Effective Internal Auditing

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PPT_Sampling for Effective Internal Auditing (Mwenya Chitalu CIA)

Effective Internal Auditing

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INTERNAL AUDITING

By

Mwenya P. Chitalu CIA

EXPECTED PRESENTATION OUTCOMES

Sampling Policy

Statistical & Non-statistical Sampling

Statistical Terminologies

Statistical Sampling Plans

External Auditing Standards

Sample Selection Methods

Illustrations

DEMYSTIFYING STATISTICAL SAMPLING

The Principle (or Law) of Parsimony: That things are usually

connected in the simplest or most economical way.

area covered by a formula.

Eliminate the Greek, Arabic & Roman language barrier in symbols & Formulae

that mystify Mathematics or Statistics.

Just like any other audit, Probe Statistical Assertions-Life can be made easy

with appropriate sampling.

efficiently, & effectively.

Mathematics or statistics is commitment to logical thinking.

It squeezes the most learning about the population from limited sample

data.

WHY DO AUDITORS SAMPLE?

Guides Information should be: Sufficient, Reliable, Relevant & Useful

Acknowledges Sampling Techniques in Evidence Acquisition

Opinions are NOT ABSOLUTE GUARANTEE but REASONABLE

ASSURANCE of Accuracy

Proficiency & Due Professional Care

SAMPLING POLICY

When to Sample?

How to Sample?

When a Total is easily Audited

Inquiry & Observation Procedures

Analytical Procedures

STATISTICAL & NON-STATISTICAL SAMPLING

Both Require Auditor judgment in Planning, Implementing, &

Evaluating the Sampling Plan

IPPF

STATISTICAL & NON-STATISTICAL SAMPLING

Computer Accessibility

STATISTICAL & NON-STATISTICAL SAMPLING

Procedure?

Is a Quantitative measure of Sampling Risk Desired?

What is the relative Cost & Benefit of Statistical versus Non-

statistical Sampling?

Is Technical Expertise Available?

Is Computer Software Accessible or Expertise to Write a Program?

STATISTICAL TERMINOLOGIES

the Obtained Results.

Mean (): The arithmetic average of a set of numbers.

Median: The halfway value of raw data arranged in numerical order from

lowest to highest.

STATISTICAL TERMINOLOGIES

of values in a sample (the square root of the variance).

Range: The difference between the largest and smallest values of any

group.

Population (N): The total number of items from which the sample is

drawn-Its the focus of interest comprising sampling units.

performed.

STATISTICAL TERMINOLOGIES

Logical Unit: Account or transaction selected to be sampled.

rate in the population, usually based on prior experience, inquiries, and

observations.

allowable error.

respect to the population.

population.

STATISTICAL TERMINOLOGIES

existing in the population at a specified reliability in PPS sampling.

conclusions that could be reached if the entire population were

examined.

sampling due to poor judgment or failure to adhere to professional

standards.

STATISTICAL SAMPLING

Advantages Disadvantages

minimum number of items consuming

Yields quantified data May require training and

Includes measures of sampling software costs

risk, confidence level, and May preclude experienced

precision auditors insights

Is adaptable to computer testing

Lends credibility to audit

conclusions/recommendations

NON-STATISTICAL SAMPLING

Advantages Disadvantages

Use of internal auditors No objective measure of

judgment sampling risk provided

Allows reasonable reliability Chance of wrong sample size

at reasonable cost Effectiveness depends upon

auditors skill

STATISTICAL SAMPLING PLANS

1. ATTRIBUTES SAMPLING (TESTS OF CONTROLS)

Concerns binary, yes/no, or error/non-error populations

It tests the effectiveness of controls.

Concerns monetary amounts & other measures.

It assesses materially misstated account balances & ...

Concerns primary engagement objective of few overstatements & not

understatement.

Difference & Ratio Estimations may not be efficient.

EXTERNAL AUDITING STANDARDS

Internal & External Audit Work Coordination & Recognition:

Statement on Auditing Standards (SA) No. 39: Audit Sampling & SAS

No. 47: Audit Risk & Materiality in Conducting an Audit AICPA.

Audit Risk = Inherent Risk x Control Risk x Detection Risk

materially misstated.

Inherent Risk: Material misstatement occurring in the absence of

appropriate controls.

Control Risk: Controls ineffective & fails to prevent or detect material

misstatement in a timely manner.

