Recorded on: 16-April-2013

Intermediate (IPC) Course

Paper 6 : Auditing and Assurance

Chapter 3 : Preparation for an Audit -Audit Sampling

CA .Kamal Garg

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3
Learning Objectives

Sampling and Types of sampling

Test checking

Techniques of test checks

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Key Concepts

As per SA 530 on "Audit Sampling", it means the application of audit procedures

to less than 100% of the items within an account balance or class of transactions
to enable the auditor to obtain and evaluate audit evidence;

Test checking is concerned with selecting and examining a representative

sample from a large number of similar items;

There is no hard and fast rule of selecting item for the test checking

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Audit Procedures

Compliance • designed to ensure that internal

Procedures control system is existing,
(Test of effective and efficient on a
Controls): continuing basis;

Substantive • designed to ensure that

Procedures transactions processed by
(Tests of accounting system are complete,
Details): valid and accurate

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Elements of Substantive Procedures

Completeness • i.e. transactions which should have been

of Transactions recorded are factually being recorded;

Validity of • i.e. transactions are recorded in

compliance with regulatory requirements
Transactions and financial reporting framework;

Accuracy of • i.e. transactions are recorded at

Transactions, arithmetically correct amounts

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Precautions before applying Sample Checking

The auditor must review the system of internal controls existing in the
enterprise. Test checking should be avoided in case the internal control
system is weak or ineffective.

The sample selected for test checking should be representative in

character and the transactions should be of homogeneous nature.

The auditor should identify those areas where test checking is not suitable,
for example, opening and closing entries, bank reconciliation statement, non-
recurring items, transactions of a seasonal industry, other areas where the
compliance with the applicable law is required such as managerial
remuneration under Companies Act, etc.

No element of bias should be present in selecting a sample.

The system of test checking should be reviewed from time to time so that necessary
improvements, if any, can be made.

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Methods of Determining Sampling Size

There are two main methods for

determining the size of sample
viz.

Judgmental
Sampling; and

Statistical
Sampling

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Judgmental Sampling

In this method, the sample size is determined on the basis of the personal
experience and the knowledge of the auditor;

It is one of the simple methods of sampling;

It may be noted that this method, though simple in its applicability, is

neither scientific nor objective;

The risk of personal bias in selection of sample is always present. Thus, an

element of subjectivity does prevail in this method

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Statistical Sampling

This method is more scientific in its approach than the method of

judgmental sampling;

It involves application of mathematical techniques like theory of

probability, use of random number tables etc;

But it may also be noted that the auditor need not require having an in
depth understanding of the statistical techniques because published
statistical tables are available which indicate the sample size based on
predetermined criteria

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Selecting the Sample - Methods

Auditor should select sample items in such a way that the sample can be expected to
be representative of the population;

This requires that all items in the population have an opportunity of being selected.

While there are a number of selection methods, three methods commonly used are:

Interval sampling or
Random selection; Haphazard selection
Systematic selection;

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Random Selection Method

• which ensures that all items in

Random the population have an equal
chance of selection, for
selection, example, by use of random
number tables;

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Interval Sampling Method

Interval sampling or Systematic selection, which involves selecting items using a

constant interval between selections, the first interval having a random start;

The interval might be based on a certain number of items (e.g. every 20th voucher
number) or on monetary totals (e.g. every Rs 1,000 increase in the cumulative value
of the population);

When using systematic selection, the auditor would need to determine that the
population is not structured in such a manner that the sampling interval corresponds
with a particular pattern in the population. For example, if in a population of branch
sales, a particular branch's sales occur only as every 100th item and the sampling
interval selected is 50, the result would be that the auditor would have selected all, or
none, of the sales of that particular branch.

