Chapter 10.pdf

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Accounting & Financial Management
AFM 451
James Wainberg

Chapter 10 – Audit Sampling Audit Sampling  The application of an AUDIT PROCEDURE to less than 100 % of the items within AN ACCOUNT BALANCE POPULATION or class of transactions in order to evaluate some characteristic of the group  An audit procedure is considered audit sampling ONLY if the auditor’s OBJECTIVE is to reach a conclusion about the entire account balance or transaction class (the population) on the basis of the evidence obtained from the sample o If entire population is audited, the work is NOT audit sampling. o The following are NOT AUDIT SAMPLING:  Complete (100%) audit of all elements in a balance or class  Analytical procedures that are overall comparisons, ratio calc.  A walk through – following 1 or a few transactions through the accounting and controls systems in order to obtain a general idea of the client’s systems  Methods such as enquiry of employees, obtaining written representations, I.C. questionnaire, scanning accounting records for unusual items and observation of personnel & procedures  Selecting specific items because of their high or key value or some other characteristic of special interest (i.e. suspected fraud)  Sampling = Identifying the data population from which to select a sample of items + describing an action to produce relevant evidence  Auditors use audit sampling WHEN: o The nature and materiality of the balance or class does NOT demand 100% audit o A decision must be made about the balance or class o The time and cost to audit 100% of the population would be too great  Three ASPECTS of auditing procedures are important: o Nature = 6 General Techniques (Recalc, confirmation, enquiry, inspection, observation, analysis) o Timing = When procedures are performed o Extent = Amount of work done when the procedures are performed  Audit sampling is mainly concerned with EXTENT Audit Procedure: The general audit techniques of recalculation/ reperformance, observation, confirmation enquiry, inspection and analysis Account Balance: A control account made up of many constituent items Class of Transactions: Groups of accounting entries that have the same source or purpose; credit sales, cash sales, and cash receipts are 3 diff classes Population: The set of all the elements that constitute an account balance or class of transactions Keval Shah Chapter 10 – AFM 451 1 Population Unit: Each element of a population Sampling Unit: Unit used for testing a client’s population, for example, a customer’s account, an inventory item, a debt issue, or a cash receipt Sample: A set of sampling units Sampling in Audit Programs  Internal control programs: o To obtain evidence about control objectives (7 Objectives)  Usually sampling a class of transactions such cash receipts, disbursements, purchases, sales on credit, expense details, welfare payments (eligibility)  Balance audit programs: o To obtain evidence about F/S assertions (5 Assertions - VOPEC)  Usually sampling an asset or liability balance such as A/R, Loans recevable, inventory, A/P, prepaid expenses Sampling Risk:  The probability that an auditor’s conclusions based on a sample might be different from the conclusions that would be based on an audit of the entire population (e.g., an account balance) o If an auditor with more time went through all of the invoices and found multiple errors, your sample-based decision will be proven wrong o Sampling Risk = Probability of a wrong decision based on sample evidence, and it is a fact in BOTH statistical and non-statistical sampling methods o In statistical sampling, you can measure and control it by auditing sufficiently large samples o In non-statistical sampling, you can “consider” it without measuring it, something that requires experience and expertise Non-Sampling Risk:  The possibility of making a wrong decision, which exists in both statistical and nonstatistical sampling  It cannot be measured or controlled  Factors not inherent in the sampling techniques o the auditor lacks proper training, o is not careful in examining the sample o the audit test is not appropriate  Theoretically, these risks can be reduced with strong planning and supervision and adherence to quality control standards o Performing inappropriate procedures o Failure to consider test results appropriately o Neglecting the importance of analytical review o Failure to maintain control over audit procedures o Lack of professional skepticism Keval Shah Chapter 10 – AFM 451 2 o Accounting Risk = Risk related to forecasting the future, typically affecting the measurement or valuation assertions  Recall: AR = IR x CR x DR  Nonsampling Risk can come from: o Misjudging the IR, CR or poor choice of procedures and mistakes in execution (DR) Audit Sampling Risks  Alpha Risk (Type I Error) : o The auditor concludes that the population CONTAINS A MATERIAL MISSTATEMENT when, in fact, IT DOES NOT o Auditor concludes that the population is worse in terms of errors than it really is o Controlled indirectly via test of controls  Controlled indirectly via substantive tests o Also known as the RISK OF INCORRECT REJECTION.  