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I. Review Questions
2. The two methods of projecting the known misstatement to the population are the
average difference method and the ratio method. Refer to Chapter 19 for
formula expressions of each.
3. The important thing is to audit all the sample units. You cannot simply discard
one that is hard to audit in favor of adding to the sample a customer whose
balance is easy to audit. This action might bias the sample. If considering the
entire balance to be misstated will not alter your evaluation conclusion, then you
do not need to work on it any more. Your evaluation conclusion might be to
accept the book value, as long as the account counted in error is not big enough
to change the conclusion. Your evaluation conclusion might already be to reject
the book value, and considering another account to be misstated just reinforces
the decision.
4. Two main reasons for stratifying a population when sampling for variables
(peso) measurement:
a. Some units may be individually significant (e.g., large) and taking sampling
risk with respect to them is not a good idea.
b. Auditors may want to achieve audit coverage of a large proportion of pesos
in the balance by choosing the largest units (a protective sampling
objective, which is closely related to avoiding sampling risk).
19-2 Solutions Manual - Principles of Auditing and Other Assurance Services
5. The tolerable misstatement (judged for the audit of a particular account balance)
must be less than the monetary misstatement considered material to the overall
financial statements. Also, the aggregation of multiple tolerable misstatement
amounts for several different balances under audit must be equal to or less than
the amount of monetary misstatement considered material to the overall
statements.
10. Account balances also can be audited, at least in part, at an interim date. When
account balance audit work is done before the company’s year-end date, auditors
must extend the interim-date audit conclusion to the balance-sheet date. The
process of extending the audit conclusion amounts to nothing more (and nothing
less) than performing substantive-purpose audit procedures on the transactions
in the remaining period and on the year-end balance to produce sufficient
competent evidence for a decision about the year-end balance.
12. Detection (or beta) risk affects sample size inversely for substantive testing
purposes. That is, the higher the acceptable detection risk, the smaller the
sample size; and the lower the acceptable detection risk, the larger the sample
size.
13. Precision is the range + – within which the true answer most likely falls. It is
set by the auditor as a function of materiality and those levels of beta and alpha
risk deemed acceptable. Reliability is the likelihood that the sample range
contains the true value. Also referred to as the confidence level, reliability is set
by the auditor on the basis of overall audit risk.
14. PPS sampling is restricted to populations for which the auditor suspects a few
errors of overstatement only.
15. Several statistical software packages are available to facilitate audit sampling
applications. In addition to calculating sample size and evaluating sample
results, these packages can also assist in the following sampling areas:
a. Stratify populations for sampling purposes;
b. Generate random numbers to facilitate sample selection;
c. Draw the sample, given computerized data bases.
1. b 5. c 9. d 13. a 17. d
2. a 6. b 10. a 14. a 18. b
3. c&d 7. b 11. a 15. c 19. c
4. b 8. d 12. c 16. d 20. d
Supporting Computations:
Audited Value 47,520 490,000 x 0.99 = 485,100
3. c. Book Value 48,000 = 0.99 ; 490,000 – 485,100 = P4,900
P480
d. 120 = P4
1,200 x P4 = P4,800
P 17,500
P500,000
Audit Sampling for Substantive Tests 19-5
7. = 3.5%
Case 1. a. Alpha risk is the risk of rejecting a population that is essentially correct.
Beta risk is the risk of accepting a population that is materially incorrect.
Alpha risk affects audit efficiency because overauditing results from
incorrectly rejecting a population. Beta risk impacts audit effectiveness
because underauditng results from incorrectly accepting a population.
