Audit book by m asif chapter 14 audit sampling

Auditing – Study Notes Chapter 14 Audit Sampling CHAPTER FOURTEEN AUDIT SAMPLING LO # ICAP'S STUDY TEXT REFERENCE* LEARNING OBJCTIVE LO SELECTING ITEMS FOR TESTING 4.3.1 LO RELATIONSHIP BETWEEN SAMPLING AND AUDIT RISK MODEL 4.3.2 4.3.3 LO STEPS IN SAMPLING 4.3.4 LO SAMPLE DESIGN 4.3.3 4.3.4 LO SAMPLE SELECTION 4.3.4 LO PERFORMING AUDIT PROCEDURES ON SAMPLE 4.3.5 LO PROJECTING MISSTATEMENTS RESULTS OF SAMPLING 4.3.6 AND EVALUATING *Explanation of Reference: First digit in Study Text’s Reference represents chapter number, second and third digits represents section and sub-section number Contents in brackets (if any) represent part of the sub-section which is covered by the learning objective Coverage from Question Bank: After completion of this chapter, you will be able to attempt following questions in ICAP's Question Bank:  Q # 47  Q # 55  Q # 59  Q # 62a & 62b  Q # 64c By: Muhammad Asif, ACA Auditing – Study Notes Chapter 14 Audit Sampling LO 1: SELECTING ITEMS FOR TESTING: Following are different means of selecting items for testing: 1) 100% Selection (i.e selecting all items for examination) 2) Audit sampling 100% Selection: 100% examination of population is not done in Tests of Controls but may be done in Substantive Procedures when: o Population consists of small number of large values or o There is a significant risk which cannot be reduced by other means or o 100% examination becomes cost effective (e.g when a repetitive calculation is performed automatically by computer) Audit Sampling: Audit sampling: Audit Sampling is the application of audit procedures to less than 100% of items within a population in such a way that all sampling units have a chance of selection, to draw conclusions about the entire population Audit Sampling is used in Tests of Controls and Tests of Details LO 2: RELATIONSHIP BETWEEN SAMPLING AND AUDIT RISK MODEL: Detection risk arises because of two components/reasons:  Sampling risk (due to sampling)  Non-Sampling risk Sampling Risk: Definition: “Sampling risk is the risk that auditor’s conclusion based on sampling might be different from the conclusion if entire population would have been tested.” Two Types of Incorrect conclusions in Sampling Risk: In Tests of Controls, auditor erroneously concludes that controls are operating effectively (but actually they are not) In Tests of Details, auditor erroneously concludes that population is free from material misstatement (but actually it is not) In Tests of Controls, auditor erroneously concludes that controls are not operating effectively (but actually they are) In Tests of Details, auditor erroneously concludes that population is not free from material misstatement (but actually it is) First type of risk is more important because it may lead to incorrect audit opinion How to reduce Sampling Risks: Sampling risk can be reduced through:  Increase in Sample Size  Stratification (It is the process of dividing a population into subpopulations, each of which is a group of sampling units which have similar characteristics, often monetary value.) By: Muhammad Asif, ACA Auditing – Study Notes Chapter 14 Audit Sampling Non-Sampling Risk: Definition: Non-sampling risk is the risk that auditor’s conclusion may be wrong for any reasons/errors other than sampling risk Examples: This risk arises due to errors by the auditors or incompetency of the audit team e.g  Inappropriate selection of audit procedure  Inappropriate application of audit procedures  Inappropriate interpretation of results of audit procedures (i.e failure to recognize a misstatement/deviation) How to reduce Non-Sampling Risk: Non-sampling risk can be reduced through:  Adequate planning  Adequate application of professional skepticism  Assigning more experienced and specialized staff e.g use of experts if necessary  Adequate supervision and review of the audit work performed LO 3: STEPS IN SAMPLING: 1) 2) 3) 4) Sample Design Sample Selection Performing Audit Procedures on Sample & Projecting Misstatements Evaluating results of Sampling LO 4: SAMPLE DESIGN: Designing of audit sample includes making following decisions: i Determine Purpose of sample and Population from which sample will be drawn ii Determine what constitutes a Misstatement or Deviation iii Determine Tolerable Rate of Deviation and Expected Rate of Deviation (For Tests of Controls) iv Determine Tolerable Misstatement and Expected Misstatement (For Tests of Details) v Determine Sampling Approach (i.e whether Statistical or Non-Statistical) vi Determine Method of Selection (i.e whether Systematic, Random or Haphazard) Tolerable Rate of Deviation: It is the rate of deviation (in internal control), set by auditor for which auditor obtains assurance that actual rate of deviation in population does not exceed from this set-rate Tolerable Misstatement: It is the amount of misstatement (in financial statements) set by auditor for which auditor obtains assurance that actual amount of misstatements in population does not exceed from this set-amount (it is the application of performance materiality in sampling) Expected Rate of Deviation/Expected Misstatements: Determination of Expected Rate of Deviation/Expected Misstatement is based on following factors:  Rate of deviations/misstatements in prior periods  Risk Assessment Procedures By: Muhammad