Module 6 - Audit Sampling PDF

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Winter 2018
Auditing
Professor: Kerri Hendricks...

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Module 6 – Audit Sampling Audit Sampling:  Sampling is required whenever the auditor does not test an entire group of transactions or all items in a balance (CAS 530)  In many cases, there are too many items to test, or auditor decides that it is not necessary to test all items  Sample of items tested should be representative of the population Inclusions and Exclusions Related to Audit Sampling:  Sampling involves looking at part of a population in order to reach a conclusion on the entire population o Sampling would not include:  100% audit of a balance or class of transactions,  Analytical procedures,  A walkthrough of a transaction, or  Enquiries, scanning, or observations Sampling and Non-Sampling Risk:  Sampling risk is the risk that the sample chosen by the auditor is not representative of the population available for testing, and causes the auditor to arrive at an inappropriate conclusion  Two consequences of sampling risk: o Risk that audit will be ineffective o Risk that audit will be inefficient  Tests of controls and sampling risk o If sample contains fewer deviations than population, auditor over-relies on controls  Concludes internal controls work effectively  Audit is ineffective because risk of misstatement is greater than auditor’s assessment o If sample contains more deviations that population, auditor under-relies on controls  Concludes internal controls do not work effectively  Audit is inefficient because auditor does more work than necessary Sampling Risk Implications for the Audit The risk that the auditor concludes that the client’s An increased audit risk (that is, the risk that the system of internal controls is effective when it is auditor will issue an inappropriate audit ineffective conclusion) The risk that the auditor concludes that the client’s An increase in audit effort when not required (that system of internal controls is ineffective when it is is, there is a risk that the audit will be inefficient) effective  Substantive tests and sampling risk o If sample contains no material misstatements, auditor concludes financial statements not misstated when there is one in the population  Audit is ineffective because risk of misstatement greater than auditor’s assessment o If sample contains more misstatements than population, auditor concludes financial statement misstated  Audit is inefficient because auditor does more work than necessary  Non-sampling risk is the risk that the auditor makes an inappropriate conclusion for a reason unrelated to sampling issues  The auditor could:

o o o

Use ineffective audit procedures Rely too heavily on unreliable evidence Spend too little time testing high risk accounts or critical controls

Statistical and Non-Statistical Sampling:  Statistical sampling involves random selection and probability theory to evaluate the results, including sampling risk (CAS 530) o Allows measurement of sampling risk o Can be costly to use  Non-statistical sampling allows auditor to use judgment to select sample items o More likely to use when account is low risk and corroborating evidence available Statistical Sampling:  Auditors define statistical sampling as audit sampling that uses laws of probability for selecting and evaluating a sample for the purpose of reaching a conclusion about the population o A statistical sample is selected at random o Statistical calculations are used to measure and express the results  Random sample: o Each population item has an equal likelihood of being selected in the sample o A random sample is required for statistical sampling  Statistical methods can be used to generate the preliminary estimate of sample size o A calculation of sample size is not required for a method to be considered statistical sampling Non-Statistical (Judgmental) Sampling:  Non-statistical sampling is audit sampling in which auditors do not utilize statistical calculations to express the results o The sample selection technique could be random or not o Consideration of sampling risk in these circumstances means “giving sampling risk some thoughtful attention,” without direct knowledge or measurement of its magnitude Sampling Techniques:  Random Selection: o Person selecting sample cannot influence choice of items o Each item has equal chance of being selected o Sample can be stratified before selecting random sample to increase efficiency  E.g., stratify (subdivide) population of transactions into different size ranges, then take different size of samples from each stratum  Systematic Selection: o Divide number of items in population by sample size, giving sampling interval (n). Select starting point, then take every nth item. o Risk that items are listed in way that every nth item is related – can randomly order first  Haphazard Selection: o Auditor does not use methodical technique o Not random sampling b/c personal bias could affect choice  Block Selection: o Select items grouped together o Sequence of items may make this appropriate o Non-statistical



Judgmental Selection o Auditor choose items based on judgment o E.g., after a new computer system is installed o Non-statistical

Factors to Consider when Selecting Sample:  Consider knowledge of client, control risk (CR), acceptable detection risk (DR), and planning materiality (PM)  Select an appropriate population to test  Define ‘error’ for test, set ‘tolerable error’ and confidence level required  When determining size of sample for control testing, CAS 530 requires auditor to consider: 1. Larger sample size if auditor intends to rely more heavily on that control to reduce substantive testing 2. Smaller sample size if auditor is willing to tolerate a higher deviation rate for that control 3. Larger sample size if auditor expects the population to have a higher rate of deviation for that control 4. Larger sample size if auditor requires greater confidence that the control is operating effectively (i.e., lower control risk) 5. Very little change to sample size if population has more sampling units FACTOR EFFECT ON SAMPLE SIZE Increase 1. An increase in the extent to which the auditor’s risk assessment takes into account relevant controls 2. An increase in the tolerable rate of deviation Decrease 3. An increase in the expected rate of deviation of the population to Increase be tested 4. An increase in the auditor’s desired level of assurance that the Increase tolerable rate of deviation is not exceeded by the actual rate of deviation in the population 5. An increase in the number of sampling units in the population Negligible  When determining size of sample for substantive testing, CAS 530 requires auditor to consider: 1. Larger sample size if auditor assesses risk of material misstatement as greater (higher IR, CR) 2. Smaller sample size if auditor also using other substantive procedures for same assertion 3. Larger sample size if auditor requires greater confidence from results of tests (requires lower DR) 4. Smaller sample size if auditor is willing to accept greater total error (higher tolerable misstatement) 5. Greater sample size if auditor expects to find greater misstatement in population 6. Smaller sample size if auditor using stratification of population 7. Very little change to sample size if population has more sampling units FACTOR EFFECT ON SAMPLE SIZE 1. An increase in the auditor’s assessment of the risk of material Increase misstatement 2. An increase in the use of other substantive procedures directed at Decrease the same assertion Increase 3. An increase in the auditor’s desired level of assurance that tolerable misstatement is not exceeded by actual misstatement in the population

