1Chapter 15 Audit Sampling for Tests of Controls and Substantive Tests of Transactions

Review Questions

15-1 A representative sample is one in which the characteristics of interest for the sample are approximately the same as for the population (that is, the sample accurately represents the total population). If the population contains significant misstatements, but the sample is practically free of misstatements, the sample is nonrepresentative, which is likely to result in an improper audit decision. he auditor can never know for sure whether he or she has a representative sample because the entire population is ordinarily not tested, but certain things, such as the use of random selection, can increase the likelihood of a representative sample. 15-2 !tatistical sampling is the use of mathematical measurement techni"ues to calculate formal statistical results. he auditor therefore "uantifies sampling risk when statistical sampling is used. In nonstatistical sampling, the auditor does not "uantify sampling risk. Instead, conclusions are reached about populations on a more #udgmental basis. $or both statistical and nonstatistical methods, the three main parts are% 1. '. (. &lan the sample !elect the sample and perform the tests )valuate the results

15In replacement sampling, an element in the population can be included in the sample more than once if the random number corresponding to that element is selected more than once. In nonreplacement sampling, an element can be included only once. If the random number corresponding to an element is selected more than once, it is simply treated as a discard the second time. Although both selection approaches are consistent with sound statistical theory, auditors rarely use replacement sampling* it seems more intuitively satisfying to auditors to include an item only once. 15-! A simple random sample is one in which every possible combination of elements in the population has an e"ual chance of selection. wo methods of simple random selection are use of a random number table, and use of the computer to generate random numbers. Auditors most often use the computer to generate random numbers because it saves time, reduces the likelihood of error, and provides automatic documentation of the sample selected.

1+,1

15-5 In systematic sampling, the auditor calculates an interval and then methodically selects the items for the sample based on the si-e of the interval. he interval is set by dividing the population si-e by the number of sample items desired. o select (+ numbers from a population of 1,.+/, the auditor divides (+ into 1,.+/ and gets an interval of +/. 0e or she then selects a random number between / and 12. Assume the auditor chooses 1.. he first item is the number 1.. he next is 3., then 11., 13., and so on. he advantage of systematic sampling is its ease of use. In most populations a systematic sample can be drawn "uickly, the approach automatically puts the numbers in se"uential order and documentation is easy. A ma#or problem with the use of systematic sampling is the possibility of bias. 4ecause of the way systematic samples are selected, once the first item in the sample is selected, other items are chosen automatically. his causes no problems if the characteristics of interest, such as control deviations, are distributed randomly throughout the population* however, in many cases they are not. If all items of a certain type are processed at certain times of the month or with the use of certain document numbers, a systematically drawn sample has a higher likelihood of failing to obtain a representative sample. his shortcoming is sufficiently serious that some 5&A firms prohibit the use of systematic sampling. 15-" he purpose of using nonstatistical sampling for tests of controls and substantive tests of transactions is to estimate the proportion of items in a population containing a characteristic or attribute of interest. he auditor is ordinarily interested in determining internal control deviations or monetary misstatements for tests of controls and substantive tests of transactions. 15-# A block sample is the selection of several items in se"uence. 6nce the first item in the block is selected, the remainder of the block is chosen automatically. hus, to select + blocks of '/ sales invoices, one would select one invoice and the block would be that invoice plus the next 12 entries. his procedure would be repeated 1 other times.

1+,'

15-$

he terms below are defined as follows%

T%R& '%()*)T)+* he risk the auditor is willing to take of accepting a control as effective or a rate of monetary misstatements as tolerable, when the true population exception rate is greater than the tolerable exception rate. he highest estimated exception rate in the population at a given A7A57. he exception rate the auditor expects to find in the population before testing begins. It is necessary to plan the appropriate sample si-e. he actual rate of exception discovered in the sample. It is calculated by dividing the actual number of exceptions in the sample by the sample si-e. he exception rate the auditor will permit in the population and still be willing to use the assessed control risk and9or the amount of monetary misstatements in the transactions established during planning.

a. Acceptable risk of assessing control risk too low (A7A57) b. 5omputed upper exception rate (58)7) c. )stimated population exception rate ()&)7) d. !ample exception rate (!)7) e. olerable exception rate ( )7)

15-, he sampling unit is the population item from which the auditor selects sample items. he ma#or consideration in defining the sampling unit is making it consistent with the ob#ectives of the audit tests. hus, the definition of the population and the planned audit procedures usually dictate the appropriate sampling unit. he sampling unit for verifying the occurrence of recorded sales would be the entries in the sales #ournal since this is the document the auditor wishes to validate. he sampling unit for testing the possibility of omitted sales is the shipping document from which sales are recorded because the failure to bill a shipment is the exception condition of interest to the auditor. 15-1he tolerable exception rate ( )7) represents the exception rate that the auditor will permit in the population and still be willing to use the assessed control risk and9or the amount of monetary misstatements in the transactions established during planning. )7 is determined by choice of the auditor on the basis of his or her professional #udgment. he computed upper exception rate (58)7) is the highest estimated exception rate in the population, at a given A7A57. $or nonstatistical sampling, 58)7 is determined by adding an estimate of sampling error to the !)7 (sample exception rate). $or statistical sampling, 58)7 is determined by using a statistical sampling table after the auditor has completed the audit testing and therefore knows the number of exceptions in the sample.

