Audit Sampling Concepts

CHAPTER 11
Audit Sampling
Concepts
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2003 Pearson Education Canada Inc.
11 - 1
What is a representative sample?
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11 - 2
What is a representative sample?

A representative sample has the same
characteristics as the population from
which the sample was taken.
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What can make a sample nonrepresentative?
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- sampling errors
?
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11 - 5

Sampling errors
occur because of the nature
of sampling; the proper
sampling method was selected,
applied, and interpreted but
failed to uncover material
misstatements.
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11 - 6
What can an auditor do to reduce

the risk of sampling errors?
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the risk of sampling errors?
increase sample size
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11 - 8

- sampling errors
- nonsampling errors
?
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11 - 9

- sampling errors
- nonsampling errors result from auditor
failure to recognize errors or exceptions or from the selection of ineffective or inappropriate procedures
oops!
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the risk of nonsampling errors?
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the risk of nonsampling errors?
increase auditor competence

Continuing
Professional
Education
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Audit sampling can be based on:

judgment
OR
statistics
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nonstatistical sampling
statistical sampling
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11 - 14
primary
advantage:
employs
auditors
experience
and
judgment
primary
advantage:
the audit
risk can be
quantified
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primary
advantage:
employs
auditors
experience
and
judgment
primary
advantage:
the
sampling
risk can be
quantified
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judgmentally
determine sample size
implicitly recognizing
relevant factors
explicitly recognizing
relevant factors
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judgmentally
relevant factors

relevant factors
judgmentally select a
representative sample
randomly select a
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judgmentally
relevant factors

relevant factors
randomly select a
apply audit procedures
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11 - 19
judgmentally
relevant factors

relevant factors
randomly select a
evaluate test results

judgmentally
evaluate test results

statistically and
judgmentally
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sample selection
Nonstatistical sampling employs

nonprobabilistic selection the auditor decides which
population items to select.
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sample selection
nonprobabilistic selection methods

- judgmental (directed sample) selection
auditor selects items based on characteristics because random selection
does not consider:
~ each type of transaction
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sample selection

does not consider:
~ each preparer of transactions
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sample selection

does not consider:
~ each preparer of transactions
~ large dollar balances
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sample selection

- block sampling - selection of a
sequence and examining every item in
the sequence
Ace Corporation
324
date
pay to the order of
Example:
CANADIAN BANK
examine all
cancelled
cheques of February
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sample selection

- haphazard selection - auditor selects
items without regard to characteristics
Beware
of bias!
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randomly select a
sample selection
Statistical sampling employs

probabilistic selection - every
population item has a known
chance of being selected.
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11 - 27
randomly select a
sample selection
probabilistic selection methods

- simple random sample selection
used to
sample populations
that are not segmented
for audit purposes
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11 - 28
randomly select a
sample selection

- random number tables
How
does an
auditor use
random
number tables?
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randomly select a
sample selection

- use of random number table
1. number each population item
2. establish correspondence between
table and population
3. establish a route in the table
4. select a random starting point
5. document the method
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randomly select a
sample selection

- computer generation of random
numbers
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randomly select a
sample selection

- systematic selection - the auditor calculates 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.
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randomly select a
sample selection

- probability proportional to size and
stratified sample selection
discussed in
chapter 14
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Audit Sampling
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Audit Sampling
Audit
sampling is a
method used
to determine the
proportion of
population items
containing a
particular attribute.
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When is audit sampling

appropriate?
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11 - 36
When is audit
sampling
appropriate?
tests of
controls
SALES INVOICE
Ace Company
834 Reynolds Rd.
Winnipeg, MB R2V 4E3
Sales Representative:
Quantity Description
38527
Date:
Customer:
Price
total invoice amount
Example:
credit
authorization
of sales
Terms of sale (including discounts and freight

costs):
Carrier:
Credit authorization:
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Audit Sampling Terms