4. An increase in tolerable misstatement 5. An increase in the amount of misstatement the auditor expects to find in the population 6. Stratification of the population when appropriate 7. The number of sampling units in the population

Decrease Increase Decrease Negligible

Substantive Test Techniques:  There are two main techniques applied when the auditor is using substantive testing: 1. Key Item Test – using either statistical basis or professional judgment to identify and select key items within a balance. Often the focus is selecting the largest transactions within a balance 2. Representative Sampling – used after key items selected and there is a large population of individual items significant in total but typically not individually  Remaining items are selected in a way that the sample is expected to be representative of the remaining population  Can use audit risk tables, variables estimation sampling, or attributes sampling to select the items to test Evaluating Sample Test Results:  Auditor will consider whether the results of tests applied to a sample provide evidence that: o Control tested is effective within entire population (for control tests), or o Class of transactions or account balance tested is fairly stated (for substantive tests)  If errors are found in sample, calculate for population o Deviation rate for control, or o Misstatement of transactions or account balance  If sample is representative of population o Conclude deviation from controls in sample is at same rate as deviation from control in population  Is deviation rate tolerable? More testing required? o Project monetary errors in sample to population  First remove unique errors  Consider is sample stratified  Projected error = dollar size / dollar size sample X dollar size of population or stratum  Is total projected error tolerable? More testing required? Tests of Controls and Substantive Procedures:  Audit plan is based on audit strategy o Audit strategy is developed after gaining an understanding of the client’s business (inherent risk) and its internal control structures (control risk) o Therefore, relative emphasis on (1) tests of controls and (2) substantive procedures depends on client’s audit risk AUDIT RISK = INHERENT CONTROL DETECTION AUDIT RISK RISK RISK STRATEGY High High Low No tests of Increased reliance Substantive strategy controls on substantive tests of transactions and account balances

Low

Low Increased reliance on tests of controls

High Reduced reliance on substantive tests of transactions and account balances

Combined strategy

Tests of Controls:  Preliminary assessment of CR is made after gaining an understanding of client during planning stage  Tests of controls are performed on controls identified during gaining understanding phase o To obtain evidence that controls operated effectively and consistently throughout period  Auditor can reduce reliance on substantive testing only if tests confirm CR not high  Control testing procedures include: o Inspection of documents for evidence of authorization o Inspection of documents for evidence that details included have been checked by appropriate client personnel o Observation of client personnel performing various tasks, such as opening mail and conducting inventory count o Enquiry of client personnel about how they perform their tasks o Re-performing control procedures to test their effectiveness Substantive Testing:  Types of substantive procedures: o Substantive tests of transactions o Substantive tests of balances o Analytical procedures  When CR is lower, auditor can rely more on analytical procedures and less on detailed substantive tests of transactions and balances o Analytical procedures are more efficient and place greater reliance on client’s accounting records  Examples of substantive procedures: o Confirmation from client’s bank regarding interest rates on borrowings (tests accuracy assertion for interest expense) o Recalculate interest expense (accuracy assertion) o Inspecting documents to verify date of transactions posted around year-end (cut-off assertion) o Inspecting suppliers’ invoices to verify amounts recorded as purchases (completeness) o Confirmation of A/R for amount owed (existence) o Recalculating wages payable (valuation and allocation)  Examples of analytical procedures: o Estimate depreciation expense by multiplying avg. depreciation rate by asset balance (accuracy) o Compare inventory balances for this year and last year (existence, completeness, and valuation and allocation) o Estimate movie theatre revenue by multiplying avg. ticket price x number of seats in theatre x avg. proportion of seats sold per session x number of sessions per week x weeks per year (occurrence and accuracy)

Nature, Timing, and Extent of Audit Testing  Varies depending on audit strategy adopted and type of testing (CAS 330)  Nature of audit testing: o The purpose of the test (control or substantive test; which assertion is being tested), and o The procedure used (inspection, observation, enquiry, confirmation, recalculation, reperformance, or analytical procedure  Auditor tries to gather more persuasive evidence for assertions most at risk  Timing of audit testing o Date that audit evidence relates to, and o Stage of audit when procedures are performed o Interim testing usually done for:  Control testing  Low risk accounts o Year-end testing usually done for:  High-risk accounts  Accounts affected by high deviation in control tests  Cut-off assertion  Extent of audit testing o Refers to amount of audit evidence gathered o Increase extent of control testing when control risk is low o Reduce extent of substantive testing and increase extent of reliance on analytical procedures when control testing confirms lower CR o Do little or no control testing when adopting substantive strategy (i.e., control risk high)...