REVIEW IN AUDITING THEORY: MODULE 1

AUDIT SAMPLING
Related PSA: PSA 530

When designing audit procedures, the auditor should determine appropriate means of selecting items for
testing. The means available to the auditor are:
(a) Selecting all items (100% examination);
(b) Selecting specific items, and
(c) Audit sampling.

The decision as to which approach to use will depend on the circumstances, and the application of any
one or combination of the above means may be appropriate in particular circumstances. While the
decision as to which means, or combination of means, to use is made on the basis of audit risk and audit
efficiency, the auditor needs to be satisfied that methods used are effective in providing sufficient
appropriate audit evidence to meet the objectives of the test.

Selecting All Items

The auditor may decide that it will be most appropriate to examine the entire population of items that
make up an account balance or class of transactions (or a stratum within that population). 100%
examination is unlikely in the case of tests of control; however, it is more common for substantive
procedures. 100% examination may be appropriate on the following:
a. When the population constitutes a small number of large value items;
b. When both inherent and control risks are high and other means do not provide sufficient
appropriate audit evidence; or
c. When the repetitive nature of a calculation or other process performed by a computer information
system makes a 100% examination cost effective.

Selecting Specific Items

The auditor may decide to select specific items from a population based on such factors as knowledge of
the client’s business, preliminary assessments of inherent and control risks, and the characteristics of the
population being tested. The judgmental selection of specific items is subject to non-sampling risk.
Specific items selected may include:

 High value or key items. The auditor may decide to select specific items within a population because
they are of high value, or exhibit some other characteristic, for example items that are suspicious,
unusual, particularly risk-prone or that have a history of error.
 All items over a certain amount. The auditor may decide to examine items whose values exceed a
certain amount so as to verify a large proportion of the total amount of an account balance or class of
transactions.
 Items to obtain information. The auditor may examine items to obtain information about matters such
as the client’s business, the nature of transactions, accounting and internal control systems.
 Items to test procedures. The auditor may use judgment to select and examine specific items to
determine whether or not a particular procedure is being performed.

While selective examination of specific items from an account balance or class of transactions will often
be an efficient means of gathering audit evidence, it does not constitute audit sampling. The results of
procedures applied to items selected in this way cannot be projected to the entire population. The auditor
considers the need to obtain appropriate evidence regarding the remainder of the population when that
remainder is material.

Audit Sampling
The auditor may decide to apply audit sampling to an account balance or class of transactions. Audit
sampling (sampling) involves the application of audit procedures to less than 100% of items within an
account balance or class of transactions such that all sampling units have a chance of selection.

Terms normally associated with sampling:

Population - means the entire set of data from which a sample is selected and about which the auditor
wishes to draw conclusions. For example, all of the items in an account balance or a class of transactions
constitute a population. A population may be divided into strata, or subpopulations, with each stratum
being examined separately. The term population is used to include the term stratum.
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Sampling unit - means the individual items constituting a population, for example checks listed on deposit
slips, credit entries on bank statements, sales invoices or debtors’ balances, or a monetary unit.

Sampling frame – means the documentary evidence which physically represents the sampling units in a
given population.

Sample – the portion of the population that will be subjected to audit testing. The selected sample should
be representative of the population.

Error - For purposes of PSA 530, means either control deviations, when performing tests of control, or
misstatements, when performing substantive procedures.

Tolerable error - means the maximum error in a population that the auditor is willing to accept.

Stratification - is the process of dividing a population into subpopulations, each of which is a group of
sampling units which have similar characteristics (often monetary value).

Sampling is not involved in:

1) 100% examination;
2) Selective testing; and
3) Audit procedures which either (1) have very limited purposes and provide only a small portion of
the evidence needed to meet an audit objective or (2) intentionally exclude a portion of the
population such as:
a) Performing a walkthrough test;
b) Testing controls that leave no audit trail (such as observing client personnel as they perform
internal control activities);
c) Performing analytical procedures;

Advantages of sampling over complete (100%) verification

1. Timeliness – Sampling requires lesser time; audit would be completed on a more timely basis.
2. Efficiency – Sampling can considerably reduce audit costs.
3. Effectiveness – Sampling can provide valid conclusions that the sample reflects the same
characteristics as the population.