1+,(

15-11 !ampling error is an inherent part of sampling that results from testing less than the entire population. !ampling error simply means that the sample is not perfectly representative of the entire population. :onsampling error occurs when audit tests do not uncover errors that exist in the sample. :onsampling error can result from% 1. '. he auditor;s failure to recogni-e exceptions, or Inappropriate or ineffective audit procedures.

here are two ways to reduce sampling risk% 1. '. Increase sample si-e. 8se an appropriate method of selecting sample items from the population.

5areful design of audit procedures and proper supervision and review are ways to reduce nonsampling risk. 15-12 An attribute is the definition of the characteristic being tested and the exception conditions whenever audit sampling is used. he attributes of interest are determined directly from the audit program. 15-1 An attribute is the characteristic being tested for in a population. An exception occurs when the attribute being tested for is absent. he exception for the audit procedure, the duplicate sales invoice has been initialed indicating the performance of internal verification, is the lack of initials on duplicate sales invoices. 15-1! olerable exception rate ( )7) is the result of an auditor;s #udgment. he suitable )7 is a "uestion of materiality and is therefore affected by both the definition and the importance of the attribute in the audit plan. It represents the exception rate that the auditor will permit in the population and still be willing to conclude that the control is operating effectively and9or the amount of monetary misstatements in the transactions established during planning is acceptable. he sample si-e for a )7 of 3< would be smaller than that for a )7 of (<, all other factors being e"ual. 15-15 he appropriate A7A57 is a decision the auditor must make using professional #udgment. he degree to which the auditor wishes to reduce assessed control risk below the maximum is the ma#or factor determining the auditor;s A7A57. he auditor will choose a smaller sample si-e for an A7A57 of 1/< than would be used if the risk were +<, all other factors being e"ual.

1+,1

15-1" he relationship between sample si-e and the four factors determining sample si-e are as follows% a. b. c. d. As the A7A57 increases, the re"uired sample si-e decreases. As the population si-e increases, the re"uired sample si-e is normally unchanged, or may increase slightly. As the )7 increases, the sample si-e decreases. As the )&)7 increases, the re"uired sample si-e increases.

15-1# In this situation, the sample exception rate (!)7) is (<, the sample si-e is 1// and the A7A57 is +<. $rom the +< A7A57 table ( able 1+,2) then, the 58)7 is ..3<. his means that the auditor can state with a +< risk of being wrong that the true population exception rate does not exceed ..3<. 15-1$ Analysis of exceptions is the investigation of individual exceptions to determine the cause of the breakdown in internal control. !uch analysis is important because by discovering the nature and causes of individual exceptions, the auditor can more effectively evaluate the effectiveness of internal control. he analysis attempts to tell the =why= and =how= of the exceptions after the auditor already knows how many and what types of exceptions have occurred. 15-1, >hen the 58)7 exceeds the )7, the auditor may do one or more of the following% 1. 7evise the )7 or the A7A57. his alternative should be followed only when the auditor has concluded that the original specifications were too conservative, and when he or she is willing to accept the risk associated with the higher specifications. )xpand the sample si-e. his alternative should be followed when the auditor expects the additional benefits to exceed the additional costs. hat is, the auditor believes that the sample tested was not representative of the population and that exceptions are not expected in the expanded sample. 7evise assessed control risk upward. his is likely to increase substantive procedures. 7evising assessed control risk may be done if 1 or ' is not practical and additional substantive procedures are possible. >rite a letter to management. his action should be done in con#unction with each of the three alternatives above. ?anagement should always be informed when its internal controls are not operating effectively. If a deficiency in internal control is considered to be a significant deficiency in the design or operation of internal control, professional standards re"uire the auditor to communicate the significant deficiency to the audit committee or its e"uivalent in writing. If the client is a publicly traded company, the auditor must evaluate the deficiency to determine the impact on the auditor@s

'.

(.

1.