- attribute - the tested characteristic
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- attribute
- acceptable risk of assessing control
risk too low (ARACR)- the risk that the
auditor is willing to accept that controls are accepted as effective, but the
actual population exception rate is
greater than the TER
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- attribute
risk too low (ARACR)
- tolerable exception rate (TER) - the
population exception rate the auditor
will permit and still be willing to use the
assessed control risk and/or the
amount of monetary misstatements in
the transactions established during
planning
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- attribute
- tolerable exception rate (TER)
- estimated population exception rate
(EPER) - the exception rate that the
auditor expects to find (this estimate is
made prior to any testing)
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- attribute
(EPER)
- initial sample size - determined judgmentally by the auditor implicitly considering the ARACR, TER, EPER, and
population size
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- attribute
(EPER)
- initial sample size
- exception - a deviation from the tested
characteristic
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- attribute
(EPER)
- exception
- sample exception rate (SER):
number of exceptions
sample size
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- attribute
- estimated population exception rate (EPER)
- exception
- sample exception rate (SER)
- computed upper exception rate (CUER) considering the extent of exceptions, the
worst likely population exception rate
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Audit Sampling Sequence
?
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Audit Sampling
Sequence
SALES INVOICE
38527
Date:
Customer:
1. StateAcme
the
objectives of the audit test.
Company
834 Reynolda Rd.
Example: The auditor is testing proper

credit approval of sales.
Price

Est. shipment date:
costs):
Carrier:
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2. Decide if audit sampling applies.
yes
audit
sampling
is
appropriate
Does the auditor

plan to reach
conclusions based
on a sample?
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no
audit
sampling
is not
appropriate
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3. Define attributes and exception
conditions.
In the
example, what is
the attribute?
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Audit Sampling
Sequence
SALES INVOICE 38527
Date:
3. Define attributes
and
exception
Acme Company
Customer:
conditions.834 Reynolda Rd.
the
signature
of the
credit
manager
on the
sales
invoice

In the
example, what is
Est. shipment
date:attribute?
the
Price

costs):
Carrier:
Joe Credit
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3. Define attributes and exception
conditions.
In the
example, what is
the exception
condition?
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Audit Sampling
Sequence
SALES INVOICE 38527
Date:
3. Define attributes
and
exception
Acme Company
Customer:
conditions.834 Reynolda Rd.
forged signature
of credit manager, no signature,
signature of
someone else
Price
In the
example, what is
Est. shipment date:
the
exception
Terms of sale
(including
discounts and freight
costs):
condition?
Carrier:
Jill Accountant
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audit sampling sequence

4. Define the population.
In the
example, what is the
population?
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In the
population?
2004 sales invoices
(sequence 10397 - 40465)
Population size = 30,068.
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5. Define the sampling unit.
In the
sampling unit?
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In the
sampling unit?
one
sales invoice
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6. Specify the tolerable exception rate.
This determination is based on:

- auditor judgment
- materiality
- importance of the attribute
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In the example, the auditor needs to ask:
concerning the indication of credit approval on sales invoices, what percent of
invoices without appropriate approval
would prevent auditor use of the assessed
control risk and/or the amount of monetary
misstatement in the transactions
established during planning.
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In the example, the auditors judgmentally
assess the tolerable exception rate
(TER):
TER = 7%
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When would the auditor

establish a low TER?
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When would the auditor

establish a low TER?
when the auditor
is less willing to accept exceptions (e.g., cash controls)
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7. Specify the acceptable risk of assessing control risk too low (ARACR).
To what degree
does the auditor want
to rely on controls?
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To what degree
low reliance on controls = high ARACR
high reliance on controls = low ARACR
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To what degree
In the example, the auditors judgmentally
assess the acceptable risk of assessing control risk too low:
ARACR = medium
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8. Estimate the population exception rate
(EPER) - estimate based on prior year
year audit or small preliminary sample
For the
example:
EPER = 4%
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9. Determine the initial sample size (SS).
considered
initial because
the auditor may
later decide to
sample more
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Determined judgmentally
based on
pop.
TER
ARACR
EPER
=
=
=
=
30,068
7%
10%
4%
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Sample Size Determination

FACTOR
ARACR
TER
EPER
Pop. size
RELATIONSHIP
TO SAMPLE SIZE
inverse
inverse
direct
no effect
(if pop.> 5,000)
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Determined judgmentally
based on
pop.
TER
ARACR
EPER
=
=
=
=
30,068
7%
medium
4%
sample size = 150

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Audit Sampling
Sequence
SALES
INVOICE 38527
Date:
10. Select the sample.
Acme Company
Customer:
11. Perform the
audit Rd.
procedures.
834 Reynolda
Winston-Salem, NC27109
how?
Price

Est. shipment date:
Carrier:
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Joe Credit
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SALES INVOICE
38527
Audit Sampling
Sequence
Acme Company
Date:
Customer:
Of 150
invoices
examined, 7
had no
credit
approval.