Risk Considerations in Obtaining Evidence

Sampling risk and non-sampling risk can affect the components of audit risk.

Sampling risk arises from the possibility that the auditor’s conclusion, based on a sample may be different
from the conclusion reached if the entire population were subjected to the same audit procedure.

Nonsampling risk arises from factors that cause the auditor to reach an erroneous conclusion for any
reason not related to the size of the sample, such as:
1. Failure to select appropriate audit procedures
2. Failure to recognize errors in documents examined
3. Misinterpreting the results of audit tests

For both tests of control and substantive tests, sampling risk can be reduced by increasing sample size,
while non-sampling risk can be reduced by proper engagement planning, supervision, and review.

Types of Sampling Risks

Tests of Controls
1. Risk of under-reliance – Sample does not support the auditor’s planned degree of reliance on the
control when true compliance rate supports such reliance. Also known as the risk of assessing
control risk too high - the risk the auditor will conclude that control risk is higher than it actually
is.

2. Risk of over-reliance – Sample supports the auditor’s planned degree of reliance on the control
when true compliance rate does not justify such reliance. Also known as the risk of assessing
control risk too low - the risk the auditor will conclude that control risk is lower than it actually
is.
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Substantive Testing
1. Risk of incorrect rejection – the risk the auditor will conclude that a material error exists when in
fact it does not.

2. Risk of incorrect acceptance – the risk the auditor will conclude that a material error does not
exist when in fact it does.

Effect of sampling risk on audit

a. Efficiency – The risk of under-reliance and the risk of incorrect rejection (both referred to as Alpha
Risk) affect audit efficiency as it would usually lead to additional work to establish that initial
conclusions were incorrect.

b. Effectiveness – The risk of over-reliance and the risk of incorrect acceptance (both referred to as Beta
Risk) affect audit effectiveness and is more likely to lead to an inappropriate audit opinion.

General approaches to audit sampling

Statistical sampling – approach to sampling that has the characteristics of:
• random selection of a sample; and
• use of probability theory to evaluate sample results, including measurement of sampling risk.

Advantages Disadvantages
Helps auditor May involve additional costs in
1) Design an efficient sample; 1) Training auditors;
2) Measure the sufficiency of evidential matter 2) Designing samples;
obtained; 3) Selecting items to be tested.
3) Objectively evaluate sample results.

When applying statistical sampling, the sample size can be determined using either probability theory or
professional judgment.

Nonstatistical sampling – A sampling approach that does not have characteristics of statistical sampling.

Reasons for use – Often less costly and time-consuming to apply than statistical sampling, but can be as
effective in achieving audit objectives.

Similarities – Both statistical and nonstatistical sampling

1) Can provide sufficient, competent evidential matter;
2) Involve judgment in planning, executing the sampling plan, and evaluating the sample results;
3) Require that sample item be selected in such a way that sample can be expected to be representative of
the population.

Choice of approach – The decision whether to use a statistical or non-statistical sampling approach is a
matter for the auditor’s judgment regarding the most efficient manner to obtain sufficient appropriate
audit evidence in the particular circumstances.

Sample size is not a valid criterion to distinguish between statistical and non-statistical approaches.
Sample size is a function of various factors. When circumstances are similar, the effect on sample size of
certain factors will be similar regardless of whether a statistical or non-statistical approach is chosen.

Sample Selection Methods

Appropriate for statistical and non statistical sampling
a. Use of a computerized random number generator or random number tables.

b. Systematic selection, in which the number of sampling units in the population is divided by the
sample size to give a sampling interval, for example 50, and having determined a starting point within
the first 50, each 50th sampling unit thereafter is selected. Although the starting point may be
determined haphazardly, the sample is more likely to be truly random if it is determined by use of a
computerized random number generator or random number tables. When using systematic selection,

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 the auditor would need to determine that sampling units within the population are not structured in
such a way that the sampling interval corresponds with a particular pattern in the population.

