Audit Sampling - End of chapter questions PDF

Preview

Summary

End of chapter questions...

Description

AUDIT SAMPLING (DISCUSSION) 1.

What is audit sampling?

Audit sampling is the application of audit procedures to less than 100% of items within a class of transactions or account balance such that all sampling units have a chance of selection. It is based on the premise that a sample can be sufficiently representative of an audit population to warrant valid and reliable conclusions without testing the entire population. 2.

3.

Define the following terms: a)

Error in the context of tests of controls – the two aspects of sampling risk are critical in test of controls, namely the risk of assessing control risk too high (risk of under reliance) and the risk of assessing control risk too low (risk of over reliance).

b)

Error in the context of substantive tests – the two aspects of sampling risk are critical in substantive tests, namely the risk of incorrect rejection and the risk of incorrect acceptance. What are the two components of detection risk? Explain each component briefly.

The two components of detection risk are sampling and non-sampling risk. Sampling risk is the risk that the auditor’s conclusion based on a sample may be different from the conclusion if the entire population were subjected to the same audit procedure. This exist because the sample selected for testing may not truly representative of a population. On the other hand, nonsampling risk is the risk that the auditor reaches an erroneous conclusion for any reason not related to sampling risk, including all aspects of audit risks not due to sampling. Examples of non-sampling risk include use of inappropriate audit procedures, or misinterpretation of audit evidence and failure to recognize a misstatement or deviation. 4.

Can you eliminate sampling risk? Explain.

Yes, sampling risk can be eliminated by testing the 100% of the population. It is because if the sample size were increased to include all the items in a population, there would be no sampling and therefore no sampling risk. However, examining the entire population is normally not possible for the auditor due to time and cost constraints. Instead, the auditor usually manages or controls sampling risk by making the sample more representative of the population by increasing the sample size and using appropriate method of selecting sample items. 5.

Describe the relationship between sampling risk and sample size.

There is an inverse relationship between sampling risk and sample size. The greater the sample size, the smaller the sampling risk, and vice versa. 6.

How is non-sampling risk reduced?

Some of the factors that can reduce non-sampling risk are proper planning and supervision of the audit work, and encouraging effective firm-wide quality control.

7.

In tests of controls, there are two types of sampling risk. For each type, give a short description and identify whether it affects audit efficiency or audit effectiveness. a) Risk of under reliance – or the risk of assessing control risk too high, is a risk that a sample deviation rate supports assessing control risk at the maximum when, unknown to the auditor, the true deviation rate in the population supports assessing control risk below the maximum. It affects the audit efficiency such as time, effort, and the cost of the audit. It results to over-auditing, doing more substantive tests than necessary. b) Risk of over reliance – or the risk of assessing control risk too low, is a risk that a sample does supports assessing control risk below the maximum when, unknown to the auditor, the true deviation rate in the population supports assessing control risk at the maximum. It affects the audit effectiveness, meaning errors in the financial statement may remain undetected. It results to under-auditing, doing less substantive tests than necessary because the scope of substantive tests will be restricted under the erroneous assumption that the control is effective and that the control risk is low.

8.

In substantive tests, there are two types of sampling risk. For each type, give a short description and identify whether it affects audit efficiency or audit effectiveness. a) Risk of incorrect rejection – a risk that a material misstatement exists when in fact it does not. This type of erroneous conclusion affects audit efficiency as it would usually lead to additional work to establish that initial conclusions were incorrect. b) Risk of incorrect acceptance – a risk that a material misstatement does not exist when in fact it does. The auditor is primarily concerned with this type of erroneous conclusion because it affects audit effectiveness and is more likely to lead to an inappropriate audit opinion.

9.

Which one is of greater concern to the auditor: risk affecting audit effectiveness or risk affecting audit efficiency? Explain.

Risk affecting audit effectiveness is a greater concern to the auditor since it results in an auditor performing audit procedures less than the what is necessary thereby affecting the auditor’s ability to detect material misstatements in the financial statements. It also affects effectiveness of internal control and their effect on the audit. In short, the risk affecting audit effectiveness is more likely to lead to an inappropriate audit opinion. That is why when designing tests of controls and tests of details, the auditor shall determine means of selecting items for testing that are effective in meeting the purpose of the audit procedure. 10.

