Ch1 Part 2 Audit Sampling For Tests of Details of Balance

Audit Sampling for Tests of Detail
Balance- Non-statistical sampling
Tests of details of balance are part of substantive procedure.

Substantive procedures include the following:
 Substantive tests of transactions
 Substantive tests of balances
 Analytical procedures
 In substantive tests of transactions, the auditor is concerned
about both the effectiveness of internal controls and the
monetary correctness of transactions in the accounting
system.
 In tests of details of balances, the concern is determining
whether the dollar amount of an account balance is materially
misstated
Auditing part II for class of 2018 1
Audit Sampling for Tests of Detail
 Analytical procedures include comparisons of
reported amounts with, comparable periods,
financial relationships, nonfinancial information,
budgets and expected outcomes calculated by
auditor.
 When control risk is lower, auditor can rely more
on analytical procedures and less on detailed
Substantive tests of transactions and balances.
Links for Ch 1 part 2\Examples of substantive tests
of balance.doc
..Audit Sampling for Tests of Detail
 Though substantive procedures include both
analysis and tests of details of balances,
analysis is not subject to sampling because
analytical procedures are applied to overall
balances and financial relationships (to 100%
of the items on financial statement).

Tests of Details of Balance
 Details of an account balance are the items and
transactions that make up the account balance. For example,
three customers, Mr. A, Ms. B, and Mrs. C owe the
company $50,000, $80,000, and $150,000 respectively, and
make up the total accounts receivable balance of $280,000.
 A test of details for accounts receivable could consist of
verifying (testing) the individual customer balances (details
making up the total balance). (Note, however, that testing
100% of the accounts does not constitute audit sampling.)

Why audit sampling for tests of details of balance?

Purpose of audit sampling for tests of details of
balance
This test is designed to
 Measure whether dollar amounts of account
balances are materially misstated or not.
OR
 Detect material misstatement in an account
balance.
 The test provides results in dollar terms
Sampling risks related to tests of details of

balance
1. Risk of Inappropriate Acceptance (RIA),
which results in ineffective audit, which is
the most concerned about
2. Risk of Incorrect Rejection (RIR), is risk that
leads to too much audit work being done or
inefficient audit.

Links for Ch 1 part 2\illustration of 14 steps.doc
1. State the Objectives of the Audit Test
 The objective of sampling for tests of details of balances is to
determine whether the account balance being audited is fairly stated.
2. Decide Whether Audit Sampling Applies
 Sampling may not apply in testing some account, (when small balance
accounts are ignored, when 100% of large balance accounts are audited-
sampling is not applied)
 For the population in Table 17-1,
 the auditor may decide to audit only items over $5,000 and ignore all
others because the total of the smaller items is immaterial.
 The auditor may also decide to audit all items above the tolerable
amount of say $15,000

3. Define a Misstatement
 Because audit sampling for tests of details of
balances measures monetary misstatements, a
misstatement exists whenever a sample item is
misstated.
 In auditing AR, any client misstatement in a
customer balance included in the auditor’s
sample is a misstatement.

Balance Non-statistical sampling
4. Define the Population

 In tests of details of balances, the population
is defined as the items making up the recorded
dollar population.
 The recorded population of accounts
receivable in Table 17-1 consists of 40
accounts totaling $207,295.
 The auditor will evaluate whether the recorded
population is overstated or understated.
…1. Steps in Non-statistical sampling

..4. Define the Population
 Auditors stratify the population to emphasize certain
population items and deemphasize others.
 Usually, they define each stratum on the basis of the
size of recorded dollar values.
 Such stratum help auditors to emphasize the larger
recorded dollar values,
 eg In most audit sampling situations, including confirming
accounts receivable, emphasis is given for larger recorded
dollar values
Stratum Stratum Number In Dollars in
Criteria population Population
1 > $15,000 3 $88,955
2 $5000 - $15,000 10 71,235
3 < $5,000 27 47,105
40 $207,295
There are many alternative ways to stratify this population. One
example is to have four strata (make stratum 3 items between
$2,000 and $5,000, and add a fourth stratum for items less than
$2,000).