1+,+

15-1, .continued/ report on internal control over financial reporting. If the deficiency is deemed to be a material weakness, the auditor@s report on internal control would contain an adverse opinion. 15-2- 7andom (probabilistic) selection is a part of statistical sampling, but it is not, by itself, statistical measurement. o have statistical measurement, it is necessary to mathematically generali-e from the sample to the population. &robabilistic selection must be used if the sample is to be evaluated statistically, although it is also acceptable to use probabilistic selection with a nonstatistical evaluation. If nonprobabilistic selection is used, nonstatistical evaluation must be used. 15-21 he decisions the auditor must make in using attributes sampling are% >hat are the ob#ectives of the audit testA Boes audit sampling applyA >hat attributes are to be tested and what exception conditions are identifiedA >hat is the populationA >hat is the sampling unitA >hat should the )7 beA >hat should the A7A57 beA >hat is the )&)7A >hat generali-ations can be made from the sample to the populationA >hat are the causes of the individual exceptionsA Is the population acceptableA In making the above decisions, the following should be considered%

he individual situation. ime and budget constraints. he availability of additional substantive procedures. he professional #udgment of the auditor.

&ultiple Choice Questions (rom C0A %1aminations a. a. a. (1) (1) (1) b. b. b. (() (() (() c. c. c. (') (1) (') d. d. (1) (1)

15-22 15-2 15-2!

1+,3

'iscussion Questions and 0roblems a.

*4&5%R)*3 S6ST%& (+R T7% 0+042AT)+* %8C%2 S%2%CT)+* (+R&42A

15-25

SA&02)*3 4*)T

1. !ales invoice

All invoices numbered ///1 to 3'11 All bills of lading numbered '12'3 through 'D+11 (if a random number table is used, the left,most digit E'F can be dropped) A pair of random numbers, where the first random number is the page number (1,1/), and the second random number is the line number on the page (1,3/) A pair of random numbers, where the first random number is the page number (1,1D+), and the second random number is the invoice as counted down from the top of the page (1,.+)

C7A:B4) >)):(1,3'11)

'. 4ill of lading

C7A:B4) >)):('12'3, 'D+11)

(. 5ustomer

C7A:B4) >)):(1,1/) and C7A:B4) >)):(1,3/)

1. Gine numbers on the sales #ournal that have a sales invoice recorded on them

C7A:B4) >)):(1,1D+) and C7A:B4) >)):(1,.+)

1+,.

15-25 .continued/ An example random sampling plan prepared in )xcel (&1+'+.xls) is available on the 5ompanion >ebsite. he command for selecting the random number can be entered directly onto the spreadsheet, or can be selected from the function menu (math H trig) functions. It may be necessary to add the analysis tool pack to access the 7A:B4) >)): function. 6nce the formula is entered, it can be copied down to select additional random numbers. >hen a pair of random numbers is re"uired, the formula for the first random number can be entered in the first column, and the formula for the second random number can be entered in the second column. b. $irst five numbers using systematic selection%
RA*'+& START)*3 0+)*T 3. ()RST 5 SA&02% )T%&S 3. 121 (1+ 1(2 +3( ''/11 ''11( '''.+ ''1/. ''+(2 0age 1 1 1 1 1 2ine D 12 (/ 11 +'

SA&02)*3 4*)T 1. !ales invoice

)*T%R9A2 1'1 (3'119+/)

'. 4ill of lading

1(' I('D+11,'12'3) C 3+D+9+/J

''/11

(. 5ustomer

11 (+.3 lines9+/)

&age 1, line KD

8sing systematic selection, the definition of the sampling unit for determining the selection interval for population ( is the total number of lines in the population. he length of the interval is rounded down to ensure that all line numbers selected are within the defined population.

1+,D

15-2"

a.

o test whether shipments have been billed, a sample of warehouse removal slips should be selected and examined to see if they have the proper sales invoice attached. he sampling unit will therefore be the warehouse removal slip. Attributes sampling method% Assuming the auditor is willing to accept a )7 of (< at a 1/< A7A57, expecting no exceptions in the sample, the appropriate sample si-e would be .3, determined from able 1+,D. Nonstatistical sampling method% here is no one right answer to this "uestion because the sample si-e is determined using professional #udgment. Bue to the relatively small )7 ((<), the sample si-e should not be small. It will most likely be similar in si-e to the sample chosen by the statistical method. !ystematic sample selection%

b.

c.

''D(2 .3 (// 11D'+

C C C C

&opulation si-e of warehouse removal slips ((.+'1,113D'). !ample si-e using statistical sampling (students@ answers will vary if nonstatistical sampling was used in part b. Interval (''D(29.3) if statistical sampling is used (students@ answers will vary if nonstatistical sampling was used in part b). 7andom starting point.

