Auditing – Study Notes

Chapter 14 Audit Sampling

CHAPTER FOURTEEN

AUDIT SAMPLING

LO #

ICAP'S STUDY TEXT

REFERENCE*

LEARNING OBJCTIVE

LO 1

SELECTING ITEMS FOR TESTING

4.3.1

LO 2

RELATIONSHIP BETWEEN SAMPLING AND AUDIT RISK

MODEL

4.3.2

4.3.3

LO 3

STEPS IN SAMPLING

4.3.4

LO 4

SAMPLE DESIGN

4.3.3

4.3.4

LO 5

SAMPLE SELECTION

4.3.4

LO 6

PERFORMING AUDIT PROCEDURES ON SAMPLE

4.3.5

LO 7

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

1

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:

1. 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).

2. 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.)

2

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

3

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.

4

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”.

5

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

6

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

Chapter 14 Audit Sampling

CHAPTER FOURTEEN

AUDIT SAMPLING

LO #

ICAP'S STUDY TEXT

REFERENCE*

LEARNING OBJCTIVE

LO 1

SELECTING ITEMS FOR TESTING

4.3.1

LO 2

RELATIONSHIP BETWEEN SAMPLING AND AUDIT RISK

MODEL

4.3.2

4.3.3

LO 3

STEPS IN SAMPLING

4.3.4

LO 4

SAMPLE DESIGN

4.3.3

4.3.4

LO 5

SAMPLE SELECTION

4.3.4

LO 6

PERFORMING AUDIT PROCEDURES ON SAMPLE

4.3.5

LO 7

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

1

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:

1. 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).

2. 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.)

2

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

3

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.

4

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”.

5

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

6

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

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