©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit Sampling Chapter 13

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 1 Explain the concept of representative sampling.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Representative Samples A representative sample is one in which the characteristics in the sample of audit interest are approximately the same as those of the population. Nonsampling risk is the risk that audit tests do not uncover existing exceptions in the sample.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Representative Samples Sampling risk is the risk that an auditor reaches an incorrect conclusion because the sample is not representative of the population. Sampling risk is an inherent part of sampling that results from testing less than the entire population.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 2 Distinguish between statistical and nonstatistical sampling and between probabilistic and nonprobabilistic sample selection.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Statistical Versus Nonstatistical Sampling Step 1Plan the sample. Step 2 Select the sample and perform the tests. Step 3Evaluate the results. Similarities

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Statistical Versus Nonstatistical Sampling Statistical sampling allows the quantification of sampling risk in planning the sample (Step 1) and evaluating the results (Step 3). In nonstatistical sampling those items that the auditor believes will provide the most useful information are selected. Differences

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Sample Selection Methods 1. Directed sample selection 2. Block sample selection 3. Haphazard sample selection Nonprobabilistic

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Sample Selection Methods 1. Simple random sample selection 2.Systematic sample selection 3.Probability proportional to size sample selection 4. Stratified sample selection Probabilistic

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Nonprobabilistic Sample Selection Methods Item selection based on auditor judgmental criteria Items most likely to contain misstatements Items containing selected population characteristics Large dollar coverage Directed Sample Selection

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Nonprobabilistic Sample Selection Methods Items most likely to contain misstatements Selection of several items in sequence Block Sample Selection Haphazard Sample Selection

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 3 Select representative samples.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Probabilistic Sample Selection Methods Simple Random Sample Selection Every possible combination of elements in the population has an equal chance of constituting the sample. Computer generation of random numbers Random number tables

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Probabilistic Sample Selection Methods Systematic Sample Selection The auditor calculates an interval and then selects the items for the sample based on the size of the interval. The interval is determined by dividing the population size by the number of sample items desired.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Probabilistic Sample Selection Methods Probability Proportional to Size Sample Selection Probability Proportional to Size Sample Selection A sample is taken where the probability of selecting any individual population item is proportional to its recorded amount (PPS).

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Probabilistic Sample Selection Methods Stratified Sample Selection The population is divided into subpopulations by size and larger samplesare taken of the larger subpopulations.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 4 Define and describe audit sampling for exception rates.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Sampling for Exception Rates The occurrence rate, or exception rate, is the ratio of the items containing the specific attribute to the total number of population items.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Sampling for Exception Rates Following are types of exceptions in populations of accounting data: – deviations from client’s established controls – monetary misstatements in populations of transaction data – monetary misstatements in populations of account balance details

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 5 Use audit sampling in tests of controls and substantive tests of transactions.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Terms Used in Audit Sampling Terms Related to Planning Characteristic or attribute Acceptable risk of assessing control risk too low (ARACR) Tolerable exception rate (TER) Estimated population exception rate (EPER) Initial sample size

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Terms Used in Audit Sampling Terms Related to Evaluating Results Exception Sample exception rate (SER) Computed upper exception rate (CUER)

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley I: Plan the Sample Step 1State the objectives of the audit test.Step 2Decide whether audit sampling applies.Step 3Define attributes and exception conditions.Step 4Define the population.Step 5Define the sampling unit.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley I: Plan the Sample Specify acceptable risk of assessing control risk too low. Step 7 Estimate the population exception rate.Step 8Determine the initial sample size.Step 9 Specify the tolerable exception rate.Step 6

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley II: Select the Sample and Perform the Tests Select the sample.Step 10Perform the audit procedures.Step 11

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley III: Evaluate the Results Generalize from the sample to the population. Step 12 Analyze exceptions.Step 13Decide the acceptability of the population.Step 14

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Guidelines for ARACR and TER Tests of Control Factor Assessed control risk – Consider: Nature, extent, and timing of substantive tests Quality of evidence available for tests of controls Significance of the transactions and related account balances that the internal controls are intended to affect

