Arens C11e PPT ch13

Auditing: The Art and Science of Assurance Engagements
Chapter 13: Audit Sampling Concepts
Copyright 2011 Pearson Canada Inc.
Auditing, Canadian Eleventh Edition
Chapter 13 Learning Objectives

1. Define sampling. State when an auditor would use statistical rather than non-statistical sampling. 2. Explain the three different ways that an auditor can select a statistical sample. 3. Describe the 14 steps in planning and selecting a sample, performing the tests, and evaluating the sample.
13-2 Copyright 2011 Pearson Canada Inc.
Importance of Sampling to Auditors

The auditor doesnt look at everything just pieces. The auditor CANNOT look at everything.
Purpose of Sampling
Sampling is a method of obtaining information that will permit an estimate of the value or quality of a population by examining only a portion of the population.
Use of Sampling
The nature and materiality of the balance or class of transactions does not demand a 100% audit. A decision must be made about the balance or class of transactions. The time and cost to audit 100% of the population would be too great.
Sampling is Used to Conduct

Walk through tests (to understand internal controls) Tests of controls Tests of details
Representative Sampling
Definition: The characteristics in the sample of audit interest are approximately the same as those of the population.
(Continued)
Representative Sampling (Continued)

Non-representativeness can occur due to: -Non-sampling risk: Audit test do not uncover the exceptions in the sample due to failure to recognize them, or due to ineffective procedures -Sampling risk: Results from testing less than the entire population
Statistical Sampling
Sampling that uses the laws of probability for selecting and evaluating a sample from a population for the purposes of reaching a conclusion about the population selected at random statistical calculations are used to measure and express the results
Statistical vs. Non-Statistical

Similarities Both require a structured process involving planning, selection, conducting, evaluating Any type can be stratified Differences Sampling risk can be quantified in statistical sampling using mathematical formulae
Non-Probabilistic (Judgmental) Sample Selection Methods

Directed sample selection, useful for:
Items likely to contain errors Items containing selected characteristics (e.g. old amounts Large dollar item coverage
Block sample selection (e.g. sequences) Haphazard sample selection
Probabilistic Sample Selection Methods

Simple random sample selection Systematic sample selection Probability proportionate-to-size sample selection (also known as MUS monetary unit sampling)
Advantages of Statistical Sampling

Provides for quantitative evaluation of the sample results. Provides a more defensible expression of the test results. Provides for more objective recommendations for management.
Disadvantages of Statistical Sampling

Requires random sample selection which may be more costly and time consuming. Might require additional training costs for staff members to use statistics or specialized software.
Advantages of Non-statistical Sampling

Allows the auditor to inject his or her subjective judgment in determining the sample size and selection process to audit items of greatest value and highest risk. May be designed so that it is equally effective and efficient as statistical sampling while being less costly.
Disadvantages of Non-Statistical Sampling

Disadvantages Cannot draw objectively valid statistical inferences from the sample results. Cannot quantitatively measure and express sampling risk.
Professional Judgment Problem 13-25, p. 440

Making decisions about sampling Does the implementation method matter?
Sampling Process
For both statistical and non-statistical methods, the four main parts are:
1. Planning the sample
2.
3. 4.
Selecting the sample

Performing the tests Evaluating the results
Steps in Sampling Process

We are going to look at the fourteen steps in the sampling process, comparing the process for tests of controls versus tests of details.
1. State the Objectives of the Test

Test of controls:
Are the controls applied? Are there monetary errors or fraud or other irregularities
Test of detail:
Auditor wants to determine the maximum amount of overstatement and understatement that could exist based on the sample
2. Decide if Audit Sampling Applies

Some controls can be sampled (e.g. is a shipping document attached?) while others cannot be (e.g. separation of duties) Ability to sample for test of details depends on the nature of the population (e.g. capital assets may not be sampled, depending upon volume, while A/R confirmations will be
3. Define Attributes and Exception or Error Conditions

Term related to Test of control (e.g. planning: attribute sample) Define the item of interest Identify the characteristic or attribute of interest Test of detail (e.g. for MUS sample) Individual dollars
Define exceptions or errors
Define the control deviation (an exception)
Normally, any monetary difference (error)
3. Define Attributes and Exception or Error Conditions- Sales and A/R

Term related to planning: Test of controls (e.g. attribute sample) Sales
Are sales approved for credit?
Test of details (e.g. for MUS sample) Accounts Recbl

Individual dollars
Define the item of interest
Define exceptions or errors
Sale made that causes customer balance to exceed credit limit
Confirmed amount different from amount in customer account

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4. Define the Population

Population can be defined in a way to suit the audit tests. Must sample from the entire population as defined. In testing controls over sales population is likely recorded sales invoices. In testing details in accounts receivable it is the recorded dollar population. Most populations can be stratified, if needed.
5. Define the Sampling Unit

