Auditing Theory (AT-10)

CKC- BSA 3

AUDIT SAMPLING
(BASED ON PSA 530: AUDIT SAMPLING AND OTHER SELECTIVE TESTING PROCEDURES)

Selecting items of testing to gather audit evidence

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
c. Audit sampling

Selecting all items (100% examination)

 Unlikely in the case of tests of control but more common for substantive procedures
 May be appropriate when:
a. The population constitutes a small number of large value items
b. When both inherent risk and control risk are high and other means do not
provide sufficient appropriate audit evidence
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 nonsampling risk
 Specific selected items may include:
 High value or key items
 All items over a certain amount
 Items to obtain information
 Items to test procedures
 While an efficient means of gathering audit evidence, it does not constitute audit sampling. The
results of audit procedures applied to specific items selected cannot be projected to the entire
population

AUDIT SAMPLING
1. “Audit Sampling” involves the application of audit procedures to less than 100% of items with an
account balance or class of transactions
2. Sampling may be statistical or nonstatistical.
I. Statistical sampling means any approach t sampling that has the following
characteristics:
a. Random selection of a sample
b. Use of probability theory to evaluate sample results

II. Nonstatistical sampling is a sampling approach that does not have

characteristics (a) and (b).

Audit sampling plan refers to the procedures an auditor applies t accomplish a sampling application. In
aids an auditor I forming conclusions about one r more characteristics or either a particular class of
transactions or a particular account balances

1. ATTRIBUTE SAMPLING
 Applicable to tests of control
 Used to test an entity’s rate of deviation (also called rate of occurrence) from a
prescribed control procedure
2. VARIABLES SAMPLING
 Applicable to substantive test
 Most commonly used to test whether recorded account balances are fairly stated
SAMPLING RISK
1. It 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
procedures
2. The confidence level (also called reliability level) is the mathematical complement of the
applicable sampling risk factor
3. It is to be measured and controlled. The auditor controls it by specifying the acceptable level
when developing the sampling design
4. For tests of control, it has the following aspects:
a. Risk of assessing control risk too low (Risk of Overreliance)
 The risk that the auditor would conclude that the control risk is lower
than it actually is
 It affects audit effectiveness and is more likely to lead to an
inappropriate audit opinion
b. Risk of assessing control risk too high (Risk of under reliance)
 The risk that the auditor would conclude that control risk is higher than
actually is
 It affects audit efficiency as it would lead to additional work to establish
that initial conclusions were incorrect
5. For substantive tests, it has the following aspects:
a. Risk of incorrect acceptance
 The risk that the auditor would conclude that a material error exists
when in fact it does
 It affects audit effectiveness and is more likely to lead to an
inappropriate audit opinion
b. Risk of incorrect rejection
 The risk that the auditor would conclude that a material error exists
when in fact it does not
 It affects audit effectiveness as it would lead to additional work to
establish that initial conclusions were incorrect
NONSAMPLING RISK
It arises from factors that cause the auditor to reach an erroneous conclusion for any reason not related
to the size of the sample. For example, most audit evidence is persuasive rather than conclusive, the
auditor might use inappropriate procedures, or the auditor might misinterpret evidence and fail to
recognize an error.

5 STEPS IN ATTRIBUTE SAMPLING PLAN

1. Define the objectives of the plan
2. Define the population
 For example, if an auditor’s objective is to test controls designed to assure
that all shipped goods are invoiced, the population would be defined as all
sipping documents issued during the period not all sales invoices

3.Define the attribute and deviation conditions

 An attribute s a characteristic of control. For example, the supervisor’s
signature of approval on a document. A deviation is the absence of an
attribute
4. Determine the sample size
The sample size is determined by considering the following factors:
a. Risk of assessing control risk too low
b. Tolerable deviation rate
c. Expected population deviation rate

Risk of assessing control risk too low

 There is an inverse relationship between the risk and the sample size. The higher the
acceptable risk, the smaller the sample size
 Because the risk of assessing control risk too low relates to the effectiveness of the
audit, it is kept at a relatively low level by the auditor

Tolerable deviation rate

 This the maximum deviation rate that the auditor is willing to accept
  The lower the rate of deviation that the auditor is willing to accept, the larger the
sample size needs to be

Expected population deviation rate (expected error)

 The rate of deviation from the prescribed control procedure the auditor expects to find
in the population
 The higher the rate of deviation the auditor expects, the larger the sample size needs
to e so as to be in a position o make a reasonable estimate of the actual rate of
deviation
 Factors relevant to the auditor’s consideration of the expected error rate include:
o The auditor’s understanding of the business (in particular, procedures
undertaken to obtain an understanding of the accounting and internal control
systems)
o Charges in the personnel or in the accounting and internal control systems
o The results of audit procedures applied in prior periods
o The results of other audit procedures

5. Determine the method of sample selections

Some commonly used methods are:
a. Random number sampling
 Each item in the population has an equal chance and nonzero probability of selection
 It is usually accomplished by generating random numbers from a random number table
or computer program and tracing them to associated documents or items in th
population
 It is appropriate for both statistical and nonstatistical sampling
b. Systematic selection
 The number of sampling units in the population is divided by the sample size to give a
sample interval, for example 50, and having determined the starting point within the
first 50, each 50th sampling unit is hereafter 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, the auditor would need to determine that sampling
interval corresponds with a particular pattern in the population

c. Block selection or cluster sampling

 It involves selecting a block(s) of contiguous items from within the population
 It cannot be ordinarily used in audit sampling because most populations are structured
such that items in 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 sample

d. Haphazard selection
 The auditor selects a sample without following a structured technique
 It is not appropriate when using statistical sampling

e. Stratification
 This involves subdividing the population into subpopulations or strata, i.e., a group of
sampling units which have similar characteristics (often monetary value)
 The strata must be explicitly defined so that each sampling unit can belong to only one
stratum
 This method enables the auditor to direct his efforts towards the items he considers
would potentially contain the greater monetary error

