audit sampling notes


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audit sampling notes

  2. 2. Nature of Audit SamplingThe process of using auditing procedures to test less than 100 percent of various items in a companys account balance such that each unit may have an equal opportunity of being selected.
  3. 3. Define Audit SamplingRefer to Definition on ISA 530 for Audit SamplingProcess of selecting a subset of a population of items for the purpose of making inferences to whole population.The process of using auditing procedures to less than 100 per cent of various items in a companys account balance such that each unit may have an equal opportunity of being selected.It is used to conduct test of control and substantive test.
  4. 4. PurposeAudit sampling help auditors on doing their audit work at a given period of time. It is possible for auditor to make details examination on all the items being examined.To gather or get the evidences from the audit procedures being performed. Sampling is only the method (efficient) or sources of the evidence.To detect error and any materially misstatements.To show or a s a prove that the auditor have done their work.
  5. 5. select the audit samples1) Simple random sampling – cases are selected in a completely random way which ensures that each case has an equal chance of being selected e.g. by using a computerised random number list or drawing random numbers out of a hat.2) Stratified random sampling – The population is divided into groups depending on characteristics they share in common e.g. diagnosis, age etc. A random sample is then selected from each group.
  6. 6. Know to select the audit samples3) Interval random sampling – The population is arranged in order and the first case is then selected at random. The rest of the cases are then selected at pre-defined intervals, e.g. every 3rd or every 5th patient.4) Rapid-cycle sampling – This method can be used where you know there may be a problem and you want to obtain results as quickly as possible. Here you carry out the audit with a relatively small sample, implement changes and then re-audit using another small sample to determine whether improvements have been made. This method uses lots of small data sets to monitor care and can make the change cycle quicker to complete.
  7. 7. factors affecting the sample size. There are several factors which must be considered when deciding upon the sample size.Population Size This is only relevant in very small populations.Level of confidence Even a 100% sample will not give complete assurance .Auditors work to level of confidence which can be expressed precisely .For example ,a 5% confidence level means that there is 19 chances out of 20 that the sample is representative of the population as a whole.Precision Clearly the level of confidence and the precision interval are related ,in that for a given sample size higher confidence can be expressed in a wider precision interval and vice versa.
  8. 8. RiskRisk is a highly important concept in modern auditing and in high riskareas a large sample will be desirable because high confidence levels andnarrow precision intervals are required. MaterialityThis is really a subset of risk. Materiality is fundamental to modernauditing and with all populations being sample, materiality should beconsidered in fixing the sample size.Subjective factorsThis is most important and yet difficult area of consideration .Theauditor expects to gain audit evidence about a population from asample.Expected error/deviation rateThe theory requires that the samples size required is a function of theerror .This is only known after the results have been evaluated .Howeveran estimate based on previous experience and knowledge of otherfactors may give a good indication
  9. 9. Audit samples selection methoda)All items selectionb)Specific selectionCHARACTERISTICS OF SAMPLE:Random A random sample is one where each item of the population has an equal or specified chance of being selected. Statistical inferences may not be valid unless the sample is random.Representatives The sample should be representative of the differing items in the whole population .For example ,it should contains a similar proportion of high and low value item to the population.
  10. 10. ProtectiveProtective that is of the auditor. More intensive auditing should occur onhigh value items known to be high risk.UnpredictableClient should not be able to know or guess which items will be examined.Several METHODS available to an auditor for selecting items: (Shouldhave 7 techniques for audit sampling and 3 under non-statistical while 4under statistical method of selection)HaphazardSimply choosing items subjectively but avoiding bias. Bias might come inby tendency to favor items in a particular location or in an accessible file forconversely in picking items because they appear unusual.Simple randomAll items in population have a number .Numbers are selected by a meanswhich gives every number an equal chance of being selected.
  11. 11. StratifiedDividing the population into sub population and is useful when partsof the population have higher than normal risk. Frequently high valueitems form a small part or the population and 100% checked and theremainder are sampled.Cluster samplingThis is useful when data is maintained in clusters as wage records arekept in weeks or sales invoice in months. The idea is to select a clusterrandomly and then to examine all the items in the cluster chosen.Random systematicsInvolves making a random start and then taking every nth itemthereafter. This is commonly use method which saves the work ofcomputing random numbers.Multi stage samplingThis method is appropriate when data is stored in two or more levels.For example stock in a retail chain of shops. The first stage is torandomly select a sample of shops and the second stage is to randomlyselect stock items from the chosen shops.
  12. 12.  Test of controlPurpose of test of controls is determine the system’s internal controls comply with the stated policies, plans, laws and regulations.Auditors evaluate the design of controls and determine if the controls are in operation. They must also obtain evidence whether the controls are operating effectively.Test of controls to establish to detect material error and whether the internal controls were operating effectively through out the period being audited.Normally test of control provide information as to the rate of error in terms of control failure rather than to enable direct extrapolation in term of monetary errors in the financial statements.
  13. 13.  Substantive testPurpose of substantive test is provide audit evidence to the completeness, accuracy and validity of the information contained in the financial statements.Determine their accuracy and to draw conclusions about the materiality of the error amounts in the accounts.The objective is to obtain reliable confidence limits, such as confidence limits with actual confidence levels never less than their nominal levels which are not conservative.Example the total error amount should not be very much greater than the true error amount with sample sizes that are not too large for practical audit applications.