The need to use the right population for each

assertion
Eg.
 In testing for existence objective, the recorded
dollar population (account balances) constitute the
population.
 In testing for completeness objective, the sample

should be selected from a different source (eg
customers with zero balance)
Balance
5. Define the Sampling Unit

 Since for non-statistical audit sampling in tests of
details of balances, the sampling unit is almost
always the items making up the account balance, the
sampling unit will be the customer number.
6. Specify Tolerable Misstatement
Why it is needed?
 Auditors use tolerable misstatement, for
determining sample size and evaluating results in
non-statistical sampling.
..Audit Sampling for Tests of Detail Balance Non-statistical
sampling
How auditors determine the tolerable amount?

 The auditor starts with a preliminary judgment about materiality and
uses that total in deciding tolerable misstatement for each account.
For example:
 -Overall materiality estimated based on estimated after-tax income:
$177,000
 -Accounts receivable, to be tested, amount to $235,000.
 Total assets are $3,550,000,
 Tolerable misstatement for accounts receivable:
235,000/3,550,000 x 177,000=11,717
 However, in many cases, such a systematic approach will not be

appropriate, and the auditor will have to rely more on qualitative
factors to arrive at tolerable misstatement for each balance. The
primary basis for materiality
Auditing part II decisions is always the auditor’s judgment.14
for class of 2018
7. Specify Acceptable Risk of Incorrect Acceptance
(ARIA)
 ARIA is sampling risk (risk of making incorrect
acceptance or risk of making incorrect rejection of an
account balance)
 But auditors focus on risk of incorrect acceptance
 (Note that ARIA is the equivalent term to ARACR
(acceptable risk of assessing control risk too low) for
tests of controls and substantive tests of trans actions.)

 ARIA measures the auditor’s desired assurance

for an account balance.
 For greater assurance in auditing a balance,
auditors will set ARIA lower.
 Like for ARACR, ARIA can be set quantitatively
(such as 5% or 10%), or qualitatively (such as
low, medium or high).

How ARIA relates to sample size?

 There is an inverse relationship between ARIA
and required sample size.
 If, for example, an auditor decides to reduce
ARIA from 10% to 5%, the required sample
size will increase. Stated differently, if the
auditor is less willing to take risk, a larger
sample size is needed.

How ARIA relates to assessed control risk?
 Assessed control risk in the audit risk model is the
major factor that affects auditor's decision regarding the
level of ARIA
 When internal controls are effective, control risk can be
reduced, permitting the auditor to increase (relax)
ARIA. This, in turn, reduces the sample size required
for the test of details of the related account balance.

 Tests of details of balances for monetary

misstatements can be reduced if auditors find
internal controls effective after assessing
control risk and performing tests of controls.
 If analytical procedures (substantive tests )
indicate that the account balance is likely to be
fairly stated, ARIA can be increased/relaxed
(sample size can be reduced) .

8. Estimate Misstatements in the Population

 The auditor makes this estimate based on the following:
 Prior experience with the client and
 by assessing inherent risk,
 By considering the results of tests of controls, substantive tests
of transactions, and analytical procedures already performed.
How estimated Misstatements in the Population affects
sample size?
 As the amount of misstatements expected in the
population approaches tolerable misstatement, the
planned sample size increases.
9. Determine the Initial Sample Size
 When using non-statistical sampling, auditors determine the initial
sample size by considering the factors discussed so far.
..\Links\Links for sdb\Factors considered in determining sample size.doc
Links for sdb\Factors considered in determining sample size.doc
 Considering all of these factors requires considerable judgment.
 Auditors usually make the sample size decision by following guidelines
provided by their firm or some other source.
 Figure 17-2 presents a grid for combining these factors and a formula for
computing sample size based on the AICPA Audit Sampling Auditing
Guide.Links for sdb
\Figure 17-2 Formula for computing sample size in tests of details of bal
ance non statistical method.doc
 ..\Links\Links for sdb
\Figure 17-2 Formula for computing sample size in tests of details of balance non statistica
l method.doc Auditing part II for class of 2018 21
9. Determine the Initial Sample Size
When using non-statistical sampling,
auditors determine the initial sample
size by considering the following
factors:Links
for Ch 1 part 2\Factors considered in
determining sample size.doc
Illustration on how to determine sample size
Links for Ch 1 part 2\Figure 17-2 Formula for computing