6. Perform sampling plan

7. Evaluate and document results
These include:
a. Determining the sample deviation rate
Sample deviation rate = number of deviations observed
Sample size
b. Determining the maximum population deviation rate (achieved upper deviation limit) and
the allowance for sampling risk (achieved precision)
  The maximum deviation rate is based on the sample size and the number of
deviations discovered. There are standard tables that yield maximum population
deviation rates at specified risks of assessing control risk too low
 Allowance for sampling risk = Maximum Deviation Rate – Sample Deviation Rate
c. Considering qualitative information
The auditor considers each of the deviation’s nature, importance, and probable cause
d. Reaching an overall conclusion
In assessing control risk, the auditor considers all available quantitative and qualitative
information

COMMONLY USED ATTRIBUTES SAMPLING TECHNIQUES

1. ATTRIBUTE ESTIMATION SAMPLING
 A statistical sampling plan for tests of controls
 Appropriate when an auditor wishes to estimate a true but unknown population
deviation rate
 Uses a fixed sampling plan, i.e., the auditor tests a single sample
2. SEQUENTIAL SAMPLING (ALSO CALLED STOP-OR-GO SAMPLING)
 The sampling plan is performed in several steps
 Following each step, the auditor decides whether to stop or to go on to the next step
 Appropriate when the auditor expects zero or very few deviations
3. DISCOVERY SAMPLING
 Appropriate when the expected deviation rate is near zero and when the auditor’s
objective is to find at least one deviation in a sample if the actual population deviation
rate exceeds or equals a predetermined critical rate (tolerable deviation rate)

STEPS IN A VARIABLE SAMPLING PLAN

1. Determine the objectives of the test
The auditor’s objective is to test the reasonableness of a record account balance, called
hypothesis testing.
2. Define the population and sampling unit
3. Choose an audit sampling technique
a. Statistical vs. Nonstatistical
b. Classical variables sampling vs. Probability-proportional-to-size sampling
4. Determine the sample size
The auditor considers the following:
a. Variation within the population
 Sample size varies in the same direction as the variation in population amounts. As
population variation increases, so does the sample size
 An estimate of population variation is made by determining a population standard
deviation
b. Acceptable risk of incorrect rejection
c. Acceptable risk of incorrect acceptance
d. Tolerable error – the maximum monetary error that may exist in an account
balance without causing the financial statements to be materially misstated

5. Determine the method of sample selection

6. Perform the sampling plan
7. Evaluate the sample results
The following procedures are performed:
a. Projecting the same error to the population
b. Considering sampling risk
c. Considering qualitative information
d. Reaching an overall conclusion

CLASSICAL VARIABLES SAMPLING TECHNIQUES

A. Mean-per-unit estimation
A classical variables sampling technique that projects the sample average to the
population by multiplying the sample average by the number of items in the population

B. Difference estimation
It is a classical variables sampling technique that uses the average difference between
audited amounts and individual recorded amounts to estimate the total audited amount of a
population and an allowance for sampling risk.
 C. Ratio estimation
A classical variables sampling technique that uses the ratio of audited amounts to
recorded amount in the sample to estimate the total amount of the population and an
allowance for sampling risk

Conditions for using difference and ration estimation

1. Each population item must have a recorded book value
2. Total population book value must be known
3. Expected differences between audited and recorded book values must not be too rare

Choosing between difference and ratio estimation

Ratio estimation is more appropriate when he differences are nearly proportional to book
values.
Difference estimation is more appropriate when there is little or n relationship between the
absolute amounts of the differences and the book values.

PROBABILITY-PROPROTIONAL-TO-SIZE SAMPLING (PPS)

 PPS uses a peso as the sampling unit
 PPS sampling gives each individual peso in the population an equal chance of selection
 PPS is only useful for TESTS OF OVERSTATEMENTS (e.g., assets) since the sample selection
method dictates that the larger the transaction or amount, the more likely that it will be
selected.
 PPS is inappropriate for testing liabilities because understatement is the primary
audit consideration
EXAMPLES OF FACTORS INFLUENCING SAMPLE SIZE FOR TESTS OF
CONTROL (PSA 530, APPENDIX I)

Factor Effect on Sample size

An increase in the auditor’s intended reliance on accounting and
Internal control systems increase

An increase in the rate of deviation from the prescribed

control Procedure that the auditor is willing to accept
(Tolerable error) decrease

An increase in the rate of deviation from the prescribes

control Procedure that the auditor expects to find in the
population
(Expected error) increase

An increase in the auditor’s required confidence level (or conversely

A decrease in the risk that the auditor will conclude that the
auditor will Conclude that the control risk is lower than the actual
control risk in the
Population) increase

An increase in number of sampling units in the population negligible effect

EXAMPLES OF FACTORS INFLUENCING SAMPLE SIZE FOR SUBSTANTIVE

PROCEDURES (PSA 530, APPENDIX II)

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 increase

An increase in the use of other substantive procedures

Directed at the same financial statement assertion decrease

An increase in the auditor’s required confidence level (or

Conversely, a decrease in the risk that the auditors will conclude that
A material error does not exist, when in fact it does exist) increase

An increase in the amount of error the auditor expects to find in

The population (tolerable error) decrease

An increase in the amount of error the auditor expects to find in the

Population (expected error) increase
Stratification of the population when appropriate decrease

The number of sampling units in the population negligible effect