Asif, ACA Auditing – Study Notes   Chapter 14 Audit Sampling Understanding of business Understanding of Internal Control/Results of Tests of Controls Determining Sampling Approach: Auditor shall determine whether to use Statistical Sampling or Non-Statistical Sampling Statistical Sampling: An approach of sampling is called Statistical Sampling, if it has following characteristics: i Use of Random selection to select items ii Use of Probability theory to evaluate results e.g Random Selection, Systematic Selection Non-Statistical Sampling: (or Judgmental Sampling) A sampling approach that does not have characteristics of Statistical Sampling Instead of probability theory, it is based on judgmental opinion of auditor e.g Haphazard Selection Advantages of Statistical Sampling  It provides objective, mathematically precise basis for sampling process  Required sample size can be calculated precisely (using statistical techniques)  It is the only mean of efficient auditing in case of very large population Disadvantages of Statistical Sampling  Training and technical expertise are required  Investment in training of audit staff required  Sample size is usually larger than judgmental sampling, hence increases the time and cost of audit  Some auditors prefer to rely on their skills, experience and judgments instead of statistical models Determining Methods of Sample Selection: Random Selection: Use of a computerized random number generator or random number tables to select items Systematic Selection: In this method, a random starting point is chosen and then every nth item is selected e.g selecting every 50th item Haphazard Selection: Auditor selects sample without a structured technique, however whole population is considered by auditor in sample selection By: Muhammad Asif, ACA Auditing – Study Notes Chapter 14 Audit Sampling LO 5: SAMPLE SELECTION: Following factors influence determination of sample size: Factors (Increase in) Tolerable rate of deviation/misstatement Expected Rate of Deviation/Misstatement Desired Level of Assurance Risk of Material Misstatement Stratification of Population Other Substantive Procedures (e.g analytical procedures) Population Size Factors (Increase in) Tolerable rate of deviation/misstatement Expected Rate of Deviation/Misstatement Desired Level of Assurance Extent to which auditor considers controls in Risk Assessment Population Size Effect on Sample Size for Tests of Details Decrease Increase Increase Increase Decrease Decrease Negligible Effect on Sample Size for Tests of Control Decrease Increase Increase Increase Negligible LO 6: PERFORMING AUDIT PROCEDURES ON SAMPLE & PROJECTION: Performing Procedures: Auditor shall perform audit procedures on EACH item selected If audit procedures are not applicable to a Auditor shall perform procedures on a replacement selected item (e.g cancelled cheque) item (e.g by selecting very next cheque) If auditor is unable to apply audit procedures Auditor shall treat that item as a deviation (in case on a selected item (e.g when a cheque is of tests of controls) or a misstatement (in case of missing or positive confirmation is not received) tests of details) If auditor identifies a deviation/misstatement, auditor shall investigate whether any of them is Anomalous (Anomaly is a deviation or misstatement that is demonstrably not representative of misstatements or deviations in a population Anomaly is NOT considered for Projection) LO 7: EV ALUATING RESULTS OF SAMPLING: Projection: Projecting Deviation Rate (for T.O.C.): No explicit projection is made for deviations in tests of controls because Sample Deviation Rate is always the Projected Deviation Rate for population Projecting Misstatements (for T.O.D.): Projected misstatement means “Auditor’s best estimate of misstatements in population that are projected on the basis of sample” By: Muhammad Asif, ACA Auditing – Study Notes Chapter 14 Audit Sampling Evaluating results of Tests of Controls: Result If Projected Deviation Rate is above Tolerable Rate of Deviation If Projected Deviation Rate is below Tolerable Rate of Deviation Evaluating results of Tests of Details: Result If Projected Misstatement is below Tolerable Misstatement If Projected Misstatement is above Tolerable Misstatement Evaluation Deviation Rate is unexpectedly high Auditor may: –increase his assessment of control risk –auditor places no reliance on internal control Controls are operating effectively Auditor can rely on internal control Conclusion and Auditor's Procedures –Population is not materially misstated –No further work necessary Sample has not provided a reasonable basis for conclusion about population that has been tested Auditor shall perform other substantive procedures By: Muhammad Asif, ACA ... group of sampling units which have similar characteristics, often monetary value.) By: Muhammad Asif, ACA Auditing – Study Notes Chapter 14 Audit Sampling Non -Sampling Risk: Definition: Non -sampling. .. Selection: Auditor selects sample without a structured technique, however whole population is considered by auditor in sample selection By: Muhammad Asif, ACA Auditing – Study Notes Chapter 14 Audit Sampling. .. be reduced by other means or o 100% examination becomes cost effective (e.g when a repetitive calculation is performed automatically by computer) Audit Sampling: Audit sampling: Audit Sampling