Not appropriate for statistical sampling

c. Haphazard selection, in which the auditor selects the sample without following a
structured technique. Although no structured technique is used, the auditor would
nonetheless avoid any conscious bias or predictability (for example avoiding difficult to
locate items, or always choosing or avoiding the first or last entries on a page) and thus
attempt to ensure that all items in the population have a chance of selection. Haphazard
selection is not appropriate when using statistical sampling.
d. Block selection involves selecting a block(s) of contiguous items from within the
population. Block selection cannot ordinarily be used in audit sampling because most
populations are structured such that items in a sequence can be expected to have similar
characteristics to each other, but different characteristics from items elsewhere in the
population. Although in some circumstances it may be an appropriate audit procedure to
examine a block of items, it would rarely be an appropriate sample selection technique
when the auditor intends to draw valid inferences about the entire population based on the
sample.

Characteristic of Interest
The characteristic of interest depends on the type of test that will be performed on the sample selected.

Test of controls – the characteristic of interest is the deviation or occurrence rate, which is the number of
times a deviation from the prescribed internal control occurs in the sample.

Substantive testing – the characteristic of interest is the monetary amount of misstatement in an account
balance.

Types of Sampling Plans

Attributes sampling – a statistical sampling plan used in test of controls. This is appropriate: 1) When the
auditor wishes to estimate the true but unknown population deviation rate; 2) If the expected deviation
rate is high based on prior experience.

Variables sampling – a sampling plan used in substantive testing to estimate the total peso amount (or
possibly units) of a population or the peso amount of an error in a population.

Attribute Sampling Plan

1. Determine the objective(s) of the tests
2. Define the attribute (characteristic of a control) and deviation (absence of an attribute) conditions
3. Define the population
4. Determine the method of sample selection
5. Determine sample size
6. Perform the sampling plan
7. Evaluate sample results
8. Document the sampling plan, the procedures performed, and the conclusions reached

Factors Influencing Sample Size for Tests of Control

The following are factors that the auditor considers when determining the sample size for a test of control.
These factors need to be considered together.

FACTOR EFFECT ON
SAMPLE SIZE
An increase in the auditor’s intended reliance on accounting and internal control Increase
systems
An increase in the rate of deviation from the prescribed control procedure that the Decrease
auditor is willing to accept (Tolerable deviation rate)
An increase in the rate of deviation from the prescribed control procedure that the Increase
auditor expects to find in the population (Expected deviation rate)
An increase in the auditor’s required confidence level (or conversely, a decrease in Increase
the risk that the auditor will conclude that the control risk is lower than the actual
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control risk in the population – risk of assessing control risk too low)
An increase in the number of sampling units in the population Negligible effect

Other Sampling Techniques for Test of Controls

Sequential (Stop-or-Go) sampling
Audit sampling can be accomplished with either a fixed or sequential sampling plan.
1) Fixed sampling plan – the auditor tests a single plan, such as attribute estimation.
2) Sequential sampling plan – the sampling is performed in several steps. Following each step, the
auditor decides whether to stop testing or to go on to the next step.

Sequential sampling plan can be used as an alternative to attribute estimation when an auditor expects
zero or very few deviations within an audit population.

Discovery sampling
Discovery sampling plan may be appropriate when:
1) the audit objective is to observe at least one deviation at a specified critical rate;
2) the expected population deviation rate is near zero; and
3) the auditor desires a specified probability of observing at least one deviation of the actual population
rate exceeds the critical rate (this is comparable to the tolerable rate in attribute estimation and
sequential sampling).

Variables Sampling Plan

1. Determine the objective(s) of the tests
2. Define the population
3. Choose an audit sampling approach/technique
4. Determine sample size
5. Determine the method of sample selection
6. Perform the sampling plan
7. Evaluate sample results
8. Document the sampling plan, the procedures performed, and the conclusions reached

Sampling techniques
Probability-proportional-to-size (PPS) sampling
PPS sampling is a sampling technique that uses attribute sampling theory to evaluate the results when a
large number of transactions are captured within a single account. In PPS sampling, the auditor randomly
selects individual pesos from a population and then audits the balances, transactions, or documents –
called logical units – that include the pesos selected. Each peso in the population has an equal chance of
being selected, but the likelihood of selecting any one logical unit for testing is directly proportional to its
size.

