Copyright 2003 Pearson Education Canada Inc. CHAPTER 11 Audit Sampling Concepts
Copyright 2003 Pearson Education Canada Inc. What is a representative sample? A representative sample has the same characteristics as the population from which the sample was taken.
Copyright 2003 Pearson Education Canada Inc. What can make a sample non- representative? Sampling errors occur because of the nature of sampling; the proper sampling method was selected, applied, and interpreted but failed to uncover material misstatements.
Copyright 2003 Pearson Education Canada Inc. What can an auditor do to reduce the risk of sampling errors? increase sample size
Copyright 2003 Pearson Education Canada Inc. What can make a sample non- representative? - sampling errors - nonsampling errors result from auditor failure to recognize errors or excep- tions or from the selection of ineffec- tive or inappropriate procedures oops!
Copyright 2003 Pearson Education Canada Inc. What can an auditor do to reduce the risk of nonsampling errors? increase auditor competence Continuing Professional Education
Copyright 2003 Pearson Education Canada Inc. Audit sampling can be based on: statistics OR judgment
Copyright 2003 Pearson Education Canada Inc. nonstatistical sampling statistical sampling primary advantage: the sampling risk can be quantified primary advantage: employs auditor’s experience and judgment
Copyright 2003 Pearson Education Canada Inc. nonstatistical sampling judgmentally select a representative sample sample selection Nonstatistical sampling employs nonprobabilistic selection - the auditor decides which population items to select.
Copyright 2003 Pearson Education Canada Inc. nonprobabilistic selection methods - judgmental (directed sample) selection auditor selects items based on charac- teristics because random selection does not consider: ~ each type of transaction sample selection nonstatistical sampling judgmentally select a representative sample
Copyright 2003 Pearson Education Canada Inc. nonprobabilistic selection methods - judgmental (directed sample) selection auditor selects items based on charac- teristics because random selection does not consider: ~ each type of transaction ~ each preparer of transactions sample selection nonstatistical sampling judgmentally select a representative sample
Copyright 2003 Pearson Education Canada Inc. nonprobabilistic selection methods - judgmental (directed sample) selection auditor selects items based on charac- teristics because random selection does not consider: ~ each type of transaction ~ each preparer of transactions ~ large dollar balances sample selection nonstatistical sampling judgmentally select a representative sample
Copyright 2003 Pearson Education Canada Inc. sample selection nonprobabilistic selection methods - block sampling - selection of a sequence and examining every item in the sequence Example: examine all cancelled cheques of February Ace Corporation 324 $ pay to the order of date nonstatistical sampling judgmentally select a representative sample CANADIAN BANK
Copyright 2003 Pearson Education Canada Inc. nonprobabilistic selection methods - haphazard selection - auditor selects items without regard to characteristics sample selection Beware of bias! nonstatistical sampling judgmentally select a representative sample
Copyright 2003 Pearson Education Canada Inc. statistical sampling randomly select a representative sample sample selection Statistical sampling employs probabilistic selection - every population item has a known chance of being selected.
Copyright 2003 Pearson Education Canada Inc. statistical sampling randomly select a representative sample sample selection probabilistic selection methods - simple random sample selection used to sample populations that are not segmented for audit purposes See pg 318
Copyright 2003 Pearson Education Canada Inc. statistical sampling randomly select a representative sample sample selection probabilistic selection methods - random number tables Know benefits & drawback Pg 318
Copyright 2003 Pearson Education Canada Inc. statistical sampling randomly select a representative sample sample selection probabilistic selection methods - computer generation of random numbers
Copyright 2003 Pearson Education Canada Inc. statistical sampling randomly select a representative sample sample selection probabilistic selection methods - systematic selection - the auditor cal- culates an interval, starts at random, and selects every nth item. Beware of possible bias with numeric tests, e.g., every 314th cheque is written on a Friday.