Collectively, alpha and beta risk comprise sampling risk, defined as the
probability that the auditor will draw erroneous conclusions about a
population.
b. Attention to, and quantification of, alpha and beta risk assist the auditor in
applying an audit risk approach to substantive testing. During the audit
planning stage, the auditor identifies areas of high audit risk and sets
detection (beta) risk low for these areas. The result is that more substantive
testing is devoted to the high risk areas relative to the lower risk areas. This
approach enhances both audit efficiency and audit effectiveness.
c. Because it is closely related to the basis for the auditor’s opinion, alpha risk
is usually set equal to overall audit risk. Beta risk is set on the basis of the
auditor’s evaluation of inherent risk and control risk. The greater these risk
factors, as determined by the auditor during the audit planning stages, the
lower the beta risk set by the auditor. The lower the acceptable beta risk,
the larger the sample sizes for substantive testing purposes. Alpha and beta
risk, therefore, provide the necessary link between audit risk analysis and
substantive audit testing.
(2) Ratio estimation estimates total population value by (1) using the ratio
of the sample audited values to book values as an estimate of the ratio
19-6 Solutions Manual - Principles of Auditing and Other Assurance Services
of population audited value to book value, and (2) applying the
estimated ratio to the population book value. The computations are as
follows:
(1) Estimated ratio of audited to book value =
(3) Difference estimation estimates total population values by (1) using the
average difference between the audited and book values of sample
items as an estimate of the average difference for all population items,
(2) extending the estimated average difference by the number of items
in the population, and (3) using the resulting estimate of the total
difference between audited and book value to compute the estimated
total value. The computations are as follows:
The estimate of total value developed in ratio estimation is based upon the
ratio of audited values to book values, rather than upon mean peso value. If
this ratio has no tendency to vary with the peso value of the lot, the estimate
of total value is not affected by the mean value of items in the sample.
However, sampling error may still be present if the sample lots are not
Audit Sampling for Substantive Tests 19-7
representative of the population with respect to the ratio of audited values
to book values.
Case 3. The auditors would project the misstatement found in the sample to the
population using either the ratio or difference approach. The ratio approach
would result in a projected misstatement of P65,500. This may be computed by
first calculating the ratio of the audited to book value as 1.0131 [P23,100 /
P22,800 (since there is a net understatement of P300, the audited value is
P23,100)] and estimating the audited value of the population as:
Case 4. The audit risk (ultimate risk) of material misstatement in the financial
statements (AR) is the product of:
(1) Inherent risk (IR), the risk of material misstatement in an assertion,
assuming there were no related internal controls.
(2) Control risks (CR), the risk of material misstatement occurring in an
assertion, and not being prevented or detected on a timely basis by the
internal control structure.
(3) Detection risk (DR), the risk that the auditors’ procedures will lead them to
conclude an assertion is not materially misstated, when in fact such
misstatement does exist.
AR = IR x CR x DR
This equation may be restated to solve for the allowable detection risk as
follows:
DR = AR / (CR x IR)
Using the risk levels set forth in the problem, the allowable risk of reliance upon
substantive tests is computed as illustrated below:
P500,000 x 3
Sample size = P25,000 – (P2,000 x 1.6) = 69
Note: The reliability factor is from the zero misstatements row of the PPS sampling
table given in the case.
(2) The sampling interval is calculated simply by dividing the book value
of receivables by the sample size, as follows:
= P23,460
NOTES:
Projected misstatement
(a) Tainting percentages are calculated as the difference between book
and audited value divided by book value (e.g., (P50 – P47) / P50 =
6%).
(b) No tainting percentage is calculated for items in excess of the
sample interval and the actual misstatement is extended to
projected misstatement (as for the third error).
Incremental allowance
(a) Reliability factors are read from the PPS sampling table given in
the case, starting at zero misstatements.
(b) “Increment – 1” is the difference in the two adjacent reliability
factors minus 1 (e.g., 4.75 – 3.00 – 1.00 = .75).
(c) Misstatements in excess of the sampling interval are not
considered in the incremental allowance. This is because the
nature of the process requires that all items in excess of the
sampling interval be included in the sample – therefore no
allowance for items not in the sample is necessary.
c. The results obtained in part b would indicate that the auditors may accept
the population as not containing a tolerable misstatement at the 5 percent
level of risk of incorrect acceptance. The auditors would also consider the
results obtained in conjunction with other audit tests.
= P300,000 / 60 = P5,000
c. Projected misstatement =