Detection Risk: Substantive procedures failing to detect a material

misstatement.

EXTERNAL AUDITING STANDARDS

Sampling risk impacts the Efficiency & Effectiveness of an audit

Tests of Risk of Assessing Control Risk Risk of Assessing Control Risk

Controls Too High (i.e., not depending Too Low (i.e., depending upon

upon effective controls) ineffective controls)

Tests rejecting a materially correct (i.e., accepting a materially

balance) incorrect balance)

EXTERNAL AUDITING STANDARDS

Non-sampling Risk

The audit failing to detect an internal control weakness or material

misstatement for reasons other than the fact that sampling was used.

Application of an inappropriate audit procedure

Failure to recognize an error condition

Omission of an essential audit step

assertion tested as reasonable:

Tolerable deviation rate for tests of control

Tolerable misstatement for substantive testing

SAMPLE SELECTION METHODS

Methods Appropriate for Both Statistical & Non-statistical Sampling:

Simple Random Sampling: Items with equal chance of selection.

Systematic Sampling: nth item selection with random start within the n

interval. PPS uses systematic sampling.

Haphazard Selection: Selecting sample items without intentional bias.

Block Selection: Audit of a group of contiguous transactions like delivery

notes for March or invoices in a sequence.

Block Amount: Whole amount is audited.

Void Items: Select additional sampling units for voided items.

Missing Items: Must be treated as an error condition- In attributes,

control is not effective & in substantive testing, audited value is ZMK 0.00

ATTRIBUTE SAMPLING

characteristic may occur in a population

.

(or other characteristics) will occur or based on

statistical tables

=

Statistical table Population size (N)

specifications Confidence level (C)

Precision (P)

Expected rate of errors () &q=100-

Attributes Sampling Illustrations

2 Confidence Level 90%

Confidence Coefficient C 1.64

3 Tolerable Deviation Rate (TDR) 5%

(Based on Prior Years of Findings or Pilot Sample)

4 Planned Risk of Assessing Control Risk Too Low (Beta Risk) 5%

5 Planned Risk of Assessing Control Risk Too High (Alpha Risk) 10%

6 Desired Precision = Beta x TDR/Alpha P 2.50%

8 Expected Number of Errors (From Statistical Tables) 5

Assuming Control Procedures Anticipated Deviation Rate = Zero 0%

Upper Precision Limit (UPL) from the Statistical Tables 1.50%

(And is Less than Tolerable Deviation Rate=5%)

Upper Precision Limit (from the Tables) UPL 3.20%

Attributes Sampling Variations

unnecessarily large sample.

deviation if the percentage of deviations in the population is at or

above a specified level, e.g. Fraud, Substantial mistake or

Compliance failure.

VARIABLES SAMPLING

. discrepancy in monetary or weight terms

=

specifications Confidence level/Coefficient (C)

Precision (P)

Standard deviation ()

Variables Sampling Illustration

.

1 Recorded Amount of Accounts Receivable (N) RM 360,000 ZMK

2 Tolerable Misstatement TM 18,000 ZMK

3 Planned Risk of Incorrent Acceptance (Beta Risk) 5%

4 Planned Risk of Incorrect Rejection (Alpha Risk) 10%

5 Number of Accounts Receivable (N) 4,000 Accounts

6 Estimated Population Standard Deviation 8.68 ZMK

(Based on Prior Years of Findings or Pilot Sample)

7 Confidence Level 90%

Confidence Coefficient C 1.64

8 Desired Precision = Beta x TM/Alpha 9,000 ZMK

9 Precision per-item basis (Desired Precision/N) P 2.25 ZMK

Three Types of Variables Sampling

population by calculating a sample mean & multiplying by the number of items

in the population.

estimate & the differences are not proportional to the book values.

by calculating the ratio between the audited & book values in the sample and

using this ratio to make the estimate.

Useful when differences between book & sample values are proportional to book

values.

Variables Sampling:

Mean-per-Unit Estimation

Population: unit value for audited samples).

4,000 Accounts

Total book value:

K3,400.00/40 = K85.00 / Account.

ZMK 360,000.00

Sample size: Step 2: Multiply mean-per-unit value by number of

40 Accounts accounts in the population.

Sample book value:

ZMK 3,600.00 K85.00 4,000 Accounts = K340,000.00

Sample audit value: Over-count = K20,000.00

ZMK 3,400.00

(K340,000.00 K360,000.00)

Variables Sampling:

Difference Estimation

Case example book value for the sample.