!elect warehouse removal slip 11D'+ and every (//th warehouse removal slip after (1+1'+, 1+1'+, etc.) 5omputer generation of random numbers using )xcel (&1+'3.xls)% C7A:B4) >)):(113D',(.+'1) he command for selecting the random number can be entered directly onto the spreadsheet, or can be selected from the function menu (math H trig) functions. It may be necessary to add the analysis tool pack to access the 7A:B4) >)): function. 6nce the formula is entered, it can be copied down to select additional random numbers. d. 6ther audit procedures that could be performed are% 1. est extensions on attached sales invoices for clerical accuracy. (Accuracy) '. est time delay between warehouse removal slip date and billing date for timeliness of billing. ( iming) (. race entries into perpetual inventory records to determine that inventory is properly relieved for shipments. (&osting and summari-ation)

1+,2

15-2" .continued/ e. he test performed in part c cannot be used to test for occurrence of sales because the auditor already knows that inventory was shipped for these sales. o test for occurrence of sales, the sales invoice entry in the sales #ournal is the sampling unit. !ince the sales invoice numbers are not identical to the warehouse removal slips it would be improper to use the same sample. It would be appropriate to use attributes sampling for all audit procedures except audit procedure 1. &rocedure 1 is an analytical procedure for which the auditor is doing a 1//< review of the entire cash receipts #ournal. he appropriate sampling unit for audit procedures ',+ is a line item, or the date the prelisting of cash receipts is prepared. he primary emphasis in the test is the completeness ob#ective and audit procedure ' indicates there is a prelisting of cash receipts. All other procedures can be performed efficiently and effectively by using the prelisting. he attributes for testing are as follows%
A4')T 0R+C%'4R% ' ( 1 + ATTR)54T% 5ash receipts in the prelisting are recorded in the cash receipts #ournal. 5ustomer name, date, and amount are e"ual on the prelisting and cash receipts #ournal. 5ash discounts were approved on the related remittance advice. 5ash included in the prelisting has been included on the deposit slip.

15-2#

a.

b.

c.

d.

he sample si-es for each attribute are as follows%

T%ST +( C+*TR+2 +R S45STA*T)9% T%ST +( TRA*SACT)+*S ! ! of of of 5 ! of SA&02% S):% ARACR T%R %0%R SA&02% S):% .D .D .. .D

A4')T 0R+C%'4R% ' ( 1 +

+< +< +< +<

3< 3< D< 3<

1< 1< '< 1<

1+,1/

15-2$

a.

4ecause the sample si-es under nonstatistical sampling are determined using auditor #udgment, students@ answers to this "uestion will vary. hey will most likely be similar to the sample si-es chosen using attributes sampling in part b. he important point to remember is that the sample si-es chosen should reflect the changes in the four factors (A7A57, )7, )&)7, and population si-e). he sample si-es should have fairly predictable relationships, given the changes in the four factors. he following reflects some of the relationships that should exist in student@s sample si-e decisions% 1. '. (. 1. +. 3. .. SA&02% S):% 2/ M 5olumn 1 M 5olumn ' M 5olumn 1 N 5olumn 1 N 5olumn + M 5olumns ( H 1 %802A*AT)+* Liven Becrease in A7A57 Becrease in )7 Becrease in A7A57 (column 1 is the same as column ', with a smaller population si-e) Increase in )7,)&)7 Becrease in )&)7 Becrease in )7,)&)7

b.

8sing the attributes sampling table in Table 15-$, the sample si-es for columns 1,. are% 1. DD '. 1'. (. 1D1 1. 1'. +. '+ 3. 1D .. 112

c.
C7A*3% )* (ACT+RS 1. Increase in A7A57. '. Increase in )7. %((%CT +* SA&02% S):% Becrease Becrease )224STRAT)+* )* 0ART a or b 5ompare columns 1 and 1 5ompare columns ( and ' (population si-es are not consistent, but this has little effect on sample si-e) 5ompare columns 3 and + 5ompare columns 1 and '

(. Increase in )&)7. 1. Increase in population si-e.

Increase :o effect or slight increase

1+,11

15-2$ .continued/ d. he difference in the sample si-e for columns ( and 3 result from the larger A7A57 and larger )7 in column 3. he extremely large )7 is the ma#or factor causing the difference. The greatest effect on the sample size is the difference between TER and EPER. $or columns ( and ., the differences between the )7 and )&)7 were (< and '< respectively. hose two also had the highest sample si-e. >here the difference between )7 and )&)7 was great, such as columns + and 3, the re"uired sample si-e was extremely small. Population size had a relatively small effect on sample size . he difference in population si-e in columns ' and 1 was 22,/// items, but the increase in sample si-e for the larger population was marginal (actually the sample si-es were the same using the attributes sampling table). he sample si-e is referred to as the initial sample si-e because it is based on an estimate of the !)7. he actual sample must be evaluated before it is possible to know whether the sample is sufficiently large to achieve the ob#ectives of the test.

e.

f.