What are the risk considerations in obtaining audit evidence?

The risk considerations in obtaining audit evidence are sampling and non-sampling risk. As mentioned above, the audit is subject to sampling risk when testing less than 100% of the items in a population, and it may apply to both tests of controls and substantive tests. Even if the auditor eliminates sampling risk by testing the entire population, the auditor has still to contend with non-sampling risk. The auditor must be aware of these risks, and must reduce them as much

as possible. Sampling risk can be reduced by increasing sample size. As for non-sampling risk, it can be reduced through proper planning and supervision of the audit work. 11.

Enumerate the different means of selecting items for testing. The means available to the auditor for selecting items for testing are:   

Selecting all items (100% examination); Selecting specific items; and Audit sampling.

The application of any one or combination of these means may be appropriate depending on the particular circumstances, for example, the risks of material misstatement related to the assertion being tested, and the practicality and efficiency of the different means. 12.

What are the two general approaches to audit sampling? Explain briefly. a) Statistical sampling – it uses random-based selection of sample and applies the laws of probability to aid an auditor in designing an efficient sample, in measuring the sufficiency of evidence obtained, and in evaluating the sample results. It is a mathematically derived tool that provides the auditor with an objective basis for expressing conclusions about a population characteristic based upon a sample of items from the population. b) Non-statistical sampling – relies exclusively on subjective judgment to determine sample size and evaluate sample results. It is an auditor-derived tool for examining a sample of items from a population.

13.

What are the advantages and disadvantages of statistical sampling? Advantages of Statistical Sampling   

Aids an auditor in determining sample size required to meet given objectives. Provides more objective audit evidence. Allows an auditor to measure precision, reliability, and sampling error.

Disadvantages of Statistical Sampling    14.

There is a danger of accepting statistical evidence at face value, without sufficient skepticism. The cost of statistical sampling could exceed the benefits. Statistical sampling may be less appropriate in some cases than non-statistical sampling or other audit procedures for gathering evidence. Explain the following sample selection methods:

a)

Random number sampling – utilizes random-number tables or computergenerated random numbers to select sampling units from a population. Random-number tables contain columns and rows of randomly generated digits. Random number sampling is appropriate for both statistical and non-statistical sampling plans.

15.

b)

Systematic-sampling – involves selecting every nth item from a population of sequentially ordered items. It eliminates the need to establish correspondence between population items and random digits, and therefore is useful when population items lack identification numbers. Systematic selection is useful for non-statistical sampling, and if the starting point is selected at random, it can be useful for statistical sampling.

c)

Block selection – or cluster sampling, involves selecting a group of items arranged continuously within a larger grouping of sampling units. This is the least desirable sample selection method since it often results in excessively high sampling risk. Thus, an auditor should not use block sampling for either statistical and non-statistical sampling, unless he or she exercises considerable care in controlling sample risk.

d)

Haphazard sampling – consists of sampling units selected without special reasons, but also without conscious bias. Although it may be useful for non-statistical sampling, haphazard sampling is not appropriate for statistical sampling. What is stratification?

By definition, it is the process of dividing a population into sub-populations, each of which is a group of sampling units which have similar characteristics (often monetary value). The objective of stratification is to reduce the variability of items within each stratum and therefore allow sample size to be reduced without proportional increase in sampling risk. 16.

What is value-weighted selection?

Value-weighted selection also gives each item in the population an opportunity to be selected. However, the probability of an item to be selected in this method is directly proportional to the monetary value of such item. Having selected specific monetary units from within the population, for example, the accounts receivable balance, the auditor may then examine the particular items, for example, individual balances, that contain those monetary units. One benefit of this approach to defining the sampling unit is that audit effort is directed to the larger value items because they have a greater chance of selection, and can result in smaller sample sizes. In this method, overstatement errors is anticipated. This approach is ordinarily used in conjunction with the systematic method of sample selection and is most efficient when selecting items using CAATs. 17.

Give the steps involved in an attributes sampling plan. The procedures for attributes sampling are: 1. Determine the objective(s) of the test. 2. Define the attribute (characteristic of control) and deviation (absence of an attribute) conditions. 3. Define the population. 4. Choose an audit sampling approach/technique. 5. Determine the sample size and the sample selection method. 6. Perform the sampling plan.