Population:

(K3,400.00 K3,600.00)/40 Accounts = (K5.00)

4,000 Accounts

Total book value: Step 2: Determine the difference estimate for the

ZMK 360,000.00 population.

Sample size: (K5.00) 4,000 accounts = (K20,000.00)

40 Accounts Step 3: Estimate actual value by adding the difference

Sample book value: estimate and book value for the population.

ZMK 3,600.00

Sample audit value: (K20,000.00) + K360,000.00 = K340,000.00

ZMK 3,400.00

Book value is Overstated by K20,000.00

Variables Sampling:

Ratio Estimation

Population:

4,000 Accounts Step 2: Book value for sample = K3,600.00

Total book value:

ZMK360,000.00 Step 3: Find ratio of audit value to book value:

Sample size:

K3,400.00 / K3,600.00 = 0.94

40 Accounts

Sample book value: Step 4: Estimate actual population value by multiplying

ZMK3,600.00 ratio by population book value:

Sample audit value: 0.94 K360,000.00 = K338,400.00

ZMK 3,400.00

Book value is Overstated by K21,600.00

PROBABILITY-PROPORTIONAL-TO-SIZE (PPS) SAMPLING

. account balances for few

overstated items; e.g., in inventory,

receivables, disbursements, etc.

Size of sample (n)

(n1: AM=0, & n2:

AM>=1)

= or = ( )

specifications Reliability Factor (RF)

Tolerable Misstatement (TM)

Anticipated Misstatement (AM)

Expansion Factor (EF)

PPS ILLUSTRATION

ACCOUNTS RECEIVABLE AS AT 31ST DECEMBER 2013

.Recorded Amt of A/C Receivables RM 360,000

Tolerable Misstatement TM 18,000

Anticipated Misstatement AM 0

Risk of Incorrect Acceptance 5%

A/C No. ZMK AMT Selected Unit Amount % Interval Misstatement

ACT0001 9,450 9,450 9,000 9,450 7,875 * * 1,575

ACT0002 480 9,930

ACT0003 2,800 12,730

ACT0004 5,106 17,836

ACT0005 2,100 19,936 18,000 2,100 0 100% 9,000 9,000

ACT0006 8,000 27,050 27,000 8,000 8,000 0 9,000 0

. . . . .

. . . . .

. . . . .

ACT4000 6,000 360,000 360,000 6,000 4,500 25% 9,000 2,250

Total Projected Misstatment ZMK 12,825

Allowance for Precision Gap Widening:

(4.75-3.00-1.00) x K9,000 ZMK 6,750

(6.30-4.75-1.00) x K2,250 ZMK 1,238

Upper Misstatement Limit (UML)>TM ZMK 47,813

CONCLUSION/RECOMMENDATIONS

the Proficiency & Due Professional Care IIA Standards by Appropriate

Application of both Statistical & Non Statistical Sampling to

Reasonably Assure that Opinion Evidence is: Sufficient, Reliable,

Relevant and Useful.

REFERENCES FOR FURTHER READING

The Institute of Internal Auditors by Barbara Apostolou, PhD,

CPA, DABFA.

System by The Institute of Internal Auditors.

Professor Irvin N. Gleim, PhD, CPA, CIA, CMA, CFM.

COMMENTS, REMARKS & QUESTIONS

Confidence coefficient, C,

Based on the Risk of Incorrect

Rejection

Risk of

Incorrect Confidence Confidence

Rejection Level Coefficient

20% 80% 1.28

10% 90% 1.64

5% 95% 1.96

1% 99% 2.58

Attributes Sample Size Statistical Tables

For Tests of Controls

Five Percent (5%) Risk of Assessing Control Risk Too Low

(Number of Expected Errors in parentheses)

.Expected

Population

Deviation Tolerable Deviation Rate

Rate (%) 2% 3% 4% 5% 6% 7% 8% 9% 10% 15% 20%

0.00 149(0) 99(0) 74(0) 59(0) 49(0) 42(0) 36(0) 32(0) 29(0) 19(0) 14(0)

0.25 236(1) 157(1) 117(1) 93(1) 78(1) 66(1) 58(1) 51(1) 46(1) 30(1) 22(1)