15-2,

a.
A22+;A*C% (+R SA&02)*3 %RR+R S4(()C)%*T< Oes &robablyP :o (due to small sampling si-e) &robablyP :o (due to smaller sample si-e)P :o (!)7 exceeds )7) Oes :o due to small sample si-e

S%R 1. '. (. 1. +. 3. .. D. '< '< '< '< '< 1/< /< /<

T%R-S%R (< (< (< (< (< :A +< +<

!tudents@ answers as to whether the allowance for sampling error risk is sufficient will vary, depending on their #udgment. 0owever, they should recogni-e the effect that lower sample si-es have on the allowance for sampling risk in situations (, + and D.

1+,1'

15-2, .continued/ b. 8sing the attributes sampling table in able 1+,2, the 58)7s for columns 1,D are% 1. '. (. 1. +. 3. .. D. c.
C7A*3% )* (ACT+RS 1 ' Becrease in A7A57 Becrease in population si-e Becrease in sample si-e Becrease in the number of exceptions in the sample %((%CT +* C4%R Increase :o effect or minor decrease Increase )224STRAT)+*S )* 0ART a or b 5ompare columns 1 and ' 5ompare columns 1 and '

1./< 1.3< 2.'< 1.3< 3.'< 13.1< (./< 11.(<

5ompare columns ' and ( (both sample exception rates are '<) 5ompare columns 3 and .

Becrease

d.

he factor that appears to have the greatest effect is the number of exceptions found in the sample compared to sample si-e. $or example, in columns + and 3, the increase from '< to 1/< !)7 dramatically increased the 58)7. &opulation si-e appears to have the least effect. $or example, in columns ' and 1, the 58)7 was the same using the attributes sampling table even though the population in column 1 was 1/ times larger. he 58)7 represents the results of the actual sample whereas the )7 represents what the auditor will allow. hey must be compared to determine whether or not the population is acceptable.

e.

1+,1(

15- -

a. and b.

he sample si-es and 58)7s are shown in the following table%

)*)T)A2 SA&02% S):% (R+& TA52% 15-$ 1'. 22 3+ 2( 1D 3/ C4%R (R+& TA52% 15-, 3.'< (./ 3.1 2./ 1D.1 M'/./

ACT4A2 SA&02% S):% 1 ' ( 1 + 3 1// 1// 3/ 1// '/ 3/

S%R './< /./ 1.. 1./ +./ 1(.(

T%R 3./< (./ D./ +./ '/./ 1+./

a.

he auditor selected a sample si-e smaller than that determined from the tables in populations 1 and (. he effect of selecting a smaller sample si-e than the initial sample si-e re"uired from the table is the increased likelihood of having the 58)7 exceed the )7. If a larger sample si-e is selected, the result may be a sample si-e larger than needed to satisfy )7. hat results in excess audit cost. 8ltimately, however, the comparison of 58)7 to )7 determines whether the sample si-e was too large or too small. he !)7 and 58)7 are shown in columns 1 and + in the preceding table. he population results are unacceptable for populations 1, 1, and 3. In each of those cases, the 58)7 exceeds )7. he auditor;s options are to change )7 or A7A57, increase the sample si-e, or perform other substantive tests to determine whether there are actually material misstatements in the population. An increase in sample si-e may be worthwhile in population 1 because the 58)7 exceeds )7 by only a small amount. Increasing sample si-e would not likely result in improved results for either population 1 or 3 because the 58)7 exceeds )7 by a large amount. Analysis of exceptions is necessary even when the population is acceptable because the auditor wants to determine the nature and cause of all exceptions. If, for example, the auditor determines that a misstatement was intentional, additional action would be re"uired even if the 58)7 were less than )7.

b. c.

d.

1+,11

15- - .continued/ e.
T%R& 1. )stimated population exception rate '. olerable exception rate *AT4R% +( T%R& :onstatistical estimate made by auditor. Audit decision. Audit decision. Audit decision (determined by other audit decisions). !ample result. !ample result. !tatistical conclusion about the population.

(. Acceptable risk of assessing control risk too low 1. Actual sample si-e +. Actual number of exceptions in the sample 3. !ample exception rate .. 5omputed upper exception rate

15- 1

a.

he actual allowance for sampling risk is shown in the following table%

ACT4A2 A22+;A*C% (+R SA&02)*3 R)S= .C4%R-S%R/ 3.(< 1.2 D.1 1.3

S%R 1 ' ( 1 1./< 1./ 1./ (./

C4%R 1/.(< ..2 1'.1 ..3

b.

he 58)7 is higher for attribute 1 than attribute ' because the sample si-e is smaller for attribute 1, resulting in a larger allowance for sampling risk. he 58)7 is higher for attribute ( than attribute 1 because the auditor selected a lower A7A57. his resulted in a larger allowance for sampling risk to achieve the lower A7A57. If the auditor increases the sample si-e for attribute 1 by +/ items and finds no additional exceptions, the 58)7 is +.1< (sample si-e of 1+/ and three exceptions). If the auditor finds one exception in

c.

d.