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Guidelines for ARACR and TER Tests of Control Judgment Lowest assessed control risk Moderate assessed control risk Higher assessed control risk 100% assessed control risk Guideline ARACR of low ARACR of med. ARACR of high ARACR is N/A Highly significant balances Significant balances Less significant balances TER of 4% TER of 5% TER of 6%

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Guidelines for ARACR and TER Tests of Transaction Planned Reduction inResults of Understanding Substantive Tests ofInternal Control and Details of BalancesTests of Controls LargeExcellent Good Not good ModerateExcellent Good Not good SmallExcellent Good Not good

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Guidelines for ARACR and TER Tests of Transaction Planned Reduction in ARACR forTER for Substantive Tests of Substantive TestsSubstantive Tests Details of Balances of Transactionsof Transactions Large HighPercent or amount Mediumbased on materiality Lowconsiderations Moderate HighPercent or amount Mediumbased on materiality Medium-lowconsiderations Small High Percent or amount Medium-high based on materiality Medium considerations

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Effect on Sample Size of Changing Factors Type of ChangeEffect on Initial Sample Size Increase acceptable risk of assessing control risk too lowDecrease Increase tolerable risk rateDecrease Increase estimated population exception rateIncrease Increase population sizeIncrease (minor)

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Decide the Acceptability of the Population Revise TER or ARACR Expand the sample size Revise assessment control risk Communicate with the audit committee or management

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Summary of Audit Sample Steps PLAN THE SAMPLE (Steps 1-9) Number of exceptions in sample and actual sample size EVALUATE THE RESULTS (Steps 12-14) To Step 12 To Step 14 Sample exception rate From Step 12 Compare To/From Step 6 SELECT THE SAMPLE (Step 10) PERFORM THE TESTS (Step 11)

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 6 Differentiate audit sampling for tests of details of balances and for tests of controls and substantive tests of transactions.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Tests of Details of Balances, Controls, and Substantive Transactions Tests of Controls Substantive tests of transactions Sampling for tests of details of balances

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Learning Objective 7 Apply nonstatistical sampling to tests of details of balances.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Nonstatistical Sampling There are 14 steps required in audit sampling for tests of details of balance. These steps parallel the 14 steps used for sampling for tests of controls and substantive tests of transactions. There are a few differences because of the different objectives of the tests.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Tests of Controls and Substantive Tests of Transactions Step 1State the objectives of the audit test.Step 2Decide whether audit sampling applies.Step 3Define attributes and exception conditions.Step 4Define the population.Step 5Define the sampling unit.

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit Sampling for Tests of Details of Balances Step 1State the objectives of the audit test.Step 2Decide whether audit sampling applies.Step 3Define misstatement conditions.Step 4Define the population.Step 5Define the sampling unit. Difference

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Tests of Controls and Substantive Tests of Transactions Specify acceptable risk of assessing control risk too low. Step 7Estimate the population exception rate.Step 8 Determine the initial sample size.Step 9Specify the tolerable exception rate.Step 6

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit Sampling for Tests of Details of Balances Specify acceptable risk of incorrect acceptance. Step 7 Estimate misstatements in the population. Step 8Determine the initial sample size.Step 9Specify tolerable misstatement.Step 6 Difference

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Tests of Controls and Substantive Tests of Transactions Select the sample.Step 10Perform the audit procedures.Step 11 This is the same as in “Audit Sampling for Tests of Details of Balances.”

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Tests of Controls and Substantive Tests of Transactions Generalize from the sample to the population. Step 12 Analyze the exceptions.Step 13Decide the acceptability of the population.Step 14

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit Sampling for Tests of Details of Balances Generalize from the sample to the population. Step 12 Analyze the misstatements.Step 13Decide the acceptability of the population.Step 14 Difference

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Action When a Population Is Rejected Take no action until tests of other audit areas are completed Perform expanded audit tests in specific areas Increase the sample size Adjust the account balance Request the client to correct the population Refuse to give an unqualified opinion

©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley End of Chapter 13