1. Prepared by: Angela Davis CA, CFE, MSc Booth University College
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2. OVERVIEW OF TESTS OF CONTROLS, SUBSTANTIVE PROCEDURES, AND SAMPLING
Understand the difference between tests of controls and substantive tests
Explain the factors that impact the nature, timing, and extent of audit testing
Explain how audit sampling is used in an audit
Understand the difference between sampling and non-sampling risk
Differentiate between statistical and non-statistical sampling
Describe sampling methods and the factors to be considered when choosing a sample
Determine the factors that influence the sample size when testing controls
Determine the factors that influence the sample size when substantive testing
Outline how to evaluate the results of tests conducted on a sample.
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3. Tests of controls and substantive procedures
Audit plan contains audit procedures for
testing controls, and
conducting detailed substantive tests
Control tests/procedures are designed to see if controls work effectively to prevent or detect and correct material misstatements at the assertion level
Substantive tests/procedures are tests designed to detect material misstatements at the assertion level
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4. Tests of controls and substantive procedures
Audit plan is based on audit strategy
Audit strategy is developed after gaining an understanding of the client’s business (inherent risk) and its internal control structures (control risk)
Therefore, relative emphasis on (1) tests of controls and (2) substantive procedures depends on client’s audit risk
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5. Tests of controls and substantive procedures
Table 6.1
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6. Tests of controls
Preliminary assessment of control risk (CR) is made after gaining an understanding of client during planning stage
Tests of controls are performed on controls identified during gaining understanding phase
To obtain evidence that controls operated effectively and consistently throughout period
Auditor can reduce reliance on substantive testing only if tests confirm CR not high
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7. Most important controls
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8. Tests of controls cont’d
Control testing procedures include:
Inspection of documents for evidence of authorization
Inspection of documents for evidence that details included have been checked by appropriate client personnel
Observation of client personnel performing various tasks, such as opening mail and conducting a inventory count
Enquiry of client personnel about how they perform their tasks
Re-performing control procedures to test their effectiveness
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9. Which controls to test
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10. Substantive testing Types of substantive procedures:
Substantive tests of transactions
Substantive tests of balances
Analytical procedures
When CR is lower, auditor can rely more on analytical procedures and less on detailed substantive tests of transactions and balances
Analytical procedures are more efficient and place greater reliance on client’s accounting records
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11. Substantive testing cont’d
Examples of substantive procedures:
Confirmation from client’s bank regarding interest rates on borrowings (tests accuracy assertion for interest expense)
Recalculate interest expense (accuracy assertion)
Inspecting documents to verify date of transactions posted around year-end (cut-off assertion)
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12. Substantive testing cont’d
Examples of substantive procedures cont’d:
Inspecting suppliers’ invoices to verify amounts recorded as purchases (completeness assertion)
Confirmation from debtors for amount owed (existence assertion)
Recalculating wages payable (valuation and allocation assertion)
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13. Substantive testing cont’d
Examples of analytical procedures:
Estimate depreciation expense by multiplying average depreciation rate by asset balance (accuracy assertion)
Compare inventory balances for this year and last year (existence, completeness and valuation and allocation assertions)
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14. Substantive testing cont’d
Examples of analytical procedures cont’d:
Estimate movie theatre revenue by multiplying average ticket price x number of seats in theatre x average proportion of seats sold per session x number of sessions per week x weeks per year (occurrence and accuracy assertions)
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15. Analytical procedures, detail transactions, detail balances
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16. Nature, timing and extent of audit testing
Nature, timing and extent of testing varies depending on audit strategy adopted and type of testing (CAS 330)
Nature of audit testing
The purpose of the test (control or substantive test; which assertion is being tested), and
The procedure used (inspection, observation, enquiry, confirmation, recalculation, re-performance or analytical procedure)
Auditor tries to gather most persuasive evidence for assertions most at risk
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17. Nature, timing and extent of audit testing cont’d
Timing of audit testing
Date that audit evidence relates to, and
Stage of audit when procedures are performed
Interim testing usually done for:
Control testing
Low risk accounts
Year-end testing usually done for:
High risk accounts
Accounts affected by high deviations in control tests
Cut-off assertion
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18. Nature, timing and extent of audit testing cont’d
Refers to amount of audit evidence gathered
Increase extent of control testing when control risk is low
Reduce extent of substantive testing and increase extent of reliance on analytical procedures when control testing confirms lower CR
Do little or no control testing when adopting predominantly substantive strategy (ie control risk high)
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19. Audit sampling
Sampling is required whenever auditor does not test entire group of transactions or all items in a balance (CAS 530)
In many cases, there are too many items to test, or auditor decides that it is not necessary to test all items
Sample of items tested should be representative of the population
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20. Sampling and non-sampling risk
Sampling risk is the risk that the sample chosen by the auditor is not representative of the population available for testing, and causes the auditor to arrive at an inappropriate conclusion.