PPS sampling is most appropriate when:

1) no errors are expected (although it is also appropriate when one or few errors are expected); and
2) testing for overstatement (normally for assets and income).

Classical variables sampling

Classical variables sampling relies on normal distribution theory to evaluate audit samples. These may be
appropriate when the audit objective is to estimate the true but unknown monetary balance. The three
commonly used classical variables sampling techniques are:
1. Ratio estimation – uses the ratio of audited amounts to recorded amounts in the sample to
estimate the total peso amount of the population (also called point estimate) and an allowance
for sampling risk. Where: SAV = sample audited value; SBV = sample recorded book value;
PBV = population book value; and EPAV = estimated population audited value, the formula
is:
SAV/SBV x PBV = EPAV +(-) sampling risk
The use of ratio estimation is appropriate when the misstatement in an account is directly
proportional to its book value.

2. Difference estimation – uses the average difference between audited amounts and individual
recorded amounts in the sample to estimate the total audited amount of the population and an

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 allowance for sampling risk. Where: SAV = sample audited value; SBV = sample recorded
book value; SS = sample size; and P = number of items in population, the formula is:
(SAV – SBV)/SS x P = Projected error
The use of difference estimation is more appropriate when the misstatement in an account is not
affected by the book value of the item being examined.

3. Mean-per-unit estimation – projects sample average (mean) to the total population by

multiplying the sample average by the number of items in the population. Using the same
legend above, the formula is:
SAV/SS x P = EPAV +(-) sampling risk
The use of mean-per-unit estimation is appropriate when the individual population items do not
have recorded values.

Before applying ratio or difference estimation, the following three conditions must exist:
a) Each population item must have a recorded value (e.g., perpetual rather than periodic,
inventory)
b) Total population book value must be known (e.g., a recorded general ledger book value) and
must correspond to the sum of all individual population items.
c) Expected differences between audited and recorded book values must not be too rare.

Comparative advantages and disadvantages of PPS and classical variables sampling

Probability-proportional-to size (PPS) sampling Classical variables sampling
Advantages Advantages
• Automatically results in stratified sample • May result in smaller sample size if there
because items are selected in proportion to are many individual differences between
their peso amounts. recorded and audited amounts in the
population.
• Usually results in a smaller sample size • Selection of zero or negative balances
than classical variables sampling when no within a sample does not require special
errors are expected. sample design considerations.
• Can be designed more easily and sample • If necessary, it is easier to expand samples
selection can begin before the complete than PPS.
population is available
Disadvantages Disadvantages
• Evaluation of the sample will require • More complex than PPS
special sample design considerations if
sample includes understatement errors
• Evaluation may overstate the allowance for • To determine sample size, the auditor must
sampling risk when errors are found. have an estimate of the population standard
deviation.
• Generally includes an assumption that the • Normal distribution theory, the basis
audited amount of a sampling unit should underlying classical variables sampling,
not be less than zero or greater than the may not be appropriate when the sample
recorded amount. size is not large and there are either very
large items or very large differences
between recorded and audited amounts in
the population

Factors Influencing Sample Size for Substantive Procedures

The following are factors that the auditor considers when determining the sample size for a substantive
procedure. These factors need to be considered together.
FACTOR EFFECT ON
SAMPLE SIZE
An increase in the auditor’s assessment of inherent risk Increase
An increase in the auditor’s assessment of control risk (or a decrease in reliance on Increase
internal controls)
An increase in the use of other substantive procedures directed at the same financial Decrease
statement assertion
An increase in the auditor’s required confidence level (or conversely, a decrease in Increase
the risk that the auditor will conclude that a material error does not exist, when in
fact it does exist – risk of incorrect acceptance)

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An increase in the total error that the auditor is willing to accept (tolerable error) Decrease
An increase in the amount of error the auditor expects to find in the population Increase
(expected error)
Stratification of the population when appropriate Decrease
The number of sampling units in the population Negligible Effect