1 Module 5

AUDIT SAMPLING

A. Basic Audit Sampling Concepts

1. Definition of Sampling

a. Audit Sampling

Audit Sampling is the application of the audit procedure to less than 100% of the item within an account
balance or class of transactions for the purpose of evaluating some characteristics of the balance or class.

2. General Approaches to Audit Sampling – Nonstatistical & Statistical

a. Both involve judgment in planning, executing sampling plan and
evaluating the result of the sample.

Both can provide sufficient competent evidential matter.

Statistical Sampling Advantages

1) Design an efficient sample
2) Measure the sufficiency of the evidential matter
3) Evaluate the sample results
- The auditor can objectively quantify sampling risk to limit it to a level considered acceptable

Statistical Sampling Disadvantages

1) Costs & Time
2) Training auditors
3) Designing sample
4) Selecting items

3. Uncertainty and Audit Sampling

a. Audit Risk

AR = IR x CR x DR

AR = IR x CR x AP x TD

AR = Audit Risk
IR = Inherent Risk
CR = Control Risk
DR = Detection Risk
AP = Analytical Procedure Risk
TD = Test of Details Risk
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b. Nonsampling Risk

Definition: audit risk that are not due to sampling

Examples:
1.Failure to select appropriate audit procedures
2.Failure to recognize misstatements in documents examined
3.Misinterpreting the result of audit tests

Controlled by:
1. Adequate planning
2. Supervision of audit work
3. Adherence quality control standards

c. Sampling Risk

Definition: The risk that the auditor’s conclusion, based on a sample, might be different from the conclusion
which would be reached if the test were applied in the same way to the entire population

Types:
1.Test of Control Sampling Risk

a. Risk of assessing control risk too high (Alpha Risk):

The risk that the assessed level of control risk based on the sample is greater than the true operating
effectiveness of the control, substantive test will consequently be expanded beyond the necessary level, leading
to audit inefficiency, this risk relate to the audit efficiency.

b. Risk of assessing control risk too low (Beta Risk):

The risk that the assessed level of control risk based on the sample is less than the true operating effectiveness of
the control, substantive test will not be expanded to the necessary level, leading to materially misstated
financial statements, this risk relate to the audit effectiveness.

True Operating Effectiveness of the Controls

The Test of Controls Adequate for planned Inadequate for planned

Sample Indicate: assessed level of control risk assessed level of control risk

Incorrect Decision
Extent of operating Correct Decision
Risk of assessing control risk too low
effectiveness is adequate
Incorrect Decision
Extent of operating Correct Decision
Risk of assessing control risk too high
effectiveness is inadequate
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Note: To support the planed level, the deviation rate must be less than tolerable rate
(For both True & Auditor’s conclusion)

2. Substantive Test Sampling Risk

Risk of incorrect rejection (Alpha Risk):

The risk that the sample supports the conclusion that the recorded account balance is materially misstated when
it is not materially misstated, this risk relate to the audit efficiency, and the performance of additional audit
procedures will lead to the correct conclusion.

Risk of incorrect acceptance (Beta Risk):

The risk that the sample supports the conclusion that the recorded account balance is not materially misstated
when it is materially misstated, this risk relate to the audit effectiveness, and the auditor will not perform
additional audit procedures and the financial statements may include such misstatements.

The Population Actually Is

The Substantive Test Not Materially Misstated Materially Misstated

Sample Indicate:
Correct Decision Incorrect Decision
The Population is not
(Risk of Incorrect Acceptance)
materially misstated
Incorrect Decision
The Population is materially Correct Decision
(Risk of Incorrect Rejection)
misstated

4. Types of Audit Tests in Which Sampling May Be Used

a. Test of Controls

Assess the effectiveness of design or the operation of internal control in preventing or detecting material
misstatements in the financial statements assertions.

b. Substantive Tests

Obtain evidence about the validity and propriety of the accounting treatment of transaction or balance.

c. Duel-Purpose Tests

- Single sample is used to test a control and substantive test

- Auditor should select the higher sample size that requires for the two purposes.
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5. Types of Statistical Sampling Plans

Audit Sampling Technique

Attribute Sampling Variable Sampling

(Test of Control) (Substantive Test)
(Rate of Occurrence) (Dollars $ Amounts)

Statistical Nonstatistical Statistical Nonstatistical

Regular Discovery Sequential Probability – Classical variable

Proportional – to – Size (PPS) Sampling Techniques

DUS CMA CAV Mean Diff- Ratio Regression

Per Unit

Attribute Sampling
Summery of Relationship to Sample Size

Increase In Effect on Sample Size

Risk of assessing control risk too low Decrease
Tolerable Rate Decrease
Expected population Deviation Rate Increase
Population Increase

Variable Sampling
Summery of Relationship to Sample Size

Increase In Effect on Sample Size

Risk of – Incorrect Acceptance Decrease
Risk of – Incorrect Rejection Decrease
Tolerable Misstatement (Errors) Decrease
Expected Misstatement (Errors) Increase
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Population Increase
Variation Increase

Sampling Steps
Attribute Sampling (Tests of Controls) Variable Sampling (Substantive Tests)

