CHAPTER 13 AUDIT SAMPLING

Learning Check
13-1. No. Audit sampling is applicable to both tests of controls and substantive tests. However, it is not equally applicable to all auditing procedures. or e!ample, it is widely used in vouching, confirming, and tracing, but it is ordinarily not used in inquiring, observing, and analytical procedures. 13-". a. #ampling ris$ relates to the possibility that a properly drawn sample may not be representative of the population from which it is drawn. Nonsampling ris$ refers to the portion of audit ris$ that is not due to e!amining only a portion of the data. %here are two types of sampling ris$s for tests of controls and two for substantive tests. %he types of sampling ris$ and their potential effects on the audit are& %ests of controls& The risk of assessing control risk too low is the ris$ that the assessed level of control ris$ based on the sample supports the planned assessed level of control ris$ when the true operating effectiveness of the control structure policy or procedure, if $nown, would not be considered adequate to support the planned assessed level. The risk of assessing control risk too high is the ris$ that the assessed level of control ris$ based on the sample does not support the planned assessed level of control ris$ when the true operating effectiveness of the control structure policy or procedure, if $nown, would be considered adequate to support the planned assessed level. #ubstantive tests& The risk of incorrect acceptance is the ris$ that the sample supports the conclusion that the recorded account balance is not materially misstated when it is materially misstated. The risk of incorrect rejection is the ris$ that the sample supports the conclusion that the recorded account balance is materially misstated when it is not materially misstated. %he ris$ of assessing control ris$ too low and the ris$ of incorrect acceptance relate to audit effectiveness. %he ris$ of assessing control ris$ too high and the ris$ of incorrect re'ection relate to the efficiency of the audit. 13-3. a. (oth nonstatistical and statistical sampling )1* require the e!ercise of 'udgment, )"* can provide sufficient evidential matter required by the third

b.

standard of field wor$, and )3* are sub'ect to some sampling and nonsampling ris$. %he critical difference is that the laws of probability are used to measure and control sampling ris$ in statistical sampling. b. #tatistical sampling benefits the auditor in )1* designing an efficient sample, )"* measuring the sufficiency of the evidence obtained, )3* evaluating sample results, and )+* quantifying and controlling sampling ris$. %he types of statistical sampling techniques used in auditing are attribute sampling and variables sampling. Attribute sampling is used in tests of controls to estimate the rate of deviations from prescribed controls in a population. ,ariables sampling is used in substantive tests to estimate the total dollar amount of a population or the dollar amount of error in a population. %he primary purpose of a test of controls is to estimate the rate of deviations from prescribed controls in a population. or e!ample, the auditor wants to estimate the percentage of the time that a specific internal controls fails to function as designed. %he primary purpose of a substantive test is to estimate the total dollar amount of a population or the dollar amount of error in a population. or e!ample, the auditor wants to estimate the amount by which total accounts receivable might be misstated and determine whether the potential misstatement is material to the financial statements.

13-+. a. b.

13--. a.

b.

13-.. %he concepts associated with audit sampling does not apply to the following tests of controls& %ests that rely primarily on inquiry and observation. )e.g., many tests of the control environment, tests of segregation of duties, or observation of physical controls*. %ests of computer application controls because they can test a programmed decision point with only two elements of test data )one test to determine that the control appropriately accepts transactions that meet the control criteria and one to see that it appropriately re'ects transactions that fail to meet control criteria*. %ests of computer application controls that may show e!ceptions on a computer screen and prevent further processing of a transaction )%ested with inquiry and observation, and by submitting transactions that may generate e!pected error messages*. 13-/. a. ive types of control procedures where the auditor is li$ely to use some form of nonstatistical sampling for tests of controls include& )1* programmed control procedures, )"* computer general control procedures, )3* manual follow-up of e!ceptions identified by programmed controls, )+* management performance reviews, and )-* controls over management discretion in financial reporting. 0ther e!amples might include controls over management1s use of spreadsheets in the financial reporting process, or tests of the control environment.

b.