1+,1+

the additional items, the 58)7 is 3./< (sample si-e of 1+/, four

1+,13

15- 1 .continued/ exceptions). >ith a )7 of 3<, the sample results will be acceptable if one or no exceptions are found in the additional +/ items. his would re"uire a lower !)7 in the additional sample than the !)7 in the original sample of (./ percent. >hether a lower rate of exception is likely in the additional sample depends on the rate of exception the auditor expected in designing the sample, and whether the auditor believe the original sample to be representative. 15- 2 a. he following shows which are exceptions and why%
)*9+)C% *4&5%R +/'D 3.21 3D1/ .(31

%8C%0T)+*< :o :o Oes :o

T60% +( %8C%0T)+* )rror was detected and corrected by client. !ales invoice was voided. &roof of shipment not presented. 5redit collection problem* should be noted for review of allowance for doubtful accounts. Buplicate sales invoice not properly filed. Invoices not recorded by proper date* represents potential cutoff problem. 5ustomer orders not included in invoice package to verify compliance with the order. )rror in pricing. :o internal verification. Buplicate sales invoice not properly filed. 5redit not authori-ed. Internal verification of price extensions and postings of sales invoices was not included.

.3'+ D1(1 D+'D

Oes Oes Oes

D+33 D.D/ 2132 22.1

Oes Oes Oes Oes

b.

It is inappropriate to set a single acceptable tolerable exception rate and estimated population exception rate for the combined exceptions because each attribute has a different significance to the auditor and should be considered separately in analy-ing the results of the test.

1+,1.

15- 2 .continued/ c. he 58)7 assuming a +< A7A57 for each attribute and a sample si-e of 1+/ is as follows%
)*9+)C% *4&5%R 3D1/ .3'+ D.D/ D+'D D1(1 D+33 D+33 22.1 2132 *4&5%R +( %8C%0T)+*S 1 (

'%SCR)0T)+* +( ATTR)54T% !hipping document not located Buplicate sales invoice9customer order not located Invoice date improper &rice extensions postings incorrect &rice extensions and postings not internally verified 5redit not authori-ed

S%R .3.< './/<

1 1 ' 1

.3.< .3.< 1.((< .3.<

d.
)*9+)C% *4&5%R 3D1/ .3'+ D.D/ D+'D D1(1 D+33 D+33 22.1 2132 SA&02)*3 %RR+R S4(()C)%*T< Oes &robablyP Oes Oes &robablyP Oes

T%R-S%R +.((< 1./< +.((< +.((< 1.3.< +.((<

P !tudents@ answers will most likely vary for this attribute.

1+,1D

15- 2 .continued/ e. $or each exception, the auditor should check with the controller to determine an explanation for the cause. In addition, the appropriate analysis for each type of exception is as follows%

)*9+)C% *4&5%R 3D1/ .3'+

%8C%0T)+* A*A26S)S 5onfirm the account balances to the customers* examine the reduction in the perpetual inventory records. race the amount to the sales #ournal and accounts receivable master file* examine the shipping document and recompute the sale amount. Betermine who recorded the invoice and check several others prepared by him or her to determine if the problem consistently occurs. )xamine the accounts receivable master file for subse"uent cash receipt* examine sales invoices for other invoices to the same customer to determine if customer orders were attached. 5heck the price on other invoices to the same customer. 5heck the price on other invoices that have the same product. !ee .3'+ 5heck credit history of customer and evaluate collectibility of the customer;s account. 7echeck actual price, extensions and postings* determine who the clerk was and check several other invoices for proper indication of performance.

D1(1

D+'D

D+33 D.D/ 2132 22.1

15-

a.

Attributes sampling approach: he test of control attribute had a 3< !)7 and a 58)7 of 1'.2<. he substantive test of transactions attribute has !)7 of /< and a 58)7 of 1.3<. Nonstatistical sampling approach: As in the attributes sampling approach, the !)7s for the test of control and the substantive test of transactions are 3< and /<, respectively. !tudents@ estimates of the 58)7s for the two tests will vary, but will probably be similar to the 58)7s calculated under the attributes sampling approach. Attributes sampling approach: )7 is +<. 58)7s are 1'.2< and 1.3<. herefore, only the substantive test of transactions results are satisfactory. Nonstatistical sampling approach: 4ecause the !)7 for the test of control is greater than the )7 of +<, the results are clearly not acceptable. !tudents@ estimates for 58)7 for the test of control

b.