Test of controls:
Usually a physical unit, e.g. invoice, shipping document, purchase order
Test of details:
If MUS, would be the individual dollar For non-statistical sampling, it is likely the unit making up the balance, e.g. an unpaid invoice
6. Specify Tolerable Exception Rate (TER) or Specify Materiality

Test of controls
TER is the exception rate the auditor will permit in the population and still be willing to use the assessed control risk As TER increases, the sample size decreases
Test of details
Materiality is used to determine the tolerable misstatement amount for the audit of each account
These decisions require the use of professional judgment.
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7. Specify ARACR or ARIA

Test of controls
Acceptable Risk of Assessing Control Risk Too Low (ARACR) is the risk that the auditor will take of accepting controls as effective when population error rates are actually greater
Test of details
Acceptable Risk of Incorrect Acceptance (ARIA) is the risk the auditor will take of accepting a balance as correct when the true misstatement is greater than materiality
(Continued)
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7. Specify ARACR or ARIA (Continued)

Test of controls
Assumes TER 6%, ARACR 10%, true error rate 8% True error rate exceeds TER, so population is NOT acceptable, but auditor does not know!
Test of details
If ARIA changes from 10% to 5%, sample size increases, since assurance required increases When controls are good (control risk is low), ARIA can be increased
8. Estimate Population Exception

Rate or Misstatements
Test of controls
Estimated population error rate (EPER) is an advance estimate of the percentage of exceptions in the population The lower the EPER, the smaller the sample size
Test of details
Provide an advance estimate of the total dollar error (misstatements) in the population Use prior year data and professional judgment.
9. Determine the Initial Sample Size

For non-statistical (also called judgmental) sampling, professional judgment is used to calculate the sample size. For statistical sampling, mathematical formulae are used, either in specially prepared tables or using software designed for audit sampling. For stratified sampling, the sample is allocated among the strata.
10. Select the Sample

Using the number of items determined in Step #9, choose the items from the population using the sampling unit defined in Step #5. Use probabilistic or non-probabilistic methods.
To enable quantification of sampling risk, probabilistic (statistical) methods must be used.
11. Perform the Audit Procedures

For test of controls, examine each item for the attribute defined in Step #3, recording all exceptions found (e.g. all sales approved for credit). For test of details, apply the audit procedures to each item to determine whether it is correct or contains a misstatement (e.g. send and reconcile confirmations, conduct alternative procedures).
12. Generalize from the Sample to the Population

For test of controls the sample error rate (SER) equals actual number of exceptions divided by actual sample size But that is not necessarily equal to the actual population rate: a potential range must be calculated In practice, auditors tend to test controls when they expect no exceptions Method of generalization depends on the sampling methodology used (Continued)
12. Generalize from the Sample to the Population (Continued)

When generalizing tests of details, auditors deal with dollar amounts rather than with exceptions Misstatements found are projected from the sample results to the population
Need to consider sampling error and sampling risk (ARIA)
13. Analyze Exceptions or Misstatements

Test of controls
What breakdown in internal controls caused the exceptions? (does it affect control risk?) Should additional substantive testing be conducted because of these results?
Test of details
Were the misstatements caused by control exceptions? (need to reassess control risk? Is additional substantive testing required?
14. Decide the Acceptability of the Population

Test of controls
If TER (Tolerable Error Rate) is sufficiently larger than SER (sample error rate) will normally accept the population
Test of details
Compare the difference between the projection to the population and materiality Use decision rule for statistical sampling
(Continued)
14. Decide the Acceptability of the Population (Continued)

What if the auditor decides the population is NOT acceptable? What to do? 1. Revise TER (tolerable error rate), ARACR, or ARIA (the risks of accepting incorrect populations) - not easily defensible 2. Expand the sample size. Will decrease the sampling error OR you could end up with the same result. 3. Revise assessed control risk. This will likely mean an increase in tests of detail. 4. Report weaknesses in management letter.

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Auditing: The Art and Science of Assurance Engagements

Chapter 13: Audit Sampling Concepts

Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Chapter 13 Learning Objectives

13-2 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Importance of Sampling to Auditors

13-3 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

13-4 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

13-5 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Sampling is Used to Conduct

13-6 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

13-7 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Representative Sampling (Continued)

13-8 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

13-9 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Statistical vs. Non-Statistical

13-10 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Non-Probabilistic (Judgmental) Sample Selection Methods

Block sample selection (e.g. sequences) Haphazard sample selection

13-11 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Probabilistic Sample Selection Methods

13-12 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Advantages of Statistical Sampling

13-13 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Disadvantages of Statistical Sampling

13-14 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Advantages of Non-statistical Sampling

13-15 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Disadvantages of Non-Statistical Sampling

13-16 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Professional Judgment Problem 13-25, p. 440

13-17 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Selecting the sample

13-18 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

Steps in Sampling Process

13-19 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

1. State the Objectives of the Test

13-20 Copyright 2011 Pearson Canada Inc.

Auditing, Canadian Eleventh Edition

2. Decide if Audit Sampling Applies