1. Determine the objective of the test 1. Determine the objective of the test
2. Define the population
Define the sample unit
2. Define the deviation conditions
Consider the completeness of the population
Identify significant items
3. Select an audit sampling technique
3. Define the population
Statistical
Define the period covered by the test
1. Probability – Proportional – to – Size (PPS)
Define the sample unit
2. Classical variable Sampling Techniques
Consider the completeness of the population
Nonstatistical
4. Determine the method of selecting the sample 4. Determine the sample size by considering:
Random-number sampling* Variation within the population (Standard Deviation)
*(Every item in the population have the same Acceptable level of risk
opportunity to be selected) Tolerable misstatement
Systematic sampling Expected amount of misstatement
(random start then every nth item is selected) Effect of population size
Stratified sampling
(break down the population into subpopulations and
apply different selection methods to each)
Haphazard sampling
Block sampling (least desirable method)
5. Determine the sample size by considering: 5. Determine the method of selecting the sample
Acceptable risk of assessing control risk too low Random-number sampling
Tolerable rate Systematic sampling
(Range of procedural deviations in the population) Other sampling
Expected population deviation rate
Effect of population size
Sequential or a fixed sample-size approach

6. Perform the sampling plan 6. Perform the sampling plan

7. Evaluate the sample results 7. Evaluate the sample results

Calculate the deviation rate Project the misstatements to the population
= Number of Observed Deviations =
b. Consider sampling risk
Sample Size c. Consider the qualitative
Consider sampling risk aspects of the misstatement
Consider the qualitative aspects of the deviation d. Reach an overall
Reach an overall conclusion conclusion
Accept: Deviation Rate + Allowance for Sampling Risk
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< Tolerable Rate

8. Document the sampling procedures. 8. Document the sampling procedures.

B. Sampling in Test of Controls

C. Sampling in Substantive Test of Details

1. Probability – Proportional – to – Size (PPS) Sampling

Variable Sampling (Substantive Tests)

1. Determine the objective of the test : Determine reasonableness of accounts receivable
2. Define the population : Individual dollars in account
3. Select an audit sampling technique : Probability – Proportional – to – Size (PPS)
4. Determine the sample size
- Tolerable Misstatement (TM) $ 50,000
- Risk of incorrect misstatement .05
- Expected misstatement $ 10,000

Book Value of Population x Reliability Factor

Calculation Sample Size =
Tolerable Misstatement – ( Expected Misstatement x Expansion Factor )

$ 1000,000 x 3
= = 88
$ 50,000 – (10,000 x 1.6)

Book Value of Population

Sampling Interval =
Sample Size

$ 1000,000
= = $ 11,333.33
88
5. Determine the method of selecting the sample : Systematic sampling
6. Perform the sampling plan
7. Evaluate the sample results
Project the misstatements to the population : Assume 3 misstatements
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(1) (2) (3) = (1 – 2) (4) = (3/1) (5) (6) = ( 4 x 5 )
Book Value Audited Value Misstatement Taint % Sampling Interval Projected Misstatement
$ 100 $ 95.00 $ 5.00 5% $ 11,333 $ 567
$ 11,700 $ 212.00 $ 11,488.00 -- * NA $ 11,488
$ 65 $ 58.50 $ 6.50 10% $ 11,333 $ 1,133
Projected Misstatement $ 13,188
* Not applicable : Sample Book Value > Sampling interval (Projected Misstatement = Misstatement)

b. Basic Precision = Reliability Factor x Sampling Interval

= 3.0 x $ 11,333.33 = $ 34,000.0

c. Incremental Allowance for Projected Misstatements

Reliability Increment (Increment – 1) Projected Incremental

Factor Misstatements Allowance

3.00 -- -- -- --
4.75 1.75 .75 $ 1,133 $ 850
6.30 1.55 .55 567 $ 312
Incremental Allowance for Projected Misstatements $ 1,162

d. Allowance for Sampling Risk

Allowance for Sampling Risk = Basic Precision + Incremental Allowance for Projected Misstatements

e. Upper Limit on Misstatements

Upper Limit on Misstatements = Projected Misstatements + Allowance for Sampling Risk

8. Document the sampling procedures.

2. Classical Variables Sampling

a. Classical Variable Sampling Model
b. Variations of Classical Variable Sampling

 Mean-Per-Unit Estimation
Is a classical variable sampling technique that projects the sampling average to the total population by
multiplying the sample average by the number of items in the population

 Difference Estimation
Is classical variable sampling technique that uses the average difference between audited amounts and recorded
amounts to estimate the total audited amount of a population and an allowance for sampling risk.

 Ratio Estimation
Is a classical variable sampling technique that uses the ratio of audited amounts to recorded amounts in the
sample to estimate the total dollar amount of the population and an allowance for sampling risk.
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- It is an appropriate method when testing a population for which a large number of errors is expected.

 The Regression Approach

Is similar to the difference and ratio approaches

 Difference and Ratio Estimation

Is an alternative to Mean-Per-Unit Estimation, it measures the difference between audit and book value or the
ratio of audit to book value, as the differences are little, the population will have little variance.
It is more efficient but requires a smaller sample size.

3. Comparison of (PPS) Sampling to Classical Variables Sampling

Probability- Proportion-to Size (PPS) Classical Variable Sampling

Advantages Advantages

(1) Easier to use Smaller sample size

(2) Size of sample not based on variation of audited Easier to expand sample size
amount (3) Selection of zero balances dose not require special sample
(3) Automatically results in a stratified sample design
(4) Significant items are automatically identified (4) Inclusion of negative balances dose not require special
(5) Smaller sample size sample design
(6) Easily designed

Solution Notes
 Regardless of whether the statistical or nonstatistical sampling is being used, the deviation rate of the
sample should be compared to the tolerable rate.
 Considering Tolerable misstatements should be related to preliminary judgments about materiality level.
 In Statistical Technique auditor, the auditor use:
Variability: To obtain an estimate of a population standard deviation.
Mode: Most frequent balance
Median: Middle balance
Range: Difference between the highest and the lowest values.