sample size in tests of details of balance non statist
ical method.doc
Phase 2: Select the Sample and Perform the Audit
Procedures
10. Select the Sample
 For non-statistical sampling, auditing standards permit
the auditor to use any of the selection methods discussed
earlier.
 In selecting the method, consideration should be given
 When stratified sampling method is used, the

auditor selects samples independently from
each stratum.
 In our example from Table 17-1, the auditor
will select seven sample items from the 10
population items in stratum 2 and six of the 27
items in stratum 3.

11. Perform the Audit Procedures
 The auditor applies the appropriate audit procedures (eg.
Confirmation ) to each item in the sample to determine
whether it contains a misstatement.
 It is assumed that auditors send the sample of positive
confirmations and determine the amount of misstatement
in each account confirmed;
 for non-responses, they use alternative procedures to
determine the misstatements.
 The assumption is that the auditor sends first and second
requests for confirmations and performs alternative
procedures.
Also assume the auditor reaches the following

conclusions about the sample after reconciling
all timing differences:
Dollars Audited
Stratum Sample Recorded Audited Client
Size Value Value Misstatement
1 3 $88,955 $91,695 $(2,740)
2 7 43,995 43,024 971
3 6 13,105 10,947 2,158
16 $146,055 $145,666 $389

Phase 3: Evaluating the result
12 & 14. Generalize from the Sample to the Population
and Decide the Acceptability of the Population
The auditor must generalize from the sample to the
population by :
1. Projecting misstatements from the sample results to the
population and
2. Considering sampling error and sampling risk (ARIA).
In this example, will the auditor conclude that accounts

receivable is overstated by $389? No.

Decide the Acceptability of the Population

 This process involves the computation of a point estimate
Calculating a point estimate.

 The point estimate can be calculated in different ways, but a
common approach is to assume that misstatements in the
unaudited population are proportional to the misstatements in the
sample.
 Calculation must be done for each stratum and then totaled,
rather than combining the total misstatements in the sample.
 In our example, the point estimate of the misstatement is
calculated by using a weighted-average method, as shown below:

Client
Misstatement / Recorded
Recorded x Value for the = Point estimate of
Value of the stratum Misstatement
Stratum Sample
1 $ (2,740 )/$88,955 x $ 88,955 = $ (2,740)
2 $ 971 /$43,995 x 71,235 = 1,572
3 $ 2,158 /$13,105 x 47,105 = 7,757
$ 6,589

What does this point estimate of $6,589 indicate,

overstatement/understatement?
• The point estimate of the misstatement in the population,
$6,589, indicates existence of an overstatement.
Can this figure represent overstatement in the population?

No
 The point estimate of $6,589 is based on sample
 Due to sampling error, the point estimate, by itself, may not be
an adequate measure of the population misstatement (it may
not exactly measure the misstatement in the population; it may
be closer to the misstatement in the population)
..Audit Sampling for Tests of Detail Balance
Non-statistical sampling
Accept/not accept decision:
 Population is not accepted when:
 the auditor concludes that the misstatement in a population exceed
the tolerable misstatement (after considering sampling error)
 Population is accepted when:
 the auditor concludes that the misstatement in a population may not
exceed tolerable misstatement (after considering sampling error)
But what factors should auditors consider in determining
sampling error (possibility that the misstatement in a population
may exceed tolerable misstatement ) in non statistical method?