7. Evaluate sample results. 8. Comply with documentation requirements. 18.

Give at least three determinants of the sample size for tests of controls. Relate each determinant to sample size. 





19.

Extent to which the risk of material misstatement is reduced by the operating effectiveness of controls. The more assurance the auditor intends to obtain from the operating effectiveness of controls, the lower the auditor’s assessment of the risk of material misstatement will be, and the larger the sample size will need to be. Rate of deviation from the prescribed control activity the auditor is willing to accept (tolerable error). The lower the tolerable rate of deviation, the larger the sample size needs to be. Rate of deviation from the prescribed control activity the auditor expects to find in the population (expected error). The higher the expected rate of deviation, the larger the sample size needs to be so that the auditor is in a position to make a reasonable estimate of the actual rate of deviation.

Give the steps involved in a variables sampling plan. The procedures for variables sampling are: 1. 2. 3. 4. 5. 6. 7. 8.

20.

Determine the objective(s) of the test. Define “fair presentation” and “material misstatement’ Define the population. Choose an audit sampling approach/technique. Determine the sample size and the sample selection method. Perform the sampling plan. Evaluate sample results. Comply with documentation requirements

Give at least three determinants of the sample size for substantive tests. Relate each determinant to sample size.







The auditor’s assessment of the risk of material misstatement. The higher the auditor’s assessment of the risk of material misstatement, the larger the sample size needs to be. The auditor’s assessment of the risk of material misstatement is affected by inherent risk and control risk. The use of other substantive procedures directed at the same assertion. The more the auditor is relying on other substantive procedures (tests of details or substantive analytical procedures) to reduce to an acceptable level the detection risk regarding a particular population, the less assurance the auditor will require from sampling and, therefore, the smaller the sample size can be. The auditor’s required confidence level. The greater the level of assurance that the auditor requires that the results of the sample are in fact indicative of the actual amount of misstatement in the population, the larger the sample size needs to be.

21.

What are other sampling considerations mentioned in PSA 530? PSA 530 (Redrafted) includes the following considerations when performing audit sampling:   

22.

Nature and Cause of Deviations and Misstatements Projecting Misstatements Evaluating Results of Audit Sampling When is projection necessary?

For tests of controls, no explicit projection of deviations is necessary since the sample deviation rate is also the projected deviation rate for the population as a whole. For substantive tests (test of details), the auditor shall project misstatements found in the sample to the population, and should consider the effect of the projected error on the particular audit objective and on other areas of audit. When a misstatement has been established as an anomaly, it may be excluded when projecting misstatements to the population. However, the effect of any such misstatement, if uncorrected, still needs to be considered in addition to the projection of the non-anomalous misstatements. If a class of transactions or account balance has been divided into strata, the error is projected for each stratum separately. Projected errors plus anomalous errors for each stratum are then combined when considering the possible effect of errors on the total class of transactions or account balance. 23.

Discuss the following projection techniques: a)

Difference estimation – used to measure the estimated total misstatement amount in a population when there is both a recorded value and an audited value for each item in the sample. This method frequently results in smaller sample sizes than any other method, and it is relatively easy to use. The use of difference estimation is appropriate when the misstatement in an account is not affected by the book value of the item being examined.

b)

Ratio estimation – is similar to difference estimation except that the point estimate of the population misstatement is determined by multiplying the portion of sample amount misstated times the total recorded population book value. The ratio estimates results in even smaller sample sizes than difference estimation if the size of the misstatements in the population is proportionate to the recorded value of the population items. The use of this technique is appropriate when the misstatement in an account is directly proportional to its book value.

c)

Mean-per-unit estimation – under this technique, the auditor is concerned with the audited value rather than misstatement amount of each item in the sample. Except for the definition of what is being measured, this method is calculated in exactly the same manner as the difference estimation. The point estimate of the audited value is the average audited value of items in the sample times the population size. The computed precision interval is computed on the basis of the audited value of the sample items rather

than the misstatements. The use of this technique is appropriate when individual populations do not have recorded values. 24.

What is probability-proportional-to-size (PPS) sampling? In probability-proportional-to-size (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 no errors are expected (although it is also appropriate when one or few errors are expected); and testing for overstatement (normally for assets and income)....