1+,12

15-

.continued/ should be greater than the !)7 of 3<. $or the substantive test of transactions, the !)7 is /<. It is unlikely that students will estimate 58)7 for this test greater than +<, so the results are acceptable for the substantive test of transactions. c. If the 58)7 exceeds the )7, the auditor may% 1. '. (. 1. 7evise the )7 if he or she thinks the original specifications were too conservative. )xpand the sample si-e if cost permits. Alter the substantive procedures if possible. >rite a letter to management in con#unction with each of the above to inform management of a deficiency in their internal controls. If the client is a publicly traded company, the auditor must evaluate the deficiency to determine the impact on the auditor@s report on internal control over financial reporting. If the deficiency is deemed to be a material weakness, the auditor@s report on internal control would contain an adverse opinion.

In this case, the auditor has evidence that the test of control procedures are not effective, but no exceptions in the sample resulted because of the breakdown. An expansion of the attributes test does not seem advisable and therefore, the auditor should probably expand confirmation of accounts receivable tests. In addition, he or she should write a letter to management to inform them of the control breakdown. d. Although misstatements are more likely when controls are not effective, control deviations do not necessarily result in actual misstatements. hese control deviations involved a lack of indication of internal verification of pricing, extensions and footings of invoices. he deviations will not result in actual errors if pricing, extensions and footings were initially correctly calculated, or if the individual responsible for internal verification performed the procedure but did not document that it was performed. In this case, we want to find out why some invoices are not internally verified. &ossible reasons are incompetence, carelessness, regular clerk on vacation, etc. It is desirable to isolate the exceptions to certain clerks, time periods or types of invoices.

e.

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Case a. b. Audit sampling could be conveniently used for procedures ( and 1 since each is to be performed on a sample of the population. he most appropriate sampling unit for conducting most of the audit sampling tests is the shipping document because most of the tests are related to procedure 1. $ollowing the instructions of the audit program, however, the auditor would use sales #ournal entries as the sampling unit for step ( and shipping document numbers for step 1. 8sing shipping document numbers, rather than the documents themselves, allows the auditor to test the numerical control over shipping documents, as well as to test for unrecorded sales. he selection of numbers will lead to a sample of actual shipping documents upon which tests will be performed. Note: The sampling data sheet that follows assumes an attributes sampling approach. he only difference between the sampling data sheet for attributes sampling and for nonstatistical sampling is the actual determination of sample si-e. $or nonstatistical sampling, students@ answers will vary, but will most likely be comparable to the sample si-es determined under attributes sampling.
%0%R 1./ /./ 1./ T%R +./ 1./ +./ )*)T)A2 ARACR SA&02% S):%> 1/ 1/ 1/ .. +. ..

15- !

c.

'%SCR)0T)+* +( ATTR)54T%S A duplicate sales invoice exists for the shipping document selected. !hipping document agrees with related duplicate sales invoice. he duplicate sales invoice has attached a copy of the shipping document, shipping order, and customer order. he shipping order has proper credit approval. he duplicate sales invoice has internal verification of computations. he duplicate sales invoice has the same price and "uantity as approved price list and shipping document. 5ustomer name, amount and date agrees between duplicate sales invoice and sales #ournal and subsidiary ledger. P

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assumes the shipping document is the sampling unit.

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Q )ntegrated Case Application 15- 5 a. and d. 0)**AC2% &A*4(ACT4R)*3?0ART 9 Client@ &innacle ?anufacturing Audit Area@ ests of 5ontrols and !ubstantive est of ransactionsRAc"uisitions.

'efine the +bAective.s/% )xamine vendors; invoices, receiving reports, purchase orders, and other related documents to determine whether the system has functioned as intended and as described in the audit program. 'efine the population preciselB .including stratificationC if anB/% Souchers from 1919'//2 to 1/9(19'//2. $irst voucher number T 1311. Gast voucher number T (131'. 'efine the sampling unitC organiDation of population itemsC and random selection procedures% Soucher number, recorded se"uentially in the ac"uisitions #ournal* random number function in electronic spreadsheet.
0lanned Audit )nitial Sample SiDe Actual Results *umber Sample of SiDe %1ceptions Calculated Sampling %rror .T%R-S%R/

'escription of Attributes 1. )vidence of internal verification of voucher package including propriety of purchase, dates, unit costs, prices, extensions, footings, account classification, recording in #ournal, and posting and summari-ation. (3a, b) '. &rices on vendors; invoices conform to approved price limits established by management. (3c) (. &rice times "uantity and other calculations on the vendor;s invoice are correct. (3d) 1. )vidence of proper account classification on vendors; invoices. (3e) +. Bates on entries in purchases #ournal agree with dates on receiving reports. (3f) 3. )vidence of internal verification of each purchase voucher. (3g) Results@

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4ased on the results of the tests, all controls appear effective except for evidence of internal verification. !ince there was also an error on timing and an error in comparing the vendor;s invoice amount to the ac"uisitions #ournal that is not included as an attribute, a larger than normal sample in year,end testing of accounts payable is appropriate. 1. he planned audit variables are #udgmental. he results of the prior year from part III were used to decide )&)7. Initial sample si-e and 58)7 are #udgments. '. here was an error discovered where there was no attribute. his happens in practice too. he auditor should not ignore the exception even though it is an unplanned discovery.