 An auditor using non-statistical sampling cannot formally measure
sampling error and therefore must subjectively consider the
possibility that the true population misstatement exceeds a tolerable
amount.
Auditors do this by considering:
1. The difference between the point estimate and tolerable
misstatement (this is called calculated sampling error)
2. The extent to which items in the population have been audited 100
%
3. Whether misstatements tend to be offsetting or in only one
direction
4. The amounts of individual misstatements
5. The sample size
Balance
Consideration of the difference between the point estimate
and tolerable misstatement (calculated sampling error)
 In our example, suppose that tolerable misstatement is $40,000.
 Calculated sampling error: 40,000- 6589= 33,411, this much greater
than the point estimate (larger gap)
 In that case, the auditor may conclude it is unlikely, that the true
population misstatement exceeds the tolerable amount
 Suppose that tolerable misstatement is $15,000 as before,
 Calculated sampling error: 15,000- 6589= 8,411 (only $8,411 greater than the
point estimate, ( narrow gap)
 In that case, the auditor will consider other factors since the gap is narrower, there
could be a possibility that misstatement in the population could exceed the
tolerable misstatement

Balance
Consideration of the extent to which items in

the population have been audited 100 %
 If the larger items in the population were
audited 100% (if 100% of the accounts with
larger balances are audited) any unidentified
misstatements will be restricted to smaller
items.

Balance
Consideration of whether misstatements tend

to be offsetting or in only one direction
 If the misstatements tend to be offsetting and
are relatively small in size, the auditor may
conclude that the true population misstatement
is likely to be less than the tolerable amount.

Consideration of sample size and individual

misstatement amount
 When sample size is considered large, auditors will
be more confident and willing to accept that the
true population misstatement is less than tolerable
misstatement.
 If one or more of these other conditions differs,
auditors may judge the chance of a misstatement in
excess of the tolerable amount to be high and the
recorded population unacceptable.
13. Analyze the Misstatements
 Auditors should evaluate the nature and cause of each
misstatement found in tests of details of balances.
 Assume when the auditor confirmed accounts receivable,
all misstatements are resulted from the client’s failure to
record returned goods. The auditor will determine:
 Why that type of misstatement occurred so often?
 The implications of the misstatements on other audit areas,
 The potential impact on the financial statements, and its effect
on company operations.
 The same approach is followed for all misstatements.
Why auditors analyze the cause of misstatement?
 Analysis help auditros to decide whether any
modification of the audit risk model is needed.
 In the previous example, if the auditor concluded that
the failure to record the returns resulted from a
breakdown of internal controls, it might be necessary to
reassess control risk.
 That in turn will probably cause the auditor to reduce
ARIA, which will increase planned sample size.

Action When a Population is Rejected
 When the auditor concludes that the misstatement in a population
may exceed tolerable misstatement after considering sampling
error, the population is not considered acceptable. At that point, an
auditor has several possible courses of action.
1. Take No Action Until Tests of Other Audit Areas are
Completed
Ultimately, the auditor must evaluate whether the financial
statements taken as a whole are materially misstated.
If offsetting misstatements are found in other parts of the audit,
such as in inventory, the auditor may conclude that the estimated
misstatements in AR are acceptable.
-
 However, before the audit is finalized, the auditor must evaluate
whether a misstatement in one account may make the financial
statements misleading even if there are offsetting misstatements.
2. Perform Expanded Audit Tests in Specific Areas
 If an analysis of the misstatements indicates that most of the
misstatements are of a specific type, it may be desirable to
restrict the additional audit effort to the problem area.
 For example, if an analysis of the misstatements in
confirmations indicates that most of the misstatements result
from failure to record sales returns, the auditor can make an
extended search of returned goods to make sure that they have
been recorded.
3. Increase the Sample Size

