampling • Haphazard sampling • Stratified GBW 8th ed., Ch. 9

16. SAMPLE SELECTION METHODS: Random Number • Uses computer-generated numbers to select sampling units • Match number to prenumbered documents • Appropriate for both statistical & nonstatistical sampling GBW 8th ed., Ch. 9

17. 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 GBW 8th ed., Ch. 9

18. 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 GBW 8th ed., Ch. 9

19. SAMPLE SELECTION METHODS: Haphazard Sampling • Sampling units selected without special reason or conscious bias • Inappropriate for statistical sampling • Useful for nonstatistical sampling GBW 8th ed., Ch. 9

20. SAMPLE SELECTION METHODS: Stratified Sampling • Subdivide population into homogeneous strata • Select separate sample for each strata by one of prior methods GBW 8th ed., Ch. 9

21. OTHER TECHNIQUES: Sequential Sampling • Stop-or-go • Performed in stages • Auditor decides to stop or continue sampling after each stage GBW 8th ed., Ch. 9

22. OTHER TECHNIQUES:Nonstatistical Sampling • Used when costs outweigh benefits of statistical sampling • Auditor judgment guided by • Experience • Prior knowledge • Current information GBW 8th ed., Ch. 9

23. 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 GBW 8th ed., Ch. 9

24. 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 GBW 8th ed., Ch. 9

25. OBJECTIVES OF TEST • To estimate account balance that is not recorded • To test reasonableness of recorded account balance GBW 8th ed., Ch. 9

26. DEFINING POPULATION • Audit population • All items constituting an account balance or class of transactions defined by auditor’s characteristic of interest • Sampling unit • Any individual elements of a population GBW 8th ed., Ch. 9

27. 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) GBW 8th ed., Ch. 9

28. SAMPLING DECISIONS • Choice between statistical & nonstatistical sampling based on • Costs • Effectiveness • Need for quantitative estimate of sampling risk GBW 8th ed., Ch. 9

29. 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 GBW 8th ed., Ch. 9

30. 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 GBW 8th ed., Ch. 9

31. 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 GBW 8th ed., Ch. 9

32. 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) GBW 8th ed., Ch. 9

33. PPS SAMPLE SELECTION • Used for statistical sampling methods • Random number • Systematic sampling GBW 8th ed., Ch. 9

34. EVALUATING RESULTS:PPS Decision Rule If the upper error limit is less than or equal to the tolerable error, the account is fairly presented GBW 8th ed., Ch. 9

35. NONSTATISTICAL SAMPLING Used when • No apparent need to quantify sampling risk • Cost of statistical sampling exceeds benefits • Cost to select sampling units exceeds benefits GBW 8th ed., Ch. 9

36. SAMPLE SIZE IN NONSTATISTICAL SAMPLING • Requires • Degree audit assurance • Substantial, moderate, little • Assurance factor • Estimated tolerable error GBW 8th ed., Ch. 9

37. EVALUATING SAMPLE RESULTS • When likely error is estimated, auditor has 4 choices • Accept client’s book value • Propose audit adjustment • Perform additional substantives tests • Request client to revalue entire population GBW 8th ed., Ch. 9