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Haphazard Selection Method

• which may be an acceptable alternative to random

selection, provided that the auditor attempts to draw
Haphazard a representative sample from the entire population
with no intention to either include or exclude specific
units. When the auditor uses this method, care needs
selection to be taken to guard against making a selection that is
biased, for example, towards items which are easily
located, as they may not be representative

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Stratified Sampling

One another method which is used is Stratified Sampling;

This method involves dividing the whole population into separate groups.
These groups are called strata. The sample is taken from these strata;

Each stratum is treated as if it was a separate population and the

proportionate of items is selected from this stratum;

In a way, this method is an extension of random sampling.

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Example :Stratified Sampling

For example, debtors’ balances may be divided into

following strata:

balances in excess of Rs. 1,00,000;

balances in the range of Rs. 75,000 – Rs.

1,00,000;

balances in the range of Rs. 25,000 – Rs.

75,000; and

balances below Rs. 25,000

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Audit Risk

"Audit risk" means the risk that the auditor gives an inappropriate audit
opinion when the financial statements are materially misstated;

Audit risk has three components:

Inherent Risk Control Risk Detection

(IR); (CR); and Risk (DR)

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Components of Audit Risk

• is the susceptibility of an account balance or class of

"Inherent transactions to misstatement that could be material,
either individually or when aggregated with
risk" misstatements in other balances or classes, assuming
that there were no related internal controls.

• is the risk that a misstatement, that could occur in an

account balance or class of transactions and that
"Control could be material, either individually or when
aggregated with misstatements in other balances or
risk" classes, will not be prevented or detected and
corrected on a timely basis by the accounting and
internal control systems.

• is the risk that an auditor's substantive procedures will

"Detection not detect a misstatement that exists in an account
balance or class of transactions that could be material,
risk" either individually or when aggregated with
misstatements in other balances or classes

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Mathematical Model of Audit Risk

Audit Risk (AR) is the function

of Risk of Material
Misstatements (RMM) and
Detection Risk;

AR = RMM (x) DR; or • = IR (x) CR (x) DR

The range of AR lies in

between ZERO to One (0% to
100%)

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Sampling Risk - An Introduction

Sampling risk represents the possibility that auditor's conclusion based on a

sample is different from that reached if the entire population were subject to
audit procedure;

The auditor may conclude that material misstatements exist, in fact they do not;
or material misstatements do not exist but in fact they do exist;

Auditor can lower the sampling risk by increasing the sampling size

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Non Sampling Risk

Non-sampling risk includes factors that cause auditors to reach a

conclusion other than the sampling size.

Misinterpretation of evidence and inappropriate procedures are

good examples of non-sampling risks;

Changing of the sampling size would not reduce non-sampling

risk

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Sampling Risk

Risk that auditor’s conclusion based on sample may be

different from the conclusion if the entire population
were subjected to same audit procedure

Leads to two typesof

erroneous conclusions

Test of Controls – More effective than

actually are
Test of details – Material Misstatement
does not exist when it does
Test of Controls – Less effective than
actually are
Test of details – Material Misstatement
exists whenIn fact it does not

Leads to inappropriate
Audit opinion Leads to additional work

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Audit Sampling
Audit Sampling

Application of audit procedures to less than 100% of the items

Sampling Risk

Risk of Risk of Risk of Risk of

Under Reliance Over Reliance Incorrect Rejection Incorrect Acceptance

Methods to select Sample

Random Systematic
Selection Selection

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Tolerable Error

Tolerable error is the maximum error in the population that

the auditor would be willing to accept and still concludes that
the result from the sample has achieved the audit objective;

Tolerable error is considered during the planning stage and,

for substantive procedures, is related to the auditor's
judgment about materiality;

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Review Questions

• Sampling technique is essentially dependent upon application of

1 compliance procedures alone?

• If Internal Control System is sound then auditors choose a larger

2 sample size?

• Sample checking is mandatory for an audit examination?

3

• If due to sampling risk the auditors have given inappropriate opinion,

4 they have no defence and they are liable for their reporting?

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 Thank you

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