Name : Safira Yafiq Khairani - 1802112130

Review Question Chapter 17

1. What major difference between (a) test of controls and substantive tests of
transactions and (b) test of details of balances make attribute sampling inappropriate
for tests of details of balance?

Answer :
The most important difference between (a) tests of controls and substantive
tests of transactions and (b) tests of details of balances is in what the auditor wants to
measure. In tests of controls and substantive tests of transactions, the primary concern
is testing the effectiveness of internal controls and the rate of monetary misstatements.
When an auditor performs tests of controls and substantive tests of transactions, the
purpose is to determine if the exception rate in the population is sufficiently low to
justify reducing assessed control risk to reduce substantive tests.
When statistical sampling is used fortests of controls and substantive tests of
transactions, attributes sampling is ideal because it measures the frequency of
occurrence (exception rate). In tests of details of balances, the concern is determining
whether the monetary amount of an account balance is materially misstated.
Attributes sampling, therefore, is seldom useful for tests of details of balances.

2. Why is it difficult to determine the appropriate sample size for MUS? How should the
auditor determine the proper sample size?

Answer:
The difficulty in determining sample size lies in estimating the number and
amount of misstatements that may be found in the sample. The upper bound of a
monetary unit sample is sensitive to these factors. Thus, sample size varies a great
deal with differing assumptions about them. Generally, the auditor will determine
sample size by making reasonable but conservative assumptions about the sample
exception rate and average misstatement amount. In the absence of information
about misstatement amount, which is most difficult to anticipate, a 100% assumption
is often used.

3. Distinguish between the point estimate of the total misstatement and the true value of
the misstatement in the population. How can each be determined?

Answer :
The point estimate is an estimate of the total amount of misstatement in the
population as projected from the known misstatements found in the sample. The
projection is based on either the average misstatement in the sample times the
population size, or the net percent of misstatement in the sample times the population
book value. The true value of misstatements in the population is the net sum of all
misstatements in the population and can only be determined by a 100% audit.

4. Define what is meant by the population standard deviation and explain its importance
in variables sampling. What is the relationship between the population standard
deviation and the required sample size?
 Answer :
The population standard deviation is a measure of the difference between the
individual values and the mean of the population. It is calculated for all variables
sampling methods but not for monetary unit sampling. For the auditor, it is usually
estimated before determining the required sample size, based on the previous year's
results or on a preliminary sample.
The population standard deviation is needed to calculate the sample size
necessary for an acceptable precision interval when variable sampling methods are
used. After the sample is selected and audited, the population standard deviation is
estimated from the standard deviation calculated from the values in the sample. The
required sample size is directly proportional to the square of the population
standard deviation.

5. Define monetary unit sampling and explain its importance in auditing. How does it
combine features of attribute and variable sampling?

Answer :
Monetary unit sampling is a method whereby the population is defined as the
individual dollars (or other currency) making up the account balance. A random
sample is drawn of these individual monetary units and the physical audit units
containing them are identified and audited.
The results of auditing the physical audit units are applied, pro rata, to the
random monetary units, and a statistical conclusion about all population monetary
units is derived. Monetary unit sampling is now the most commonly used method of
statistical sampling for tests of details of balances. This is because it uses the implicity
of attributes sampling yet still provides a statistical result expressed in dollars. It does
this by using attribute tables to estimate the total proportion of population dollars
misstated, based on the number of sample dollars misstated, and then modifies this
amount by the amounts of misstatements found.
This latter aspect gives monetary unit sampling its "variables" dimension,
although the normal distribution theory is not used; rather an arbitrary rule of thumb is
applied to make the adjustment.

6. Define what is meant by sampling risk. Does sampling risk apply to non-statistical
sampling, MUS, attributes sampling, and variables sampling? Explain.

Answer :
Sampling risk is the risk that the characteristics in the sample are not
representative of those in the population. The two types of sampling risk faced by the
auditor testing an account balance are: a. The risk of incorrect acceptance (ARIA) —
this is 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 (ARIR) —this is the risk that the sample supports the conclusion
that the recorded account balance is materially misstated when it is not materially
misstated.
Sampling risk occurs whenever a sample is taken from a population and thus
before applies to all sampling methods. While ARIA applies to all sampling methods,
ARIR is only used in variables sampling and difference estimation.
7. What are the major differences in the 14 steps used in non-statistical sampling for
tests of detail balances versus for tests of controls and substantive tests of
transactions?

Answer :
The steps in non-statistical sampling for tests of details of balances and
fortests of controls are almost identical, as illustrated in the text. The major
differences are that sampling for tests of controls deals with exceptions and sampling
for tests of details of balances concerns dollar amounts. This results indifferences in
the application of the two methods, but not the steps.

8. MUS automatically increases the probability of selecting a high value item from the
population. How does MUS not help the auditor detect material misstatement?

Answer :
The two methods of selecting a monetary unit sample are random sampling
and systematic sampling. Under random sampling, in this situation, 57 random
numbers would be obtained (the sample size in 17-14) between 1 and12,625,000.
These would be sorted into ascending sequence. The physical audit units in the
inventory listing containing the random monetary units would then be identified by
cumulating amounts with an adding machine or spreadsheet if the data is in machine-
readable form. As the cumulative total exceeds a successive random number, the item
causing this event is identified as containing the random dollar unit. When systematic
sampling is used, the population total amount is divided by the sample size to obtain
the sampling interval.
A random number is chosen between 1 and the amount of the sampling
interval to determine the starting point. The dollars to be selected are the starting point
and then the starting point plus the interval amount applied successively to the
population total. The items on the inventory listing containing the dollar units are
identified using the cumulative method described previously. In applying the
cumulative method under both random sampling and systematic sampling, the page
totals can be used in lieu of adding the detailed items if the page totals are considered
to be reliable .

