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## CHAPTER 9 AUDIT SAMPLING: AN APPLICATION TO SUBSTANTIVE TESTS OF ACCOUNT BALANCES

9-1 The steps in a statistical sampling application for substantive testing include (by phases): Planning: 1. Determine the test objectives. 2. Define the population characteristics: o Define the population. o Define the sampling unit. o Define a misstatement. 3. Determine sample size, using the following inputs: o Desired confidence level or risk of incorrect acceptance. o Tolerable misstatement. o Expected misstatement. o Population size. Performance: 4. Select sample items. 5. Perform the audit procedures: o Understand and analyze any misstatements observed Evaluation: 6. Calculate the projected misstatement and the upper limit on misstatement. 7. Draw final conclusions. 9-3 The following table shows how the desired confidence level, tolerable misstatement, and expected misstatement are related to sample size: Factor Desired confidence level Tolerable misstatement Expected misstatement Relationship to Sample Size Direct Inverse Direct

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9-4

The advantages and disadvantages of MUS are: Advantages: When the auditor expects no misstatements, MUS will normally result in a smaller sample size than classical variables sampling. The calculation of sample size and the evaluation of the sample results are not based on the variation (that is, the standard deviation) between items in the population. MUS, when applied using a probability proportional to size sample selection procedure as outlined in the text, automatically results in a stratified sample because sampled items are selected in proportion to their monetary amount. Disadvantages: Selection of a zero or negative balance generally requires special design consideration. The general approach to MUS assumes that the audited amount of the sample item is not in error by more than 100 percent. When more than one or two misstatements are detected using a MUS approach, the sample results calculations may overstate the allowance for sampling risk.

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The decision rule for determining the acceptability of sample results when MUS is used compares the tolerable misstatement (TM) to the upper misstatement limit (UML). If UML is less than TM, the evidence supports the fair presentation of the account. If UML is greater than TM, the evidence does not support the fair presentation of the account balance. The advantages and disadvantages of classical variables sampling are: Advantages: When the auditor expects a large number of differences between book and audited values, classical variables sampling will normally result in a smaller sample size than MUS. Classical variables sampling techniques are effective for both overstatements and understatements. No special evaluation considerations are necessary if the sample data include both types of misstatements. The selection of a zero balance generally does not require special sample design considerations since the sampling unit will not be an individual dollar but rather an account, a transaction, or a line item. Disadvantages: In order to determine sample size, the auditor must estimate the standard deviation of the audited value or differences. If few misstatements are detected in the sample data, the true variance tends to be underestimated and the resulting projection of the misstatements to the population is not likely to be reliable.

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9-11 9-12 9-13 9-14 9-15 D D B A C 9-16 9-17 9-18 9-19 9-20 B A A C C

Solutions to Problems
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## a. The advantages of MUS over classical variables sampling are as follows:

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MUS sampling is generally easier to use than is classical variables sampling. The calculation of sample size in a MUS sample is not based on an estimate of the standard deviation in the population. MUS sampling in conjunction with probability-proportional-to-size selection results in a stratified sample. Individually significant items are automatically identified. If no misstatements are expected, MUS will usually result in a smaller sample size than classical variables sampling. b. Using Table 8-5 in the text with a desired confidence level = 95%, tolerable misstatement = 5% (\$15,000 \$300,000), and expected misstatement = 2%, (\$6,000 \$300,000) sample size is equal to 181 items. The sampling interval is \$1,657 (\$300,000 181). Using ACL with a desired confidence level = 95%; population = \$300,000; tolerable misstatement = \$15,000; and expected misstatement = \$6,000; the sample size is equal to 161 items. The sampling interval is \$1,853.93. c. The total projected misstatement for the three misstatements identified is calculated by first computing the tainting factor as follows: Misstatement Number 1 2 3 Book Value \$400 500 3,000 Audit Value \$320 0 2,500 Tainting Factor .20 1.00 Not applicable, since book value exceeds sampling interval.

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## The upper misstatement limit is calculated as follows:

Misstatement Number Basic Precision 2 1 Add misstatements detected in logical units greater than the sampling interval: 3 Misstatement Tainting Factor 1.0 1.0 .20 Sampling Interval \$1,657 1,657 1,657 Projected Misstatement (column 2 x 3) NA 1,657 331 95% Upper Limit Increment (from Table 8-8*) 3.0 1.7 (4.7-3.0) 1.5 (6.2-4.7) Upper Misstatement (column 2 x 3 x 5) \$4,971 2,817 497

