1. What is audit sampling?

Audit sampling is based on the premise that a sample can be sufficiently

representative of an audit population to warrant valid and reliable conclusions
without testing the entire population. An audit population may consist of all the items
within a class of transactions, such as all credit sales processed for a specified
period, or all the transactions constituting an account balances, such as accounts
receivable.
A population may be divided into strata, or sub-populations, with each stratum
being examined separately. The term population is used to include the term stratum.
relation to audit procedures.
2. Define the following terms:

a. Error in the context of tests of controls

Tests of controls are performed when the auditor's risk assessment
includes an expectation of the operating effectiveness of controls, Based
on the auditor's understanding of internal control, the auditor identifies the
characteristics or attributes that indicate performance of a control, as well
as possible deviation conditions which indicate departures from adequate
performance. The presence or absence of attributes can then be tested by
the auditor. Audit sampling for tests of controls is generally appropriate
when application of the control leaves audit evidence of performance (for
example, initials of the credit manager on a sales invoice indicating credit
approval, or evidence of authorization of data input to a microcomputer
based data processing system.

b. Error in the context of substantive tests

Substantive procedures are concerned with amounts and are of two

types: tests of details of classes of transactions, account balances, and
disclosures and substantive analytical procedures. The purpose of
substantive procedures is to obtain audit evidence to detect material
misstatements at the assertion level. In the context of substantive
procedures, audit sampling and other means of selecting items for testing,
relate only to tests of details. When performing tests of details, audit
sampling and other means of selecting items for testing and gathering
audit evidence may be used to verify one or more assertions about a
financial statement amount (for example, the existence of accounts
receivable), or to make an independent estimate of some amount (for
example, the value of obsolete inventories).

3. What are the two components of detection risk? Explain each component
briefly.
 A. Sampling risk- uncertainties related to sampling. Sampling risk arises from the
possibility that the auditor's conclusion, based on a sample may be different
from the conclusion reached if the entire population were subjected to the
same audit procedure

Sampling risk results from the fact that a particular audit sample may not be
representative of the population tested. That is, the sample may contain
disproportionately more or fewer control deviations or monetary differences
than exist in the class of transactions or account balance as a whole,
suggesting that the auditor's conclusions may be different if the entire
population were tested. Since sampling risk can be reduced simply by
increasing sample size, sampling risk varies inversely with sample size: the
greater the sample size, the smaller the sampling risk. This relationship is
quite logical, because if sample size were increased to include all the items in
a population, there would be ne sampling and therefore no sampling risk.

B. Non-sampling risk- uncertainties arising from factors unrelated to sampling.

Non-sampling risk includes all aspects of audit risk not due to sampling.

4. Can you eliminate sampling risk? Explain.

The auditor may decide to apply audit sampling to an account balance or
class of transactions. Audit sampling (sampling) involves the application of audit
procedures to less than 100% of items within an account balance or class of
transactions such that all sampling units have a chance of selection.
The effectiveness and the efficiency lie on the auditor who can reduce the
sampling risk by picking up sample that is truly representative of the population.
Carefully selected sample will decrease the rate of sampling risk. Increase in
sample will reduce the sampling risk. But increase in the sample size will affect
the overall efficiency of the audit. Here auditor has to play a serious role to
allocate the reasonable sample for applying audit procedure to reduce the
sampling risk.

5. Describe the relationship between sampling risk and sample size.

To determine the number of items to be selected for a particular sample

for a test of controls, the auditor should consider the tolerable rate of deviation
from the controls being tested, the likely rate of deviations, and the allowable risk
of assessing control risk too low. When circumstances are similar, the effect on
sample size of those factors should be similar regardless of whether a statistical
or nonstatistical approach is used. Thus, when a nonstatistical sampling
approach is applied properly, the resulting sample size ordinarily will be
comparable to, or larger than, the sample size resulting from an efficient and
effectively designed statistical sample.
 The auditor may be able to reduce the required sample size by
separating items subject to sampling into relatively homogeneous groups on the
basis of some characteristic related to the specific audit objective. For example,
common bases for such groupings are the recorded or book value of the items,
the nature of controls related to processing the items, and special considerations
associated with certain items. An appropriate number of items is then selected
from each group.

After assessing and considering the levels of inherent and control risks,
the auditor performs substantive tests to restrict detection risk to an acceptable
level. As the assessed levels of inherent risk, control risk, and detection risk for
other substantive procedures directed toward the same specific audit objective
decreases, the auditor's allowable risk of incorrect acceptance for the substantive
tests of details increases and, thus, the smaller the required sample size for the
substantive tests of details. For example, if inherent and control risks are
assessed at the maximum, and no other substantive tests directed toward the
same specific audit objectives are performed, the auditor should allow for a low
risk of incorrect acceptance for the substantive tests of details.3 Thus, the auditor
would select a larger sample size for the tests of details than if he allowed a
higher risk of incorrect acceptance.

6. How is non-sampling risk reduced?

Non-sampling risk includes all aspects of audit risk not due to sampling. It
includes the possibility of selecting audit procedures that are not appropriate to
achieve the specific objective. For example, non-sampling risk could result from
human errors, such as failing to detect errors contained within sample items or
overlooking or misinterpreting errors that are detected. Several factors can serve
to reduce non-sampling risk, including proper planning and supervision and
encouraging effective firm-wide quality control.
7. In tests of controls, there are two types of sampling risk. For each type,
give a short description and identify whether it affects audit efficiency or
audit effectiveness.