9. Explain how the auditor determines tolerable misstatement for MUS

Answer :
A unique aspect of monetary unit sampling is the use of the preliminary
judgment about materiality, as discussed in Chapter 9, to directly determine a
tolerable misstatement amount for the audit of each account. Most sampling
techniques require the auditor to determine tolerable misstatement for each account by
allocating the preliminary judgment about materiality. This is not required when
monetary unit sampling is used. The preliminary judgment about materiality is used.

10. Explain what is meant by acceptable risk of incorrect acceptance. What are the major
audit factors affecting ARIA?

Answer :
Acceptable risk of incorrect acceptance (ARIA) is the risk the auditor is
willing to take of accepting a balance as correct when the true misstatement in the
 balance is greater than tolerable misstatement. ARIA is the equivalent term to
acceptable risk of assessing control risk too low for audit sampling for tests of
controls and substantive tests of transactions.
The primary factor affecting the auditor's decision about ARIA is control risk
in the audit risk model, which is the extent to which the auditor relies on internal
controls. When internal controls are effective, control risk can be reduced, which
permits the auditor to increase ARIA, which in turn reduces the required sample size.
Besides control risk, ARIA is also affected directly by acceptable audit risk and
inversely by inherent risk and other substantive tests, readily performed on the
account balance, assuming effective results. For example, if acceptable audit risk is
reduced, ARIA must also be reduced. If analytic procedures were performed and there
is no indication of problem areas, there is a lower likelihood of misstatements in the
account being tested, and ARIA can be increased.

11. In using difference estimation, an auditor took a random sample of 100 inventory
items from a large population to test for proper pricing. Several of the inventory items
were misstated, but the combined net amount of the sample misstatement was not
material. In addition, a review of the individual misstatements indicated that no
misstatement was by itself material. As a result, the auditor did not investigate the
misstatements or make a statistical evaluation. Explain why this practice is improper.

Answer :
This practice is improper for a number of reasons:
 No determination was made as to whether a random sample of 100 inventory
items would be sufficient to generate an acceptable precision interval for
a given confidence level. In fact, a confidence limit was not even calculated.
 The combined net amount of the sample misstatement may be immaterial
because large overstatement amounts may be off setting large understatement
amounts resulting in a relatively small combined net amount.
 Although no misstatement by itself may be material, other material misstatements
might not have exhibited themselves if too small of a sample was taken.4.
Regardless of the size of individual or net amounts of misstatements in
a sample, the effect on the overall population cannot be determined unless the
results are evaluated using a statistically valid method.

12. What is relationship between ARIA and ARO for tests of controls?
Answer :
ARIA for TDB is the equivalent of ARO for TOC and STOT. There is an
inverse relationship between ARO for TOC and ARIA for TDB. If internal controls
are considered to be effective, the control risk can be reduced. While testing internal
controls, a lower control risk requires lower ARO which in turn requires a larger
sample size for testing. If controls are determined to be effective after testing, control
risk can be estimated below maximum, which permits the auditor to increase ARIA.
By increasing ARIA, auditors can reduce sample sizes for TDB.

MULTIPLE CHOICE QUESTIONS FROM CPA AND CIA EXAMINATIONS

1. Your client is a music company. You noted that the sales of CD’s only amounted to
8% of total sales as compared to music downloads, which comprised the bulk of sales.
a. When determining the sample size for tests of details of the balances of inventory,
you should have a
= (4) Bigger sample as the balance of inventory is zero
b. Your client sold 10% more vinyl records this year compared to last. However vinyl
records only amounted to 0.5% of total music sales this year. There is
= (3) A need to start auditing as in 10 years the client might only be selling vinyl.
c. Last year, you found that the clerk who enters the invoices into the system is
constantly making mistakes. Your client has replaced the clerk with an accounting
graduate. You have yet to find any mistake. When designing your audit of the revenue
cycle, you should
= (3) Continue with the same sample of size of invoice audited last year.

2. The following apply to evaluating results of audit sampling for tests of details of
balances. For each one, select the best response.
a. While performing a substantive test of details during an audit, the auditor determined
that the sample results supported the conclusion that the recorded account balance was
not materially misstated. It was, in fact, materially misstated. This situation illustrates
the risk of
= (4) Incorrect acceptance.
b. In an MUS sample with a sampling interval of $5,000, an auditor discovered that a
selected accounts receivable with a recorded amount of $10,000 had an audit value of
$8,000. If this is the only error discovered by the auditor, the projected error of the
sample would be
= (2) $2,000
c. The accounting department reports the accounts receivable balance as $175,000. You
are willing to accept that balance if it is within $15,000 of the actual balance. Using a
variables sampling plan, you compute a 95% confidence interval of $173,000 to
$187,000. You would therefore
= (4) Accept the $175,000 balance because the confidence interval is within the
materiality limits.
3. The following relate to the use of statistical sampling for tests of details of balances.
For each one, select the best response.
a. When the auditor uses monetary unit statistical sampling to examine the total dollar
value of invoices, each invoice
= (4) has a probability proportional to its dollar value of being selected
b. Which of the following would be an advantage of using variables sampling rather
than probability-proportional-to-size (PPS) sampling?
= (3) the inclusion of zero and negative balances usually does not require special
design considerations
c. In applying variables sampling, an auditor attempts to
= (4) predict a monetary population value within a range of precision