0.50 * 157(1) 117(1) 93(1) 78(1) 66(1) 58(1) 51(1) 46(1) 30(1) 22(1)

0.75 * 208(2) 117(1) 93(1) 78(1) 66(1) 58(1) 51(1) 46(1) 30(1) 22(1)

1.00 * * 156(2) 93(1) 78(1) 66(1) 58(1) 51(1) 46(1) 30(1) 22(1)

1.25 * * 156(2) 124(2) 78(1) 66(1) 58(1) 51(1) 46(1) 30(1) 22(1)

1.50 * * 192(3) 124(2) 103(2) 66(1) 58(1) 51(1) 46(1) 30(1) 22(1)

1.75 * * 227(4) 153(3) 103(2) 88(2) 77(2) 51(1) 46(1) 30(1) 22(1)

2.00 * * * 181(4) 127(3) 88(2) 77(2) 68(2) 46(1) 30(1) 22(1)

2.25 * * * 208(5) 127(3) 88(2) 77(2) 68(2) 61(2) 30(1) 22(1)

2.50 * * * * 150(4) 109(3) 77(2) 68(2) 61(2) 30(1) 22(1)

2.75 * * * * 173(5) 109(3) 95(3) 68(2) 61(2) 30(1) 22(1)

3.00 * * * * 195(6) 129(4) 95(3) 84(3) 61(2) 30(1) 22(1)

3.25 * * * * * 148(5) 112(4) 84(3) 61(2) 30(1) 22(1)

3.50 * * * * * 167(6) 112(4) 84(3) 76(3) 40(2) 22(1)

3.75 * * * * * 185(7) 129(5) 100(4) 76(3) 40(2) 22(1)

4.00 * * * * * * 146(6) 100(4) 89(4) 40(2) 22(1)

5.00 * * * * * * * 158(8) 116(6) 40(2) 30(2)

6.00 * * * * * * * * 179(11) 50(3) 30(2)

7.00 * * * * * * * * * 68(5) 37(3)

Attributes Sample Evaluation Tables

For Tests of Controls

Upper Limits at Five Percent (5%) Risk of Assessing Control Risk Too Low

Sample Actual Number of Deviations Found

Size . 0 1 2 3 4 5 6 7 8 9 10

25 11.3 17.6 * * * * * * * * *

30 9.5 14.9 19.6 * * * * * * * *

35 8.3 12.9 17.0 * * * * * * * *

40 7.3 11.4 15.0 18.3 * * * * * * *

45 6.5 10.2 13.4 16.4 19.2 * * * * * *

50 5.9 9.2 12.1 14.8 17.4 19.9 * * * * *

55 5.4 8.4 11.1 13.5 15.9 18.2 * * * * *

60 4.9 7.7 10.2 12.5 14.7 16.8 18.8 * * * *

65 4.6 7.1 9.4 11.5 13.6 15.5 17.4 19.3 * * *

70 4.2 6.6 8.8 10.8 12.6 14.5 16.3 18.0 19.7 * *

75 4.0 6.2 8.2 10.1 11.8 13.6 15.2 16.9 18.5 20.0 *

80 3.7 5.8 7.7 9.5 11.1 12.7 14.3 15.9 17.4 18.9 *

90 3.3 5.2 6.9 8.4 9.9 11.4 12.8 14.2 15.5 16.8 18.2

100 3.0 4.7 6.2 7.6 9.0 10.3 11.5 12.8 14.0 15.2 16.4

125 2.4 3.8 5.0 6.1 7.2 8.3 9.3 10.3 11.3 12.3 13.2

150 2.0 3.2 4.2 5.1 6.0 6.9 7.8 8.6 9.5 10.3 11.1

200 1.5 2.4 3.2 3.9 4.6 5.2 5.9 6.5 7.2 7.8 8.4

.

Reliability Factors (RF) for Overstatements

Overstatements

1% 5% 10% 15% 20%

0 4.61 3.00 2.31 1.90 1.61

1 6.64 4.75 3.89 3.38 3.00

2 8.41 6.30 5.33 4.72 4.28

PPS Sampling Expansion Factors

For Expected Misstatements

. Risk of Incorrect Expansion

Acceptance (%) Factor

1 1.90

5 1.60

10 1.50

15 1.40

20 1.30

25 1.25

30 1.20

37 1.15

50 1.10

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