Copyright 2003 Pearson Education Canada Inc. Audit sampling is a method used to determine the proportion of population items containing a particular attribute. Audit Sampling
Copyright 2003 Pearson Education Canada Inc. When is audit sampling appropriate? Example: credit authorization of sales SALES INVOICE Date: Ace Company Customer: 834 Reynolds Rd. Winnipeg, MB R2V 4E3 Sales Representative: Quantity Description Price total invoice amount Terms of sale (including discounts and freight costs): Carrier: Credit authorization: tests of controls
Copyright 2003 Pearson Education Canada Inc. - attribute - acceptable risk of assessing control risk too low (ARACR) - tolerable exception rate (TER) - estimated population exception rate (EPER) - initial sample size - exception - sample exception rate (SER) - computed upper exception rate (CUER) - considering the extent of exceptions, the worst likely population exception rate Audit Sampling Terms
Copyright 2003 Pearson Education Canada Inc. Audit Sampling Sequence 1. State the objectives of the audit test.
Copyright 2003 Pearson Education Canada Inc. 1. State the objectives of the audit test. Example: The auditor wants to deter- mine the acceptability of the notes re- ceivable balance of $600,000. notes receivable $600,000 acceptable? Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 1. Determine the objectives of the test. 2. Decide if audit sampling applies. Does the auditor plan to reach conclusions based on a sample? Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 1. Determine the objectives of the test. 2. Decide if audit sampling applies. 3. Define misstatement conditions. Misstatement conditions are any conditions that represent monetary fraud, errors or irregularities in the accounting records. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 1. Determine the objectives of the test. 2. Decide if audit sampling applies. 3. Define misstatement conditions. 4. Define the population. notes receivable dollars Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 1. Determine the objectives of the test. 2. Decide if audit sampling applies. 3. Define misstatement conditions. 4. Define the population. 5. Define the sampling unit. one customer name or loan number Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 1. Determine the objectives of the test. 2. Decide if audit sampling applies. 3. Define misstatement conditions. 4. Define the population. 5. Define the sampling unit. 6. Specify tolerable misstatement. What amount of monetary fraud, error or irregularity can exist in notes receivable without causing the financial statements to be materially misstated? Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 6. Specify tolerable misstatement. based on auditor judgment Audit Sampling Sequence What amount of monetary fraud, error or irregularity can exist in notes receivable without causing the financial statements to be materially misstated?
Copyright 2003 Pearson Education Canada Inc. 6. Specify tolerable misstatement. In the notes receivable example, tolerable mis- statement is established at $24,000 for both over- and understatements. Audit Sampling Sequence What amount of monetary fraud, error or irregularity can exist in notes receivable without causing the financial statements to be materially misstated?
Copyright 2003 Pearson Education Canada Inc. 7. Specify acceptable risk of incorrect acceptance. What level of risk is the auditor willing to take of concluding that the account balance is not materi- ally misstated when, in fact, it is materially misstated. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 7. Specify acceptable risk of incorrect acceptance. What level of risk is the auditor willing to take of concluding that the account balance is not materi- ally misstated when, in fact, it is materially misstated. also based on auditor judgment Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 7. Specify acceptable risk of incorrect acceptance. What level of risk is the auditor willing to take of concluding that the account balance is not materi- ally misstated when, in fact, it is materially misstated. In the notes receivable example, ARIA is established at 5%. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 8. Estimate misstatements in the population. What is the amount of mis- statement that the auditor expects to find in the population? Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. What is the amount of mis- statement that the auditor expects to find in the population? based on auditor judgment and prior year results 8. Estimate misstatements in the population. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. What is the amount of mis- statement that the auditor expects to find in the population? In the example, EPER is 1.5%; i.e., the auditor expects that 1.5% of the notes receivable balance is misstated. 8. Estimate misstatements in the population. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 9. Determine the initial sample size. For nonstatistical sampling, professional judgment of auditor is used to determine initial sample size. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 9. Determine the initial sample size. For statistical sampling of test of controls, population size, TER, ARACR, and EPER are all factors used to determine initial sample size. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. Audit Sampling Sequence 10. Select the sample. Nonprobabilistic: - Directed sample selection - Block sample selection - Haphazard sample selection
Copyright 2003 Pearson Education Canada Inc. Audit Sampling Sequence 10. Select the sample. Probabilistic: - Simple random sample selection - Systematic sample selection - Probability proportionate-to-size sample selection
Copyright 2003 Pearson Education Canada Inc. 11. Perform the audit procedures. Through confirmation of selected notes receivable balances, $1,380 of misstatements were discovered in a sample of $35,500. Audit Sampling Sequence Canada 48
Copyright 2003 Pearson Education Canada Inc. 12. Generalize from the sample to the population. Audit Sampling Sequence Project the sample misstatement results to the population and consider sampling error and sampling risk: sample misstatement total recorded point estimate total sample pop. value of misstatement x=
Copyright 2003 Pearson Education Canada Inc. 12. Generalize from the sample to the population. Project the sample misstatement results to the population and consider sampling error and sampling risk: In the notes receivable example: Audit Sampling Sequence sample misstatement total recorded point estimate total sample pop. value of misstatement x = $1,380 $35,500 x $600,000 = $23,324 point estimate
Copyright 2003 Pearson Education Canada Inc. 12. Generalize from the sample to the population. Audit Sampling Sequence tolerable misstatement - point estimate = allowance for sampling error $24,000 - $23,324 = $676 The auditor must also judgmentally assess sampling error, considering several factors. The most important of these factors is the difference between the point estimate and tolerable misstatement.