A. Risk of assessing control risk too high (or the risk of under reliance). This is
the risk that a sample deviation rate supports assessing control risk at the
maximum when, unknown to the auditor, the true deviation rate in the
population supports assessing control risk below the maximum.

B. Risk of assessing control risk too low (or the risk of over reliance). This is the
risk that a sample does support assessing control risk below the maximum
when, unknown to the auditor, the true deviation rate in the population
supports assessing control risk at the maximum.
 8. In substantive tests, there are two types of sampling risk. For each type,
give a short description and identify whether it affects audit efficiency or
audit effectiveness.

A. Risk of incorrect rejection is the risk that a sample supports the conclusion
that a recorded account balance is materially misstated when, unknown to the
auditor, the account is not materially misstated. Like the risk of assessing
control risk too high in attribute sampling, the risk of incorrect rejection relates
to the efficiency of an audit, because an initially erroneous conclusion that an
account balance is misstated would ordinarily be revised when the auditor
considers other evidence or performs additional audit procedures. For
example, an auditor would ordinarily revise an initial conclusion that Cost of
Goods Sold is misstated if a physical inventory observation and inventory
price testing revealed that Inventory was not misstated, and other procedures
revealed that Accounts Receivable and Sales were not misstated.

B. Risk of incorrect acceptance, in contrast, is the risk that a sample supports

the conclusion that a recorded account balance is not materially misstated
when, unknown to the auditor, the account is materially misstated. Like the
risk of assessing control risk too low in attribute sampling, the risk of incorrect
acceptance relates to audit effectiveness and is particularly critical to an
auditor, because incorrectly accepting a misstated account balance could
result in financial statements that are materially misstated and therefore
misleading.
17. Give the steps involved in an attributes sampling plan.
The procedures for attributes sampling are presented below:
a. Determine the objective(s) of the test.
b. Define the attribute (characteristic of a control) and deviation (absence of
an attribute) conditions.
c. Define the population.
d. Choose an audit sampling approach / technique.
e. Determine the sample size and the sample selection method.
f. Perform the sampling plan.
g. Evaluate sample results.
h. Comply with documentation requirements.
18. Give at least three determinants of the sample size for tests of controls. Relate
each determinant to sample size.
a. The extent to which the risk of material misstatement isreduced by the
operating effectiveness of controls. The more assurance the auditor
 intends to obtain from the operating effectiveness of controls, the lower the
auditor's assessment of the risk of material misstatement will be, and the
larger the sample size will need to be. When the auditor's assessment of the
risk of material misstatement at the assertion level includes an expectation of
the operating effectiveness of controls, the auditor is required to perform tests
of controls. Other things being equal, the more the auditor relies on the
operating effectiveness of controls in the risk assessment, the greater is the
extent of the auditor's tests of controls (and therefore, the sample size is
increased)
b. The rate of deviation from the prescribed control activity the auditor is
willing to accept (tolerable error). The lower the rate of deviation that the
auditor is willing to accept, the larger the sample size needs to be.
c. The rate of deviation from the prescribed control activity the auditor
expects to find in the population (expected error). The higher the rate of
deviation that the auditor expects, the larger the sample size needs to be so
as to be in a position to make a reasonable estimate of the actual rate of
deviation. Factors relevant to the auditor's consideration of the expected error
rate include the auditor's understanding of the business (in particular. risk
assessment procedures undertaken to obtain an understanding of internal
control), changes in personnel or in internal control, the results of audit
procedures applied in prior periods and the results of other audit procedures.
High expected error rates ordinarily warrant little, if any, reduction of the
assessed risk of material misstatement, and therefore in such circumstances
tests of controls would ordinarily be omitted.
19. Give the steps involved in a variables sampling plan.
The procedures for variables sampling are presented below
a. Determine the objective(s) of the test.
b. Define "fair presentation" and "material misstatement".
c. Define the population.
d. Choose an audit sampling approach / technique.
e. Determine the sample size and the sample selection method.
f. Perform the sampling plan.
g. Evaluate sample results.
h. Comply with documentation requirements.
20. Give at least three determinants of the sample size for substantive tests.
Relate each determinant to sample size.
a. The auditor's assessment of the risk of material misstatement. The
higher the auditor's assessment of the risk of material misstatement,
the larger the sample size needs to be. The auditor's assessment of
the risk of material misstatement is affected by inherent risk and
control risk.
For example, if the auditor does not perform tests of controls, the
auditor's risk assessment cannot be reduced for the effective operation
of internal controls with respect to the particular assertion. Therefore,
in order to reduce audit risk to an acceptably low level, the auditor
needs a low detection risk and will rely more on substantive
procedures. The more audit evidence that is obtained from tests of
details (that is, the lower the detection risk), the larger the sample size
will need to be.

b. The use of other substantive procedures directed at the same

assertion. The more the auditor is relying on other substantive
procedures (tests of details or substantive analytical procedures) to
reduce to an acceptable level the detection risk regarding a particular
class of transactions or account balance, the less assurance the
auditor will require from sampling and, therefore, the smaller the
sample size can be.
c. The auditor's required confidence level. The greater the degree of
confidence that the auditor requires that the results of the sample are
in fact indicative of the actual amount of error in the population, the
larger the sample size needs to be.