2hen testing programmed control procedures the auditor usually want to $now that the $ey aspect of the program )1* processed transactions that met that criteria of the control procedures and should be processed and )"* re'ected transactions that did not meet the criteria of the control procedures and should not be processed. 2hen using 3AA%s, such as test data, it is sufficient to test each condition. 4f the auditor wants to assess control ris$ as low based on a programmed control procedure the auditor will usually )1* directly test the programmed control procedures using 3AA%#, )"* test computer general control procedures to gain assurance that the programmed control functioned effectively over time, and )3* test the effectiveness of manual follow-up of e!ceptions identified by the programmed control procedure.

c.

13-5. %he following table outlines the steps in a nonstatistical sampling plan for tests of controls and identifies the professional 'udgment)s* involved in each step.
1. ". 3. +. Step 6etermine the ob'ectives of the test of controls 6etermine procedures to evaluate internal controls 7a$e a decision about the audit sampling technique. 6efine the population and sampling unit. Professional Judgment 6etermine audit ob'ectives and how the ob'ectives of the test relate to financial statement assertions. %he determination of procedures is a matter of professional 'udgment that provides evidence about the effective design and operation of internal controls. %he choice of using statistical or nonstatistical sampling is a matter of professional 'udgment. %he population depends on the control being tested. 4n many cases, there may be several ways to identify different sampling units for the same control )e.g., each report or each item on a report*. #ample si9e is a function of a variety of factors. %he auditor uses professional 'udgment to ma$e a decision about each 'udgment that influences sample si9e. 4f the auditor uses nonstatistical sampling the auditor also uses professional 'udgment to determine the sample si9e used. %he auditor uses professional 'udgment in determining the technique used to select a representative sample from the population. 4n step " the auditor used professional 'udgment to determine the procedures to be performed. Now the auditor uses 'udgment to apply those procedures to each sampling unit. :udgment is necessary to determine if evidence supports a control deviation or whether the control functioned effectively. %he auditor uses professional 'udgment to sum the sample results and pro'ect the sample results on the population, particularly in a nonstatistical sample. =rofessional 'udgment is an integral part of documenting the audit conclusions about effective operation of a control based on sample results.

-.

8se professional 'udgment to determine sample si9e.

.. /.

#elect a representative sample. Apply audit procedure.

5. <.

;valuate the sample results. 6ocument conclusions

13-<. %he following discussion e!plains each factor that influences sample si9e. 1. %he nature of the control. 7anagement1s review of wee$ly e!penditure reports is a manual control and should be tested more e!tensively than an automated control.

". 3. +. -. .. /.

%he frequency of operation of the control. %he control operates wee$ly and would be tested less e!tensively than controls that operate daily or on every transaction. %he importance of the control. 4f management1s review of wee$ly e!penditure reports is critical to the audit strategy, it needs to be tested more e!tensively than if the control is only tangential to the audit strategy. %he ris$ of assessing control ris$ too low. %he smaller the amount of sampling ris$ the larger the sample si9e. %olerable deviation rate. %he smaller the rate of deviation )inappropriate or inadequate review of wee$ly reports* from the proscribed control procedure that the auditor can tolerate, the larger the sample si9e. ;!pected population deviation rate. %he closer the tolerable deviation rate and the e!pected deviation rate are to each other, the larger the sample si9e. =opulation si9e. or small population si9es, such as a wee$ly control activity, sample si9e decrease as the population si9e decreases.

13-1>. 4n a few instances the logic behind audit sampling does not apply to substantive tests. or e!ample, audit sampling does not apply to& 4nitial procedures, #ubstantive analytical procedures, 7any tests of details of accounting estimates, and 7any tests of details of disclosures. 13-11. %he following table outlines the steps in a nonstatistical or statistical sampling plan for substantive tests and identifies the professional 'udgment)s* involved in each step.
1. ". Step 6etermine the ob'ectives of the substantive test 6etermine substantive audit procedure to perform Professional Judgment 6etermine audit ob'ectives and the ob'ectives of the test relate to financial statement assertions. %he determination of substantive audit procedures is a matter of professional 'udgment that provides evidence about the potential amount of misstatement in an account. %he choice of using statistical or nonstatistical sampling is a matter of professional 'udgment. %he population depends on the account balance being evaluated. 4n many cases, there may be several ways to identify different sampling units for the same account balance )e.g., each customer or each sales invoice receivable from a customer*. #ample si9e is a function of a variety of factors. %he auditor uses professional 'udgment to ma$e a decision about each 'udgment that influences sample si9e. 4f the auditor uses nonstatistical sampling the auditor also uses professional 'udgment to determine the sample si9e used. %he auditor uses professional 'udgment in determining the technique used to select a representative sample from the population. 4n step " the auditor used professional 'udgment to determine the procedures to be performed. Now the auditor uses 'udgment to apply those procedures to each sampling unit. :udgment is necessary to

3. +.