Copyright 2003 Pearson Education Canada Inc. 12. Generalize from the sample to the population. The auditor must also judgmentally assess sampling error, considering several factors. The most important of these factors is the difference between the point estimate and tolerable misstatement. In the notes receivable example: Audit Sampling Sequence tolerable misstatement - point estimate = allowance for sampling error $24,000 - $23,324 = $676
Copyright 2003 Pearson Education Canada Inc. 13. Analyze exceptions or misstatements. evaluate the nature and cause of each misstatement Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 13. Analyze the exceptions or misstatements. evaluate the nature and cause of each misstatement This evaluation may affect the auditor’s conclu- sions regarding financial statements, client operations, and/or other areas. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. 14. Determine the acceptability of the population. Decision Rule: Considering sampling error, if the point estimate is less than the tolerable mis- statement, accept the conclusion that the book value is not misstated by a material amount. Audit Sampling Sequence
Copyright 2003 Pearson Education Canada Inc. In the notes receivable example: Decision Rule: Considering sampling error, if the point estimate is less than the tolerable mis- statement, accept the conclusion that the book value is not misstated by a material amount. original point estimate estimate of point estimate incl. of misstatement sampling error sampling error += $23,324 + $1,500 = $24,824 judgmentally determined conclusion?
Copyright 2003 Pearson Education Canada Inc. $24,824>$24,000 tolerable misstatement The notes receivable balance of $600,000 is not acceptable. In the notes receivable example: Decision Rule: Considering sampling error, if the point estimate is less than the tolerable mis- statement, accept the conclusion that the book value is not misstated by a material amount. original point estimate estimate of point estimate incl. of misstatement sampling error sampling error += $23,324 + $1,500 = $24,824 conclusion?
Copyright 2003 Pearson Education Canada Inc. - take no action until tests of other audit areas are completed - perform expanded audit tests in specific areas - increase sample size - request the account balance be adjusted - request the client to correct the population - refuse to give an unqualified opinion What are the auditor’s options? book value is not acceptable
Copyright 2003 Pearson Education Canada Inc. When an internal control is judged unacceptable, what options does the auditor have?
Copyright 2003 Pearson Education Canada Inc. - revise the Tolerable exception rate This may be considered ethically questionable. WHY? When an internal control is judged unacceptable, what options does the auditor have?
Copyright 2003 Pearson Education Canada Inc. - expand the sample size When is this appropriate? When an internal control is judged unacceptable, what options does the auditor have?
Copyright 2003 Pearson Education Canada Inc. This is only appropriate if the auditor believes that the sample was not repre- sentative of the population. When an internal control is judged unacceptable, what options does the auditor have? - expand the sample size
Copyright 2003 Pearson Education Canada Inc. - revise the assessed control risk up- ward, and increase tests of details of balances for related accounts (a/r, sales, bad debt expense, allowance for doubtful accounts) When an internal control is judged unacceptable, what options does the auditor have?
Copyright 2003 Pearson Education Canada Inc. When an internal control is judged unacceptable, the auditor is required to communicate this weakness to management, and may inform the audit committee as well.
Copyright 2003 Pearson Education Canada Inc. Homework not required not required Do only 11-25