11. Perform the audit
procedures.
834 Reynolda Rd.

Winston-Salem, NC27109
Price

Carrier:
Joe Credit
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12. Generalize from the sample to the
population.
= 30,068
pop.
= 7%
TER
ARACR = medium
= 4%
EPER
= 150
SS
exceptions
= 7
Considering these factors,

judgmentally determine CUER
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population.
= 30,068
pop.
= 7%
TER
ARACR = medium
= 4%
EPER
CUER
= 150
SS
exceptions
= 8%
= 7
Considering these factors,

judgmentally determine CUER
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population.
CUER
= 8%
What does
this mean?
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population.
CUER
= 8%
There is a medium
risk (ARACR) that the
true exception rate > 8%
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13. Analyze the exceptions. Is there a
justifiable reason?
In the example, the auditors found 7 sales invoices without credit approval. Could they be
sales to internal departments or subsidiaries?
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14. Decide on the acceptability of the
population.
Decision rule:
For population acceptability:
CUER < TER

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Decision rule:
For population acceptability:
CUER < TER

8% < 7%
The population is
not acceptable; the controls regarding the
indication of credit approval on sales
invoices are not satisfactory.
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When an internal control is

judged unacceptable, what
options does the auditor have?
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- revise the TER and/or

ARACR
This may be
considered ethically questionable.
WHY?
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- expand the sample size
When is this
appropriate?
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- expand the sample size

This is only appropriate
if the auditor believes that
the sample was not representative of the population.
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- revise the assessed control risk upward, and increase tests of details of
balances for related accounts (a/r,
sales, bad debt expense, allowance for
doubtful accounts)
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judged unacceptable, the
auditor is required to
communicate this weakness
to management, and may
inform the audit committee as
well.
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1. State the objectives of the audit test.
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1. State the objectives of the audit test.
Example: The auditor wants to determine the acceptability of the notes receivable balance of $600,000.
notes receivable
$600,000
acceptable?
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1. Determine the objectives of the test.
Does
the auditor
plan to reach
conclusions
based on a
sample?
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3. Define misstatement conditions.
?
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Misstatement
conditions are any conditions
that represent monetary fraud,
errors or irregularities
in the accounting
records.
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?
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notes
receivable
dollars
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?
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one
customer
name or loan
number
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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?
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based on
auditor judgment
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In the notes
receivable example, tolerable misstatement is established at $24,000
for both over- and understatements.
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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 materially misstated when, in fact, it is
materially misstated.
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acceptance.
also based on
auditor judgment
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acceptance.
In the
notes receivable example,
ARIA is established at 5%.
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8. Estimate misstatements in the population.
What is the amount of misstatement that the auditor expects

to find in the population?
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based on
auditor judgment and prior
year results
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In the example,
EPER is 1.5%; i.e., the auditor
expects that 1.5% of the notes
receivable balance is misstated .
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9. Determine the initial sample size.
For nonstatistical sampling,
professional judgment of auditor
is used to determine initial sample
size.
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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.
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Nonprobabilistic:
- Directed sample selection
- Block sample selection
- Haphazard sample selection
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Probabilistic:
- Simple random sample selection
- Systematic sample selection
- Probability proportionate-to-size
sample selection
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11. Perform the audit procedures.
Canada 48
Through confirmation
of selected notes receivable
balances, $1,380 of misstatements
were discovered in a sample
of $35,500.
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population.
Project the sample misstatement
results to the population and consider
sampling error and sampling risk:
sample misstatement
total sample
total recorded
pop. value
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point estimate
of misstatement
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population.
Project the sample misstatement
results to the population and consider
sampling error and sampling risk:
sample misstatement
total sample
total recorded
pop. value
point estimate
of misstatement
In the notes receivable example:

$1,380 x $600,000 = $23,324 point estimate
$35,500
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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.
tolerable misstatement - point estimate
= allowance for sampling error
$24,000 - $23,324 = $676
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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.
tolerable misstatement - point estimate
= allowance for sampling error
$24,000 - $23,324 = $676
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13. Analyze exceptions or
misstatements.
evaluate the nature

and cause of each
misstatement
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13. Analyze the exceptions or
misstatements.
evaluate the nature and

cause of each misstatement
This evaluation may
affect the auditors conclusions regarding financial
statements, client operations,
and/or other areas.
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14. Determine the acceptability of the
population.
Decision Rule:
Considering sampling error, if the point
estimate is less than the tolerable misstatement, accept the conclusion that
the book value is not misstated by a
material amount.
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Decision Rule:
material amount.

original point estimate
estimate of
point estimate incl.
+
=
of misstatement
sampling error
sampling error
$23,324 + $1,500 = $24,824

judgmentally
determined
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conclusion?
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Decision Rule:
material amount.

original point estimate
estimate of
point estimate incl.
+
=
of misstatement
sampling error
sampling error
$23,324 + $1,500 = $24,824

conclusion?
$24,824>$24,000 tolerable
misstatement
The notes receivable balance
of $600,000 is not acceptable.
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book value
is not
acceptable
What are the

auditors
options?
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book value
is not
acceptable
What are the

auditors
options?
- take no action until tests of other audit

areas are completed
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book value
is not
acceptable
What are the

auditors
options?

areas are completed
- perform expanded audit tests in specific
areas
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book value
is not
acceptable
What are the

auditors
options?

areas are completed
areas
- increase sample size
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book value
is not
acceptable
What are the

auditors
options?

areas are completed
areas
- request the account balance be adjusted
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book value
is not
acceptable
What are the

auditors
options?

areas are completed
areas
-request the client to correct
the population
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book value
is not
acceptable
What are the

auditors
options?

areas are completed
areas
- request the client to correct the population
- refuse to give an unqualified opinion
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CHAPTER 11

2003 Pearson Education Canada Inc.

What is a representative sample?

2003 Pearson Education Canada Inc.

What is a representative sample?

2003 Pearson Education Canada Inc.

What can make a sample nonrepresentative?

2003 Pearson Education Canada Inc.

What can make a sample nonrepresentative?

2003 Pearson Education Canada Inc.

What can make a sample nonrepresentative?

2003 Pearson Education Canada Inc.

What can an auditor do to reduce

2003 Pearson Education Canada Inc.

What can an auditor do to reduce

increase sample size

2003 Pearson Education Canada Inc.

What can make a sample nonrepresentative?

2003 Pearson Education Canada Inc.

What can make a sample nonrepresentative?

2003 Pearson Education Canada Inc.

What can an auditor do to reduce

2003 Pearson Education Canada Inc.

What can an auditor do to reduce

increase auditor competence

2003 Pearson Education Canada Inc.

Audit sampling can be based on:

2003 Pearson Education Canada Inc.

2003 Pearson Education Canada Inc.

2003 Pearson Education Canada Inc.

2003 Pearson Education Canada Inc.

2003 Pearson Education Canada Inc.

determine sample size

2003 Pearson Education Canada Inc.

determine sample size

apply audit procedures

apply audit procedures

2003 Pearson Education Canada Inc.

determine sample size

apply audit procedures

apply audit procedures

evaluate test results

evaluate test results

2003 Pearson Education Canada Inc.

Nonstatistical sampling employs

2003 Pearson Education Canada Inc.

nonprobabilistic selection methods

2003 Pearson Education Canada Inc.

nonprobabilistic selection methods

2003 Pearson Education Canada Inc.

nonprobabilistic selection methods

2003 Pearson Education Canada Inc.

nonprobabilistic selection methods

pay to the order of

2003 Pearson Education Canada Inc.

nonprobabilistic selection methods

2003 Pearson Education Canada Inc.

Statistical sampling employs

2003 Pearson Education Canada Inc.

probabilistic selection methods

2003 Pearson Education Canada Inc.

probabilistic selection methods

2003 Pearson Education Canada Inc.