7a$e a decision about the audit sampling technique. 6efine the population and sampling unit.

-.

8se professional 'udgment to determine sample si9e.

..

#elect a representative sample.

/.

Apply audit procedures.

5. <.

;valuate the sample results. 6ocument conclusions

determine if evidence is present of a misstatement in the amount of the balance or transaction tested. %he auditor uses professional 'udgment to sum the sample results and pro'ect the sample results on the population, particularly in a nonstatistical sample. =rofessional 'udgment is an integral part of documenting the audit conclusions about the potential for material misstatement in the financial statements.

13-1". a.

%he inventory population can be defined as )1* all inventory irrespective of location, or )"* all inventory in the warehouse and then all inventory at retail locations, or )3* each location may be treated as a separate population. %he sampling unit could be defined as each stoc$ number )irrespective of location*, or each stoc$ number at each location, or it could be defined in terms of physical location, such as bin number, or rac$ in a retail store.

b.

13-13. %he A43=A1s Audit Sampling Guide )pp. .5?.<* identifies several advantages and disadvantages of ==# sampling. %he advantages of ==# sampling are& 4t is generally easier to use than classical variables sampling because the auditor can calculate sample si9es and evaluate sample results by hand or with the assistance of tables. %he si9e of a ==# sample is not based on any measure of the estimated variation of audit values. ==# sampling automatically results in a stratified sample because items are selected in proportion to their dollar values. ==# systematic sample selection automatically identifies any item that is individually significant if its value e!ceeds an upper monetary cutoff. 4f the auditor e!pects no misstatements, ==# sampling will usually result in a smaller sample si9e than under classical variables sampling. A ==# sample can be designed more easily, and sample selection may begin before the complete population is available. 4n contrast, ==# sampling has the following disadvantages& 4t includes an assumption that the audit value of a sampling unit should not be less than 9ero or greater than boo$ value. 2hen understatements or audit values of less than 9ero are anticipated, special design considerations may be required. 4f understatements are identified in the sample, the evaluation of the sample may require special considerations. %he selection of 9ero balances or balances of a different sign )e.g. credit balances* requires special consideration. ==# evaluation may overstate the A#@ when misstatements are found in the sample. As a result, the auditor may be more li$ely to re'ect an acceptable boo$ value for the population. As the e!pected number of misstatements increases, the appropriate sample si9e increases. %hus, a larger sample si9e may result than under classical variables sampling. =rofessional 'udgment should be e!ercised by the auditor in determining the appropriateness of this approach in a given audit circumstance.

13-1+. a.

%he sampling unit in a ==# sample is the individual dollar )the population is considered to be a number of dollars equal to the dollar amount o the population*. %he logical sampling unit is the account, document, transaction, etc., with which an individual dollar unit selected for inclusion in the sample is associated. #ince the individual dollar is the sampling unit in ==# sampling, the more dollars associated with a logical sampling unit the greater its chance of selection. 3onversely, logical units with 9ero balances have no chance of selection. %herefore, they should be treated separately when using ==# sampling. 4n testing accounts with credit balances, such as liabilities, the auditor is usually primarily concerned with understatement. #ince ==# sampling results in selection proportional to si9e. %he more an item is understated, the less its chance of selection. Accordingly, the approach is incompatible with the ob'ective. %he formula for calculating sample si9e in a ==# sample is&
n= BV x RF TM ) AM x F *

b.

13-1-. a.

b.

;!planations of the factors in the above formula and their effect on sample si9e are& Factor (, @ %7 A7 ; Explanation (oo$ value of population tested @eliability factor for specified ris$ of incorrect acceptance %olerable misstatement Anticipated misstatement ;!pansion factor for anticipated misstatement Relationship to Sample Size 6irect 6irect )1* 4nverse 6irect )"* 6irect

)1* )"*

Note that while the relationship between @ and n is direct, the relationship between the ris$ of incorrect acceptance )which is controlled through the @ factor* and n is inverse. Note that while the relationship between A7 and n is direct, the relationship between the ris$ of incorrect re'ection )which is controlled through the A7 factor* and n is inverse.

