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SAMPLING FOR EFFECTIVE

INTERNAL AUDITING
By
Mwenya P. Chitalu CIA
EXPECTED PRESENTATION OUTCOMES

Why Do Auditors Sample?


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.

Reducing ideas to small, easy-to-write symbols & saying a lot in a small


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.

If it cannot be measured, then it cannot be managed economically,


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?

International Standards for the Professional Practice of Internal Auditing:


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

Cost-Benefit Considerations: The Economy, Efficiency & Effectiveness,

Corroborating Evidence for Control Processes & Account Balances


SAMPLING POLICY

Written Policy Statement

When to Sample?

Who Should Sample?

How to Sample?

Inappropriate Uses for Sampling:


When a Total is easily Audited
Inquiry & Observation Procedures
Analytical Procedures
STATISTICAL & NON-STATISTICAL SAMPLING

Three Characteristics in Common:


Both Require Auditor judgment in Planning, Implementing, &
Evaluating the Sampling Plan

Actual Audit Procedures Performed are the same

Both Non-Statistical & Statistical Techniques are Permitted by the


IPPF
STATISTICAL & NON-STATISTICAL SAMPLING

Differences between Statistical & Non-statistical Sampling

Sampling Risk is Controlled & Measurable

Technical Training & Knowledge is Required

Computer Accessibility
STATISTICAL & NON-STATISTICAL SAMPLING

In Summary, the following should be addressed:

What is the Internal Audit Departments Recommended Policy or


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

Confidence Level (C): Is the Reliability Level or Degree of Belief in


the Obtained Results.

Measure of Central Tendency:


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

Median: The halfway value of raw data arranged in numerical order from
lowest to highest.

Mode: The most frequently occurring value.


STATISTICAL TERMINOLOGIES

Standard Deviation (): The statistical measurement of the variability


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.

Sampling Unit: Individual items making up a Population.

Sample (n): Collection of sampling units on which audit procedures are


performed.
STATISTICAL TERMINOLOGIES
Logical Unit: Account or transaction selected to be sampled.

Expected Population Deviation Rate (): Estimate of the actual deviation


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

Precision (P): An assumed amount of possible unknown or the range of


allowable error.

Tolerable Misstatement: The auditors assessment of materiality with


respect to the population.

Upper Precision Limit: Upper limit on deviations expected in the


population.
STATISTICAL TERMINOLOGIES

Tainting: Percentage of misstatement in a logical unit in a PPS sample.

Upper Misstatement Limit (UML): Estimated maximum misstatement


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

Sampling Risk: Conclusions based on sample differing with


conclusions that could be reached if the entire population were
examined.

Non-sampling risk: Drawing incorrect conclusion for reasons other than


sampling due to poor judgment or failure to adhere to professional
standards.
STATISTICAL SAMPLING

Advantages Disadvantages

May yield desired results from Can be costly and time-


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

Flexibility Results not statistically valid


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.

2. VARIABLES SAMPLING (SUBSTANTIVE TESTS)


Concerns monetary amounts & other measures.
It assesses materially misstated account balances & ...

3. THE PPS SAMPLING ( THE CAV SAMPLING)


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 Model:


Audit Risk = Inherent Risk x Control Risk x Detection Risk

Audit Risk: Issuing unmodified opinion on financial statements that are


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

Components of Sampling Risk

Audit Test Audit Efficiency Audit Effectiveness


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)

Substantive Risk of Incorrect Rejection (i.e., Risk of Incorrect Acceptance


Tests rejecting a materially correct (i.e., accepting a materially
balance) incorrect balance)

Statistical Term Alpha Risk () Beta Risk ( )


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

Materiality: Amount of difference tolerated by the auditor & concluding the


assertion tested as reasonable:
Tolerable deviation rate for tests of control
Tolerable misstatement for substantive testing

Materiality is inversely related to sample size

Materiality assessment must be a cost versus benefit decision


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.

Methods Used Only for Non-statistical 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.

Other Considerations in Sample Selection:


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

When to use To estimate the number of times a certain


characteristic may occur in a population
.

Size of sample (n) Based on judgment about probability that errors


(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

.ITEM ACCOUNTS RECEIVABLES AS AT 31ST DECEMBER 2013

1 Population Size of Accounts Receivable N 4,000 Accounts


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%

7 Sample Size n 204 Accounts


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%)

9 Assuming 2 Actual Control Procedure Errors: 2


Upper Precision Limit (from the Tables) UPL 3.20%

10 And UPL < Conclusion???

11 CONCLUSION Controls are Effective


Attributes Sampling Variations

Stop-or-Go Sampling: The Auditor guards against selecting an


unnecessarily large sample.

Discovery Sampling: The Auditor targets discovering at least one


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

When to use When size matters; e.g., amount of a


. discrepancy in monetary or weight terms

Size of sample (n)



=

Statistical table Population size (N)


specifications Confidence level/Coefficient (C)
Precision (P)
Standard deviation ()
Variables Sampling Illustration

ITEM ACCOUNTS RECEIVABLES AS AT 31ST DECEMBER 2013


.
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

7 Sample Size n 40 Accounts


Three Types of Variables Sampling

Mean-per-unit Estimation: Estimates the total monetary amount of the


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

Difference Estimation: Estimates the total error in the population.

Useful only if population contains enough errors to generate a reliable sample


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

Ratio Estimation: Estimates the total monetary amount of the population


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

Case example Step 1: Calculate average audit value (i.e., mean-per-


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

Step 1: Calculate average difference between audit value and


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

Case example Step 1: Audit value for sample = K3,400.00


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

When to use When auditing


. account balances for few
overstated items; e.g., in inventory,
receivables, disbursements, etc.
Size of sample (n)
(n1: AM=0, & n2:
AM>=1)
= or = ( )

Statistical Recorded Amount of the Account (RM)


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%

AMT CUM Kw acha Sampling Observed Tainting Sampling Projected


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 360,000 12,825

Basic Precision(SI x RF = K9,000 x 3) ZMK 27,000


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 Accounts Receivable Materially Overstated


CONCLUSION/RECOMMENDATIONS

It is Concluded & Recommended that Internal Auditors comply with


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

1. Sampling for Internal Auditors:Text-based Self Study Course-


The Institute of Internal Auditors by Barbara Apostolou, PhD,
CPA, DABFA.

2. Internal Audit Practice-Part 1:The IIAs CIA Learning


System by The Institute of Internal Auditors.

3. Internal Audit Practice-Part 1: Gleim CIA Review by


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

Number of Risk of Incorrect Acceptance


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