Two consequences of sampling risk:
Risk that audit will be ineffective
Risk that audit will be inefficient
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21. Sampling and non-sampling risk cont’d
Tests of control and sampling risk
If sample contains fewer deviations than population, auditor over relies on controls
Concludes internal controls work effectively
Audit is ineffective because risk of misstatement is greater than auditor’s assessment
If sample contains more deviations than population, auditor under relies on controls
Concludes internal controls do not work effectively
Audit is inefficient because auditor does more work than necessary
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22. Sampling and non-sampling risk cont’d
Table 6.2
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23. Sampling and non-sampling risk cont’d
Substantive tests and sampling risk
If sample contains fewer misstatements than population, auditor concludes financial statements not misstated
Audit is ineffective because risk of misstatement greater than auditor’s assessment
If sample contains more misstatements than population, auditor concludes financial statement misstated
Audit is inefficient because auditor does more work than necessary
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24. Sampling and non-sampling risk cont’d
Non-sampling risk is the risk that the auditor makes an inappropriate conclusion for a reason unrelated to sampling issues.
The auditor could:
Use inappropriate audit procedures,
Rely too heavily on unreliable evidence,
Spend too little time testing high risk accounts or critical controls
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25. Reducing sampling risk
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26. Statistical and non-statistical sampling
Statistical sampling involves random selection and probability theory to evaluate the results, including sampling risk (CAS 530)
Allows measurement of sampling risk
Can be costly to use
Non-statistical sampling allows auditor to use judgement to select sample items
More likely used when account is low risk and corroborating evidence available
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27. Sampling methods Random selection
Person selecting sample cannot influence choice of items
Each item has equal chance of being selected
Sample can be stratified before selecting random sample to increase efficiency
E.g. stratify (subdivide) population of transactions into different size ranges, then take different size samples from each stratum
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28. Example of stratification
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29. Sampling methods cont’d
Systematic selection
Divide number of items in population by sample size, giving sampling interval (n). Select starting point, then take every nth item
Risk that items are listed in way that every nth item is related – can randomly order first
Haphazard selection
Auditor does not use methodical technique
Not random sampling because personal bias could affect choice
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30. Sampling methods cont’d
Block selection
Select items grouped together
Sequence of items may make this inappropriate
Non-statistical
Judgemental selection
Auditor chooses items based on judgement
E.g. after a new computer system installed
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31. Factors to consider when selecting sample
Consider acceptable detection risk (DR) and planning materiality (PM)
Define ‘error’ for test, set ‘tolerable error’ and confidence level required
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32. Factors to consider when selecting sample cont’d
Define population
Control testing - draw sample from entire financial year
Substantive testing - population from which sample is drawn must be defined according to assertion being tested, e.g.
Existence of inventory – draw sample from inventory records
Completeness of inventory – draw sample from physical inventory items
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33. Factors that influence sample size cont’d
When determining size of sample for control testing, CAS 530 requires auditor to consider:
Larger sample size if auditor intends to rely more heavily on that control to reduce substantive testing
Smaller sample size if auditor is willing to tolerate a higher deviation rate for that control
Larger sample size if auditor expects the population to have a higher rate of deviation for that control
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34. Factors that influence sample size cont’d
Sample size for control testing cont’d
Larger sample size if auditor requires greater confidence that the control is operating effectively (i.e. lower control risk)
Very little change to sample size if population has more sampling units
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35. Factors that influence sample size cont’d
Table 6.4
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36. Factors that influence sample size cont’d
When determining size of sample for substantive testing, CAS 530 requires auditor to consider:
Larger sample size if auditor assesses risk of material misstatement as greater (higher IR, CR)
Smaller sample size if auditor also using other substantive procedures for same assertion
Larger sample size if auditor requires greater confidence from results of tests (requires lower DR)
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37. Who decides the technique and the size used
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38. Factors that influence sample size cont’d
Sample size for substantive testing cont’d
Smaller sample size if auditor is willing to accept greater total error (higher tolerable misstatement)
5. Greater sample size if auditor expects to find greater misstatement in population
6. Smaller sample size if auditor using stratification of population
7. Very little change to sample size if population has more sampling units
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39. Factors that influence sample size cont’d
Table 6.5
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40. Evaluating sample test results
Auditor will consider whether results of tests applied to a sample provide evidence that
Control tested is effective within entire population (for control tests), or
Class of transactions or account balance tested is fairly stated (for substantive tests)
If errors are found in sample, calculate for population
Deviation rate for control, or
Misstatement of transactions or account balance
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41. Deviations and misstatements
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42. Evaluating sample test results cont’d
If sample is representative of population
Conclude deviation from controls in sample is at same rate as deviation from controls in population
Is deviation rate tolerable? – more testing required?
Project monetary errors in sample to population
First remove unique errors
Consider if sample stratified
Projected error = dollar size of error / dollar size of sample x dollar size of population or stratum
Is total projected error tolerable? – more testing required?
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43. Evaluating sample test results cont’d
As an auditor what would you conclude if the tolerable error rate was set at $3,500? What if the tolerable error rate was $7,500?
Table 6.6
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