13-1.. %he specification of anticipated misstatement provides the auditor with a means to control the ris$ of incorrect re'ection. %he auditor uses prior e!perience and $nowledge of the client and professional 'udgment in determining an amount for anticipated misstatement, bearing in mind that an e!cessively high anticipated

misstatement will unnecessarily increase sample si9e while too low an estimate will result in a high ris$ of incorrect re'ection. 13-1/. %he three factors considered in evaluating the result of a ==# sample are )a* the pro'ected misstatement determined from the sample, )b* the allowance for sampling ris$, and )c* the upper misstatement limit. 13-15. %he two components of the allowance for sampling ris$ for ==# samples are )a* basic precision and )b* an incremental allowance resulting from any misstatements found. 13-1<. A tainting percentage and pro'ected understatement are calculated for each logical unit with a boo$ value less than the sampling interval that contains a misstatement. %he tainting percentage is calculated by dividing the difference between the boo$ and audit values by the boo$ value. %he tainting percentage is then multiplied by the sampling interval to pro'ect the degree to which a logical unit is tainted with misstatement to all of the dollars in the sampling interval it represents. or each logical sampling unit with a boo$ value greater than or equal to the sampling interval, pro'ected misstatement is simply the difference between the boo$ value and the audit value. Appendi! A 13A-1. a. %he factors that influence sample si9e for tests of controls using statistical attribute sampling are& @is$ of assessing control ris$ too low %olerable deviation rate ;!pected population deviation rate =opulation si9e when auditing small populations )fewer than -,>>> units*. #ome auditors use the same ris$ of assessing control ris$ too low for all statistical tests of controls. 0ther auditors vary the ris$ of assessing control ris$ too low depending on the planned assessed level of control ris$, such that the lower the planned assessed level of control ris$, the lower the ris$ of assessing control ris$ too low. 4f the auditor plans a AlowB assessed level of control ris$, the auditor should set tolerable deviation rates between "C and /C. 2hen using a statistical attribute sample the auditor can get a sample si9e of -< with a -C ris$ of assessing control ris$ too low, a - percent tolerable deviation rate, and a >C e!pected deviation rate )assuming a large population si9e*. %he three steps involved in quantitatively evaluating sample results for a statistical test of controls are )1* calculating the sample deviation rate, )"* determining the upper deviation limit, and )3* determining the allowance for sampling ris$. %he steps involved in using the sample evaluation tables are&

b.

c. d.

13A-". a.

b.

1. ". 3. +. c.

#elect the table that corresponds to the ris$ of assessing control ris$ too low. Docate the column that contains the actual number of deviations )not the deviation rate* found in the sample. Docate the row that contains the sample si9e used. @ead the upper deviation limit from the intersection of the column and row determined in steps two and three.

2ith a sample si9e of -< and one deviation, the auditor can conclude that he or she is <-C confident that the ma!imum deviation rate in the population is not more than /./C. 2hen evaluating qualitative factor the auditor will want to consider whether there is evidence of management override of controls, collusion, or fraud. 2hen the sample results do not support the planned assessed level of control ris$ the auditor should increase the final assessed level of control ris$ to a level supported by the sample and decrease the level of detection ris$ associated with substantive tests of details accordingly. %he formula for determining sample si9e in mean-per-unit sampling is&
" ! R S xj n = A
"

13A-3. a. b.

Appendi! ( 13(-1. a.

2hen the relationship between n and N is greater than .>-, a finite correction factor is recommended resulting in an ad'usted sample si9e )nE* calculated as follows&
n = n 1+ n "

b.

%he elements in the formula for n given above represent the following& N F =opulation si9e 8@ F %he standard normal deviate for the desired ris$ of incorrect re'ection #!' F ;stimated population standard deviation A F =lanned allowance for sampling ris$ %he formula differs for difference and ratio estimation only in the term for the estimated standard deviation. 4n difference estimation, #d' )the estimated standard deviation of the differences* is substituted for #!'. 4n ratio estimation, #r' )the estimated standard deviation of the ratios* is substituted for #!'.

c.