  14. 14. Statistical vs. Non-statisticalStatistical Non-statisticalThrough the application of  Auditor does not quantify mathematical rules. sampling risk.It allows the quantification  Instead, those sample items that (measurement) of sampling auditor believes will provide the most useful information in the risk in planning the sample circumstances are selected. and evaluate the results.  Conclusions are reached aboutExample: Statistical result at populations on judgmental a 95% confidence level basis. Thus selection of provides a 5% sampling risk) nonprobability samples is often termed judgmental sampling
  15. 15. Advantages DisadvantagesVery accurate.  Inadequacy of the samples. Economical in nature.  Chances for bias. Very reliable.  Problems of accuracy. High suitability ratio towards  Difficulty of getting the the different surveys. representative sample. Takes less time.  Untrained manpower. In cases, when the universe  Absence of the informants. is very large, then the  Chances of committing the sampling method is the only errors in sampling. practical method for collecting the data.
  16. 16. Probability Sampling Non-Probability Sampling AdvantagesAdvantages  More flexible Less prone to bias  Less costly Allows estimation of magnitude  Less time-consuming of sampling error, from which  Judgmentally representative you can determine the statistical significance of samples may be preferred when changes/differences in small numbers of elements are to indicators be chosen DisadvantagesDisadvantages  Greater risk of bias Requires that you have a list of  May not be possible to generalize all sample elements to program target population More time-consuming  Subjectivity can make it difficult More costly to No advantage when small measure changes in indicators numbers over time of elements are to be chosen  No way to assess precision or reliability of data
  17. 17. Type I and Type II errorsType I and Type II errors are the two types of decision errors an auditor can make when deciding that sample evidence supports or does not support a test of controls or a substantive procedures based on a sampling application.In reference to a test of controls Type I and Type II errors are:Risk of incorrect rejection (Type I): the risk that the assessed level of control risk based on the sample is greater than the true operating effectiveness of the control. Also commonly referred to as the risk of assessing control risk too high or the risk of under- reliance.
  18. 18. Risk of incorrect acceptance (Type II): the risk that the assessed level of control risk based on the sample is less than the true operating effectiveness of the control. Also commonly referred as the risk of assessing control risk too low or the risk of over- reliance.In reference to substantive tests Type I and Type II errors as follows:Risk of incorrect rejection (Type I): the risk that the sample supports the conclusion that the recorded account balance is materially misstated when it is not materially misstated.
  19. 19. Risk of incorrect acceptance (Type II): the risk that the sample supports the conclusion that the recorded account balance is not materially misstated when it is materially misstated.The risk of incorrect rejection relates to the efficiency of the audit because such errors can result in the auditors conducting more audit work than necessary in order to reach the correct conclusion. The risk of incorrect acceptance relates to the effectiveness of the audit because such errors can result in the auditor failing to detect a material misstatement in the financial statements. This can lead to litigation against the auditor by the parties who relied on the financial statements.
  20. 20. EXPECTED ERROR IN THE POPULATIONa) Tolerable error Tolerable error is the maximum error in the population that auditors would be willing to accept and still conclude that the result from the sample has achieved the audit objective. Tolerable error is considered during the planning stage and, for substantive procedures, is related to the auditors judgement about materiality. The smaller the tolerable error, the greater the sample size needs to be. In tests of control, the tolerable error is the maximum rate of deviation from a prescribed control procedure that auditors would be willing to accept and still conclude that the preliminary assessment of control risk is valid. In substantive procedures, the tolerable error is the maximum monetary error in an account balance or a class of transactions that auditors would be willing to accept so that when the results of all audit procedures are considered, auditors are able to conclude, with reasonable assurance, that the financial statements are not materially misstated.
  21. 21. b) Expected error If auditors expect errors to be present in the population, a larger sample than when no error is expected ordinarily needs to be examined to conclude that the actual error in the population is not greater than the planned tolerable error. Smaller sample sizes are justified when the population is expected to be error free. In determining the expected error in a population, auditors would consider such matters as error levels identified in previous audits, changes in the entitys procedures and evidence available from other procedures, including tests of control.
  22. 22. NATURE OF ERRORAuditors may observe that many have a common feature, for example type of transaction, location, product line or period of time.In such circumstances, auditors may decide to identify all items in the population which possess the common feature, thereby producing a subpopulation, and extend audit procedures in this area.Auditors would then perform a separate analysis based on the items examined for each sub-population.
  23. 23. What if the auditor finds there is an error?If material error exists in the accounting records or financial statements, it must be the result of one or more of the following :a) A large number of small error – should be detected by representative sampling.b)Few large error – should be detected by selecting sampling.c) A combination of (a) and (b) – both sample types will be needed
  24. 24. i. Representative sample Drawn at random from a population. A sample should be large enough to allow auditors to draw valid inferences about the whole population. Auditors test of control will always make use of representative sampling may also be used for substantive testing.b) Selecting samples focus on particular items in the population. These are usually the large and unusual items, transactions or balances that are large enough to give a materials error if incorrect, or which are worthy of investigation.
  25. 25. ACTION TAKEN WHEN ERROR ISFOUND Auditors project the error results of the sample to the population from which the sample was selected in order to form a conclusion about the possible level of error in the population as a whole. The projection of the error results of the sample to the population as a whole involves estimating the probable error in the population by extrapolating the errors found in the sample. When projecting error results, auditors would ensure that the method of projection is consistent with the method used to select the sampling unit. This is in addition to considering the qualitative aspects of the errors found. When the population has been divided into sub-populations, the projection of errors is done separately for each sub-population and the results are combined.
  26. 26.  Auditors would consider whether errors in the population might exceed the tolerable error. To accomplish this, auditors compare the projected population error to the tolerable error taking into account the results of other audit procedures relevant to the specific control or financial statement assertion. The projected population error used for this comparison in the case of substantive procedures is net of adjustments made by the entity. When the projected error exceeds tolerable error, auditors re-assess the sampling risk and if that risk is unacceptable, consider extending the audit procedure or performing alternative audit procedures, either of which may result in them proposing an adjustment to the financial statements.