 When the auditor increases the sample size,
sampling error is reduced
 However, for tests such as AR confirmation and
inventory observation, it is often difficult to increase
the sample size because of the practical problem of
“reopening” those procedures once the initial work is
done.
 By the time the auditor discovers that the sample was
not large enough, several weeks have usually passed.
 It is much more common to increase sample

size in audit areas other than confirmations
and inventory observation, but it is
occasionally necessary to do so even for these
two areas.
 When stratified sampling is used, increased
samples usually focus on the strata containing
larger amounts, unless misstatements appear
to be concentrated in some other strata.
4. Adjust the Account Balance
 When the auditor concludes that an account balance is
materially misstated, the client may be willing to
adjust the book value based on the sample results.
 In the preceding example, assume the client is willing
to reduce book value by the amount of the point
estimate ($6,589) to adjust for the estimate of the
misstatement.
 The auditor’s estimate of the misstatement is now zero,
but it is still necessary to consider sampling error.

4. Adjust the Account Balance
 Again, assuming a tolerable misstatement of
$15,000, the auditor must now assess whether
sampling error exceeds $15,000, not the $15,000-
$6,589= $8,411 originally considered.
 If the auditor believes sampling error is $15,000 or
less, AR is acceptable after the adjustment.
 If the auditor believes it is more than $15,000,
adjusting the account balance is not a practical
option.
5. Request the Client to Correct the Population

 In some cases, the client’s records are so inadequate
that a correction of the entire population is required
before the audit can be completed.
 For example, in AR, the client may be asked to correct
the AR records and prepare the AR listing again if the
auditor concludes that it has significant misstatements.
 When the client changes the valuation of some items
in the population, the results must be audited again.

6. Refuse to Give an Unqualified Opinion
 If the auditor believes that there is a reasonable
chance that the financial statements are materially
misstated, it would be a serious breach of auditing
standards to issue an unqualified opinion.
 For purposes of reporting on internal control, the
material misstatement should be considered a
potential indicator of a material weakness in
internal control over financial reporting.

Ch1 Part 2 Audit Sampling For Tests of Details of Balance

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Ch1 Part 2 Audit Sampling For Tests of Details of Balance

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Audit Sampling for Tests of Detail

Balance- Non-statistical sampling

Tests of details of balance are part of substantive procedure.

Auditing part II for class of 2018 3

Auditing part II for class of 2018 4

Why audit sampling for tests of details of balance?

Sampling risks related to tests of details of

Auditing part II for class of 2018 6

Auditing part II for class of 2018 7

Auditing part II for class of 2018 8

4. Define the Population

…1. Steps in Non-statistical sampling

Auditing part II for class of 2018 11

The need to use the right population for each

 In testing for completeness objective, the sample

5. Define the Sampling Unit

How auditors determine the tolerable amount?

 However, in many cases, such a systematic approach will not be

Auditing part II for class of 2018 15

 ARIA measures the auditor’s desired assurance

Auditing part II for class of 2018 16

How ARIA relates to sample size?

Auditing part II for class of 2018 17

Auditing part II for class of 2018 18

 Tests of details of balances for monetary

Auditing part II for class of 2018 19

8. Estimate Misstatements in the Population

Links for Ch 1 part 2\Figure 17-2 Formula for computing

 When stratified sampling method is used, the

Auditing part II for class of 2018 24

Also assume the auditor reaches the following

Auditing part II for class of 2018 26

In this example, will the auditor conclude that accounts

Auditing part II for class of 2018 27

Decide the Acceptability of the Population

Calculating a point estimate.

Auditing part II for class of 2018 28

Auditing part II for class of 2018 29

What does this point estimate of $6,589 indicate,

Can this figure represent overstatement in the population?

Auditing part II for class of 2018 31

Auditing part II for class of 2018 33

Consideration of the extent to which items in

Auditing part II for class of 2018 34

Consideration of whether misstatements tend

Auditing part II for class of 2018 35

Consideration of sample size and individual

Auditing part II for class of 2018 38

3. Increase the Sample Size

 It is much more common to increase sample

Auditing part II for class of 2018 43

5. Request the Client to Correct the Population

Auditing part II for class of 2018 45

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