13(-". a.

%he ris$ of incorrect acceptance is controlled in classical variables sampling plans by specifying the planned allowance for sampling ris$ )A* in the sample si9e formula. )A* is determined by multiplying the auditorEs specified tolerable

misstatement )%7* by a ratio )@* of planned allowance for sampling ris$ to tolerable misstatement. %he ratio is determined from a table based on the auditorEs specified ris$s of incomplete re'ection and acceptance. b. %hree ways of estimating the standard deviation for a mean-per-unit sampling plan are& )1* in a recurring engagement, the standard deviation found in the preceding audit may be used, )"* it may be estimated from available boo$ values in the current year, and )3* it may be based on the audit values found in a presample of 3> to -> items selected from the current yearEs population. =lanned allowance for sampling ris$ in a classical variables sampling plan provides the means by which the ris$ of incorrect acceptance is controlled. 4t is found by multiplying the auditorEs specified tolerable misstatement by a ratio determined from a table based on the specified ris$s of incorrect re'ection and acceptance. %he achieved allowance for sampling ris$ is calculated from the sample. 2hen the achieved allowance is not greater than the planned allowance used to determine sample si9e, it is used to calculate a range, plus and minus, about the estimated total population value, if the recorded boo$ value falls within this range, the sample results support the conclusion that the boo$ value is not materially misstated at a ris$ of incorrect acceptance not e!ceeding that specified in designing the sample. An ad'usted achieved allowance for sampling ris$ is calculated from a sample when the achieved allowance is greater than the planned allowance. %his ad'ustment is required so that the ris$ of incorrect acceptance associated with the range calculated for the estimated total population value will not e!ceed that originally specified by the auditor.

13(-3. a.

b.

c.

13(-+. 2hen sample results do not support the boo$ value, the auditor must use professional 'udgment in deciding on an appropriate course of action. 4f the auditor believes the sample is not representative of the population, he or she may e!pand the sample and reevaluate. Also, if the auditor believes the achieved allowance is larger than the planned allowance because the sample si9e was too small )e.g., because the population standard deviation used to determine sample si9e was underestimated*, he or she may e!pand the sample and reevaluate. 4f the auditor believes the population boo$ value may be reinstated by more than tolerable misstatement, he or she may have the client investigate, and, if warranted, ad'ust the boo$ value. %he auditor would then reevaluate the sample results relative to the ad'usted boo$ value. Appendi! 3 133-1. 3onsideration of the same factors in nonstatistical samples as in statistical samples may help to produce more efficient and effective samples. However, in nonstatistical samples the factors need not be e!plicitly quantified. %he factors to be considered are& )1* boo$ value of the population, )"* variation in the population, )3* tolerable misstatement, and )+* ris$ of incorrect acceptance. 133-". %wo acceptable methods for pro'ecting the misstatement found in nonstatistical samples to the population are& )1* the ratio method which divides the total dollar

amount of misstatement in the sample by the fraction of total dollars from the strata of the population included in the sampleG )"* the difference method which multiplies the average difference between audit and boo$ values for sample items by the number of units in the strata of the population. 4n either case the results of each strata should be added together to determine a estimated misstatement for the population. 133-3. 4n nonstatistical samples, the difference between the auditorEs total pro'ected misstatement and tolerable misstatement may be viewed as an allowance for sampling ris$.

Comprehensive Questions
13-">. );stimated %ime ? "> minutes* a. 1. 4n determining an acceptable level of ris$ of assessing control ris$ too low, an auditor should consider the importance of the control to be tested in determining the e!tent to which substantive tests will be restricted and the planned control ris$. 4n determining the tolerable deviation rate, an auditor should consider the planned control ris$ and how materially the financial statements would be affected if the control does not function properly. 4n determining the e!pected population deviation rate, an auditor should consider the results of prior yearsE test, the overall control environment, or utili9e a preliminary sample. %here is a decrease in sample si9e if the acceptable level of ris$ assessing control ris$ too low is increased. %here is a decrease in sample si9e if the tolerable deviation rate is increased. %here is an increase in sample si9e if the population deviation rate is increased.

".

3.

b.

