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Audit is a Science of examining the records and forming an opinion. A Statutory Auditor would be required to form an opinion on the Financial Statements, whereas Internal Auditors are required to report on efficiency and efficacy of the Internal Control System. However, for any type of attest functions, an Auditor is required to look into the records under a microscope. Considering the size of the Operations of the Client and the complexity of business involved, is an auditor expected to verify 100% of the records? No, not required. An Auditor is not expected to verify 100% of the records, a portion of the records are expected to be verified and the results are extrapolated to the population. The procedure to obtain or to decide on the less than 100% of the Population is called as Sample Selection.
Segregation of Data
The Population should be first analyzed based on their contents. For Example: In case of Sales, the segregation could be done as given in Table 1. After the Preliminary analysis like rendered above, the segregation of the data should be further analyzed based on: 1. 2. 3. 4. 5. Percentage of the sub-component to the Total Segment Number of times a variable has repeated Above or Below the Average Having Unusual Trends Seasonal or Cyclical Changes.
Retail Sales Product Dominated Geographically Diversified Supply to a Single customer Variety of Products Pre-dominantly Related Parties and also Non-Related Parties
The segregation of the segments will help in getting a macro level view of the spread of the Population. Students of Statistics know the above process as Stratification.
Golden Rule
Any Audit Procedure can be classified into 2 components: a. b. Testing the Control Testing the Details
Of all the Statistical and Mathematical Models one may use, at the end of the day it is the Auditors professional judgment on the quality of accounts and initial due-diligence will influence the extent of verification that is planned. Lets take some examples and discuss how the sample selection is influenced, in other words, these are the incidents where Sample Size would Increase. It is better not to decrease the sample size; since the variety of population should not be disturbed.
Client Specific: Operational Controls is Weak and higher level of verification is required Ex: Internal Controls as per Internal Audit Report or Discussion with Client indicates weak, Weak Delegation of Authority, Frequent changes in Policy without adequate explanation. Lower Rate of Tolerable Error - Ex: Multiple Regulations and Complexity of Accounts where errors may cost the Companys business and Audit Risk is high, especially in case of Listed Companies and PSU. Previous Audit Experience with Client and in Industry where Sample results has proved to be contrary to the Result of the Population. During the course of Audit; there are indications of higher rate of Errors in Accounting; then Sample size should be revised at higher end. Auditor Specific: Auditor based on his experience and professional judgment is skeptical about the Accounting practice.
Cherry Picking
Now that we know how the layout or view of the Population is, its time to pick the cherries, which would undergo the magnifying lens. Yes, the samples are now selected. Within each sub-segment, there are lots of data lying to be chosen. How do we choose the right ones? Is choosing the right one an Art or Science? Should we throw dice and chose the number? Here is where the Science of Statistics applies. Lets see what Statistics have to say as to how to select a sample: Random Number: This technique uses Random Number Table to choose among the uniform data, having homogenous characteristics. Systematic Selection: In this technique, sample size is arrived at first determining the Quantity of Sample Size. Say there are 1000 Invoices. Sample Size th th required is 100. Therefore, every 10 Invoice may be selected after 100 Invoice. Monetary Unit Selection a. Samples of all amounts below or above a particular amount may be chosen. For Example: All invoices worth Rs.10,000/- or more is chosen. Use of Pareto Analysis: ABC Analysis of the Data is done, and the segment, which yields the majority percentage, will be selected as sample. Sample which are higher or below the Average Amount.
b.
c.
Haphazard Selection Samples are selected using blindfold theory i.e., how would chose something if you were blindfolded. It is purely based on guess and is not scientific in nature. Block Selection 3
Selecting a group of data say, if there are 1000 invoices, one choses Invoice No. 500 to Invoice No. 600. Drawback in this method is the spread is narrowed and the best of samples may not be available and they necessary are not representative of sample, Multi-Stage Sample Involves sampling at various levels. In the first levels Sample Data are short-listed and then from the short list the final sample is selected.
Practical Application
Method Random Number Systematic Selection Monetary Unit Selection Haphazard Selection Block Selection Multi-Stage When to use? Characteristics of the variables are homogenous. When there is no major difference in the spread of the Population. When Opinion is sought on the Quality of the ledger Account. Non-significant items, but still need to be verified. If there are indications of errors in a particular area or cluster. Where Sample is required from a combination of variables.
Results of Verification
Lets remember, the outcome of the verification i.e., we could conclude that there is delay in accounting or accounting is incomplete or documentation is inadequate, etc., is only for the sample tested. However, since the sample reflects the population, one needs to extrapolate the results at the Population level. In simple words, we conclude that the Population has passed or failed the test of verification based on the samples we select. Hence, the selection of right sample is very important.
Or, the Auditor may conclude that the Controls are not working properly, on the other extreme. This could lead to Auditor performing additional functions, which may not be required at all. Either the Auditor Overestimates or Underestimates the effectiveness of the Controls. This could happen after the Sample Selection. To a step back; what if the method of Sampling was right and Audit Procedures were inappropriate? Example: Relying more on Internal Evidence than the External Evidence. Not enquiring into long outstanding dues represented in the Reconciliation Statements. It is called as Non-Sampling Risk. This could lead to incorrect audit conclusions of the Sample and which is extrapolated to the Population.