*otes@

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15- 5 .continued/ b. Client@ &innacle ?anufacturing Audit Area@ ests of 5ontrols and !ubstantive Bisbursements est of ransactionsR5ash

'efine the +bAective.s/@ )xamine cancelled checks and other related documents to determine whether the system has functioned as intended and as described in the audit program. 'efine the population preciselB .including stratificationC if anB/@ 5ancelled checks from 1919'//2 to 1/9(19'//2. $irst check number T D('3. Gast check number T (('3D. 'efine the sampling unitC organiDation of population itemsC and random selection procedures@ 5heck number, recorded se"uentially in the cash disbursements #ournal* random number function in electronic spreadsheet.
0lanned Audit )nitial Sample SiDe Actual Results *umber Sample of SiDe %1ceptions Calculated Sampling %rror .T%R-S%R/

'escription of Attributes 1. &ayee, name, amount, and date on cancelled check agrees with related purchases #ournal and cash disbursements entry. (2a) '. )vidence of signature, proper endorsement and cancellation of each check. (2b) (. Bate on cancelled check agrees with bank cancellation date. (2c) 1. 5ash discounts are correct. (2d)

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15- 5 .continued/ c. &opulation C voucher numbers 1311 to (131' !ample si-e C +/ 7andom !election% If random selection is performed using )xcel, the command to select numbers randomly from the population is% C7A:B4) >)):(1311, (131') he command for selecting the random number can be entered directly onto the spreadsheet, or can be selected from the function menu (math H trig) functions under the EinsertF menu. It may be necessary to add the analysis tool pack to access the 7A:B4) >)): function. 6nce the formula is entered, it can be copied down to select additional random numbers. he random numbers will vary for each student, so they are not listed in this solution. )nternet 0roblem Solution@ ApplBing Statistical Sampling

15-1 Auditors perform both statistical and non,statistical sampling. A recent article in The CPA ournal titled E!tatistical !ampling 7evisitedF by :eal 4. 0it-ig highlights some of the advantages of using statistical sampling techni"ues. 7ead the article (http%99www.nysscpa.org9cpa#ournal9'//19+/19essentials9p(/.htm) as background before answering these "uestions% 1. >hat is the primary difference between non,statistical sampling and statistical samplingA Answer@ he primary difference between non,statistical and statistical sampling is that statistical sampling allows the auditor to "uantitatively measure sampling risk using the laws of probability. In non,statistical sampling, the auditor is only able to "ualitatively assess sampling risk using auditor #udgment.

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)nternet 0roblem 15-1 .continued/ '. >hat reasons are often given to support the decision to use non, statistical sampling versus statistical samplingA Answer@ Auditors fre"uently #ustify the use of non,statistical sampling by noting the additional costs associated with the use of statistical sampling. hey argue that statistical sampling is more costly due to the cost of training auditors on the use of statistical sampling, costs of selecting the sample using random selection, and the cost of sampling evaluation that re"uires the "uantification of sampling risks using formulas based on probability theory. he article highlights, however, that the ready availability of computers and off,the,shelf software with statistical sampling applications built in have virtually mitigated most of these concerns. (. >hat is the main advantage of statistical samplingA Answer@ he primary advantage of statistical sampling is the ability to "uantitatively measure sampling risk within a specific confidence interval. he ability to "uantitatively measure sampling risk distinguishes statistical sampling from nonstatistical sampling, where the auditor is left to #udgment as to the extent of sampling risk present 1. Bescribe what is meant by Eprobability samplingF. Answer@ In probability sampling, every item in the population under audit has a known chance of selection. he decision as to which items in the population to select is left to the laws of chance, not to auditor #udgment. +. >hat is the Eupper confidence limitF as referred to in the articleA Answer@ he upper confidence limit is the pro#ected misstatement plus the allowance for sampling risk. he auditor uses the upper confidence limit to evaluate whether the sample result is acceptable or not. If the upper confidence limit exceeds the maximum tolerable misstatement amount, the auditor decides that the misstatement in the population may exceed the tolerable amount. If the upper confidence limit is less than the maximum tolerable misstatement, the auditor decides that the potential misstatement in the population is acceptable (tolerable).
(*ote% Internet problems address current issues using Internet sources. 4ecause Internet sites are sub#ect to change, Internet problems and solutions may change. 5urrent information on Internet problems is available at www.pearsonhighered.com9arens.)

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