1. ". 3.

c.

or a low ris$ of assessing control ris$ too low, it is generally appropriate to reconsider the planned control ris$ as the calculated estimate of the population deviation rate identified in the sample )/C* approaches the tolerable deviation rate )5C*. %his is because there may be an unacceptably high sampling ris$ that these sample results could have occurred with an actual population deviation rate higher than the tolerable deviation rate. 4f statistical sampling is used, an allowance for sampling ris$ can be calculated. 4f the calculated estimate of the population deviation rate plus the allowance for sampling ris$ is greater than the tolerable deviation rate, the sample results should be interpreted as not supporting the planned control ris$.

d.

13-"3. );stimated time - 3> minutes*

a.

Areas where 'udgment may be e!ercised by a 3=A in planning a statistical test include& 6etermining the ob'ectives of the plan. %he 3=A must identify the controls that are of interest and relate the controls to relevant financial statement assertions. #electing the sampling method to be used. %he 3=A may choose from among several methods including attribute and discovery sampling. 6efining the population and sampling unit. %he 3=A must give consideration to the appropriateness of the population to the ob'ectives of the plan, the populationEs homogeneity with respect to control procedures to be tested, multiple client locations, changes in control procedures during the year, and population si9e. 4n defining the sampling unit, the 3=A must consider compatibility with the ob'ective of the test and audit efficiency. #pecifying the attributes of interest. 4n attribute sampling, the 3=A must identify attributes that relate to the effectiveness of the controls being tested. 6etermining sample si9e. %he 3=A must specify the acceptable level of ris$ of assessing control ris$ too low, tolerable deviation rate, e!pected population deviation rate, and population si9e. 6etermining the sample selection method. %he 3=A must decide which sampling selection method to use )e.g., random number sampling or systematic sampling*. %he 3=A must consider the qualitative aspects of the deviations as well as the number of deviations. 6eviations that directly affect the financial statements or appear to be irregularities have greater audit significance. 2hen the sample results do not support the planned control ris$, the nature, e!tent, or timing of substantive tests are ordinarily modified, or, if applicable, tests may be made of other compensating controls. %wo techniques for selecting a nonstratified sample of 5> accounts payable vouchers are& @andom number sampling. 8se a table of random numbers or a computer program that generates random numbers to identify 5> four digit numbers that can be uniquely related to items in the population. 2hen a table of random numbers is used, the starting point in the table should be selected randomly and the path to be followed through the table should be determined in advance and followed consistently. #ystematic sampling. #elect every +>th voucher )3">> - 5>* after selecting the initial voucher )from 1-+>* randomly. 4f the 3=A is concerned that there may be a cyclical pattern in the population, he or she may use multiple random starts, multiplying the s$ip interval for a single random start )+>* by the number of multiple starts. o );stimated %ime& "- minutes*

b.

c.

13-"/ a. #ample #i9e F ..

b. c.

%he sampling interval F H++,+-1. ". 3. =ro'ected misstatement F H</,/"/."/ %he incremental allowance for sampling ris$ F H+5,/>+.-%he upper misstatement limit F H"-1,+31.5"

d.

%he auditor is <>C confident that the ma!imum overstatement in the population is H"-1,+31.5". %his is e!ceeds tolerable misstatement of H1->,>>>. %he $now errors are immaterial, so there is a ris$ that he auditor is incorrectly re'ecting the population. %he auditor might consider increasing the sample si9e. Alternatively, the client might further investigate the errors and choose to ad'ust the boo$ value of accounts receivable.

Note& %his solution is supported by an e!cel wor$sheet labeled =roblem 13-"/. 13-31. );stimated %ime ? "> 7inutes* a. b. %he pricing test is a substantive test that relates to the detection ris$ component of audit ris$. actors that should influence sample si9e are& =opulation si9e ,ariation in the population %olerable misstatement @is$ of incorrect acceptance %he sampling unit is stoc$ items appearing on the computer printout. %he items may be selected by any of the following methods& )1* simple random, )"* systematic random, )3* hapha9ard, and )+* bloc$ sampling. %he method used should provide a representative sample. 8se of a single bloc$ is generally not acceptable. Accordingly, when this method is used, several bloc$s should be selected. 4n interpreting the results, 2heeler and :ones should )1* pro'ect the misstatement found in the sample to the population and )"* consider the sampling ris$. E%he pro'ected misstatement can be calculated in either of the following ways&

c.

d.