NA

1,657

NA

NA

500

## Upper Misstatement Limit

\$8,785

Since the UML (\$8,785) is less than the TM (\$15,000), the evidence supports the fair presentation of the account balance. Using ACL and the ACL sampling interval calculated by ACL in part b, the Upper Error Limit (UML) is \$9,881.10 and the Most Likely Error is \$2,724.72. Since the UML (\$9,881.10) is less than the TM (\$15,000), the evidence supports the fair presentation of the account balance. The ACL output follows: Command: EVALUATE MONETARY CONFIDENCE 95 ERRORLIMIT 400, 80,500, 500,3000, 500 INTERVAL 1853.93 TO SCREEN Confidence: 95, Interval: 1854
Item Basic Precision 500.00 500.00 400.00 80.00 3000.00 500.00 Totals 1853.93 370.79 500.00 2724.72 Error Most Likely Error Upper Error Limit 5562.00 3244.38 574.72 500.00 9881.10

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a. Using Table 8-5 with a desired confidence level of 95% (risk of incorrect acceptance = 5%), tolerable misstatement = 4% (\$360,000 \$9,000,000), and expected misstatement = 1% (\$90,000 \$9,000,000), sample size is equal to 156. The sampling interval is \$57,692 (\$9,000,000 156). Using ACL with a desired confidence level = 95%; population = \$9,000,000; tolerable misstatement = \$360,000; and expected misstatement = \$90,000; the sample size is equal to 130 items. The sampling interval is \$68,906.25. b. The upper misstatement limit is calculated as follows:

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## Overstatement Errors Error Number 1 2 3 4

Error Number Tainting Factor 1.0 .33 .25 .20

## Audit Value 7,500 6,000 0 640

Projected Misstatement (column 2 x 3) NA 19,038 14,423 11,538

Tainting Factor .25 .33 Not applicable, since the book value exceeds the sampling interval .20
95% Upper Limit Increment (from Table 8-8*) 3.0 1.7 (4.7-3.0) 1.5 (6.2-4.7) 1.4 (7.6-6.2) Upper Misstatement (column 2 x 3 x 5) \$173,076 32,365 21,635 16,153

## Sampling Interval \$57,692 57,692 57,692 57,692

Basic Precision 2 1 4 Add misstatements detected in logical units greater than the sampling interval: Error 3

NA

57,692

NA

NA

60,000 \$303,229

## Upper Misstatement Limit

Since the UML (\$303,229) is less than the tolerable misstatement (\$360,000), Nancy Van Pelt can accept the inventory account as being fairly stated since there is only a 5 percent risk that the account contains a misstatement greater than \$360,000. Using ACL and the sampling interval calculated by ACL in part a, the Upper Error Limit (UML) is \$407,351.03 and the Most Likely Error is \$122,882.81. The ACL output follows: Command: EVALUATE MONETARY CONFIDENCE 95 ERRORLIMIT 10000.00,2500.00,9000.00,3000.00,60000.00,60000.00,800.00,160.00 INTERVAL 68906.25 TO SCREEN Confidence: 95, Interval: 68906
Item Basic Precision 60000.00 60000.00 9000.00 3000.00 10000.00 2500.00 800.00 160.00
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Error

## Upper Error Limit 206719.00 120585.94 35601.56 25150.78 19293.75

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Totals

122882.81

407351.03

Since the UML (\$407,351.03) is greater than the tolerable misstatement (\$360,000), Nancy Van Pelt cannot accept the inventory account as being fairly stated. The difference in the evaluation between the manual calculation using the tables and ACL is driven by the difference in the size of the sampling interval. The larger sampling interval increases the UML for the Basic Precision and the other errors detected in the sample. Because the \$60,000 item is smaller than the sampling interval in the ACL calculation, there is an error projection (most likely error) and an upper error limit or allowance for sampling risk added on. When using the tables the sample size is larger and the sampling interval is \$57,692 and all items greater than the interval will be tested and therefore the error associated with the \$60,000 item is not projected when the tables are used and requires no additional margin for sampling risk. c. The calculation of the adjustment for the understatement errors is as follows: Understatement Errors Error Number 5 6 Book Value 6,000 750 Audit Value 6,500 800 Tainting Factor -.083 -.067

Adjustment for Understatement Errors Tainting Factor -.083 -.067 Adjustment to UML Sampling Interval 57,692 57,692 Projected Misstatement -4,788 -3,865 -8,653

Using ACL and the results from parts a and b, the Adjustment to the Most Likely Error is -10,335.94 (112,546.87-122,882.81. The ACL output follows: Command: EVALUATE MONETARY CONFIDENCE 95 ERRORLIMIT 10000.00,2500.00,9000.00,3000.00,60000.00,60000.00,800.00,160.00,6000.00,-500.00,750.00,-50.00 INTERVAL 68906.25 TO SCREEN Confidence: 95, Interval: 68906
Item Basic Precision 60000.00 60000.00 9000.00 3000.00 10000.00 2500.00 800.00 160.00 750.00 -50.00 6000.00 -500.00 Totals 68906.25 22968.75 17226.56 13781.25 -4593.75 -5742.19 112546.87 Error Most Likely Error Upper Error Limit 206719.00 120585.94 35601.56 25150.78 19293.75 0.00 0.00 407351.03

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The incorrect assumptions, statements, and inappropriate applications of sampling are as follows:

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