Beta Risk (Type II Error) : o The auditor concludes that the population contains NO MATERIAL MISSTATEMENT when, in fact, IT DOES o Auditor concludes that the population is BETTER in terms of errors than it really is o Covers the situation where the auditor concludes the population is better (i.e. immaterial misstatements) than it actually is (i.e. material misstatements) o Controlled DIRECTLY via substantive tests Two Types of Audit Sampling  Statistical Sampling (random) o Uses the laws of probability to select and evaluate the results of an audit sample: SAMPLING RISK CAN BE QUANTIFIED  A statistical sample is selected at random = A random sample is chosen so that each population item has a PREDICTABLE PROBABILITY of being selected in the sample  Statistical calculations are used to measure and express the results o BOTH CONDITIONS (above) are necessary for a method to be considered statistical sampling  Non-Statistical Sampling (judgmental) o Audit sampling in which auditors do not utilize statistical calculations to express the results: SAMPLING RISK CAN NOT BE QUANTIFIED  Choosing items in a population for audit testing and evaluating the findings based on the auditor’s own knowledge and experience rather than statistical methods  Note: Both methods are consistent with GAAS (CAS) and both can provide SAAE Use Statistical Sampling When: 1. Random numbers can be easily associated with population items 2. Mathematically defensible objective results are desired 3. Auditor has insufficient knowledge about a population to justify non-statistical sampling Keval Shah Chapter 10 – AFM 451 3 4. Staff are sufficiently trained in statistical auditing Use Non-Statistical Sampling 1. Population is small and the time to plan and supervise statistical sampling is large relative to the time to the sample 2. A large % of the population consists of individual items which are high-value (material) or high-risk 3. The account records for the entire population are difficult to access 4. The records are maintained in a manual form Statistical Sampling is advantageous because it (NOT TOO IMP…just understand):  Requires a precise and a definite approach to the audit problem  Incorporates evaluation showing a direct relation between the sample results and the entire population under audit  Requires auditors to specify, and even quantify, particular judgments on risk and materiality.  Does not eliminate or reduce auditors’ professional judgment  Allows more objective control of audit risks  Results in better planning and documentation when properly implemented (but can be more time consuming and costly because of the greater formalism required) Use Professional Judgement  BOTH STATISTICAL AND NON-STATISTICAL SAMPLING INVOLVE PROFESSIONAL JUDGMENT in audit planning, in executing the plan, and in interpreting the results  In statistical sampling: o Judgment is required to select a tolerable deviation rate and a confidence level to draw conclusions about the population  In non-statistical sampling: o Judgment is needed to draw conclusions about the population How Sampling Risks are controlled in Statistical Auditing  The auditor is typically interested in distinguishing between 2 hypotheses: o H1: There exists a material misstatement in the total amount recorded for the accounting population. o H2: There exists NO misstatement in the amount recorded for the accounting population.  The decision rule the auditor uses in statistical auditing is to select one of these 2 hypotheses based on the results of the statistical sample Acceptance Curve  Plots the probability of acceptance of the recorded amount against total misstatement within the recorded amount of some accounting population, such as aggregate A/R  Horizontal Axis = Total Misstatement  Vertical Axis = Probability Keval Shah Chapter 10 – AFM 451 4  In a perfect world of no uncertainty  auditors want zero probability of accepting a recorded amount having MM  As the error amount increases (going left to right), the probability of acceptance goes down o How fast the curve drops depends on SAMPLE SIZE, STATISTICAL MODEL etc.  Each sample size will have a different acceptance curve  At MM, the “perfect” acceptance curve drops to 0, and it stays at 0 as the amount of error increases to way above materiality  A perfect acceptance curve  100% examination of population o There is no alpha or beta risk with a perfect acceptance curve (ideal knowledge for auditor) Keval Shah Chapter 10 – AFM 451 5 Seek a Representative Sample  A sample is considered “representative” when its characteristics are the same, or very similar, to the population as a whole o Auditors try to attain representative samples by selecting random samples where each unit in the population has an equal chance of selection.  Samples can be selected by: o unrestricted random selection o systematic random selection (i.e., every Kth element)  Note: In principle, a non-statistical sample can also be a representative sample Sampling Steps for Test of Controls Test of Controls for Assessing Control Risk 1. Specify the audit objectives 2. Define deviation conditions 3. Define the population 4. Determine the sample size 5. Select the sample 6. Perform the substantive-purpose procedures 7. Evaluate the evidence ***First 3 steps are the phase of PROBLEM RECOGNITION. ***Steps 4-6 are for EVIDENCE COLLECTION. 1. Specify the Audit Objectives  Auditors will identify and test ONLY KEY CONTROLS  INCIDENTAL CONTROLS are controls that are NOT important or are not useful in reducing the audit procedures are not tested  Key controls will be tested to determine the actual level of compliance 2. Define the Deviation Conditions  DEVIATIONS are a departures from the I/C procedure o a.k.a. errors, occurrences, or exceptions  Deviations are
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