Activity Sheet - Module 8

1. What is audit sampling?

Audit sampling is the application of an audit procedure to less than 100 percent of

the items within an account balance or class of transactions for the purpose of evaluating

some characteristic of the balance or class.

2. Define the following terms:

a. Error in the context of tests of controls

 Risk of under reliance. Based upon the sample auditor concludes that internal

control system is not adequate however actually it is not so

 Risk of Over reliance. Based upon sample auditor conclude that that Internal control

are very effective however it is not so in reality

b. Error in the context of substantive tests

 Risk of incorrect rejection. On the bases of sample auditor conclude that transaction

balance is materially misstated whereas in fact these are not

 Risk of incorrect acceptance. Based upon sample auditor conclude that transactions

balances are not materially misstated while in fact these are misstated.

3. What are the two components of detection risk? Explain each component briefly.
 Inherent risk is the susceptibility of an account balance or class of transaction to a

material misstatement, assuming that there were no internal control while the control risk

is the risk that material misstatement will not be prevented or detected and corrected on a

timely basis by the internal control system.

4. Can you eliminate sampling risk? Explain.

No, because sampling risk can be acceptably low level, but it cannot be

eliminated from base due to inherent limitations. The risk that the auditor conclusion

based on a sample on may be different from the conclusion if the entire population were

subjected to the same audit procedure.

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

The relationship between sampling risk and sample size is that they have an

inverse relationship. That is, the greater the sampling size the lower will be the sampling

risk. Accordingly, if all items in a population are checked, the sampling risk will be zero.

6. How is non-sampling risk reduced?

Non-sampling risk is the probability of arriving at an incorrect conclusion,

irrespective of selecting a correct sample. It can be reduced by high level of planning and

review, applying correct audit procedures, applying professional judgement in

interpretation of audit test results.

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.

Two types of sampling risk are efficiency and effectiveness risk. Efficiency risk

(type I error risk) is the risk that the auditor concludes that the population is worse in

terms of errors than it really is. Effectiveness risk (type II error risk) is the risk that the

auditor concludes that the population is better than it really is. It is too related for

efficiency of the audit.

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.

While performing substantive tests, sampling risk are the risk of incorrect

acceptance and the risk of incorrect rejection. The risk of incorrect acceptance is the risk

that the sample supports the conclusion that the recorded account balance is not

materially misstated when it is materially misstated whereas the risk of incorrect rejection

is the risk that sample support the result that recorded account balance is materially

misstated when it is not materially misstated.

9. Which one is of greater concern to the auditor: risk affecting audit effectiveness or risk

affecting audit efficiency? Explain.

The greater concern to the auditor is the risk affecting audit efficiency because the

primary purpose of an auditor is to accomplish an audit task with less time and increase

the profitability of an entity.

10. What are the risk considerations in obtaining audit evidence?

A large part of work involved in the performance of an audit consists of obtaining

audit evidence so that opinion to be drawn based on reliable evidence, external evidence,

written and documented evidence.

11. Enumerate the different means of selecting items for testing.

 Simple random sampling. A subset of a statistical population in which each member of

the subset has an equal probability of being chosen.

 Systematic sampling. A type of probability sampling method in which sample members

from a larger population are selected according to a random starting point but with a

fixed, periodic interval.

 Stratified sampling. A method of sampling that involves the division of a population

into smaller sub-groups known as strata.

 Cluster sampling. A method of probability sampling that is often used to study large

populations, particularly those that are widely geographically dispersed.

12. What are the two general approaches to audit sampling? Explain briefly.

The two general approaches to audit sampling are nonstatistical and statistical that

require the auditor use professional judgment in planning, performing, and evaluating a

sample and in relating the audit evidence produced by the sample to other audit evidence

when forming a conclusion about the related account balance or class of transactions.
13. What are the advantages and disadvantages of statistical sampling?

Statistical sampling allows each sampling unit to stand an equal chance of

selection. The use of non-statistical sampling in audit sampling essentially removes this

probability theory and is wholly dependent on the auditor’s judgment, keeping the

objective of sampling in mind, which is to provide a reasonable basis for the auditor to

draw valid conclusions and ensuring that all samples are representative of their

population, will avoid bias.

14. Explain the following sample selection methods:

a. Random sampling. This method of sampling ensures that all items within a population

stand an equal chance of selection by the use of random number tables or random number

generators. The sampling units could be physical items, such as sales invoices or

monetary units.

b. Systematic sampling. The method divides the number of sampling units within a

population into the sample size to generate a sampling interval. The starting point for the

sample can be generated randomly, but the standard recognizes that it is more likely to be

‘truly’ random if the use of random number generators or random number tables are used.

c. Block selection. This method of sampling involves selecting a block (or blocks) of

contiguous items from within a population. Block selection is rarely used in modern

auditing merely because valid references cannot be made beyond the period or block

examined. In situations when the auditor uses block selection as a sampling technique,

many blocks should be selected to help minimize sampling risk.

d. Haphazard sampling. When the auditor uses this method of sampling, he does so
 without following a structured technique. The standard also recognizes that this method

of sampling is not appropriate when using statistical sampling. The objective of audit

sampling is to ensure that all items that make up a population stand an equal chance of

selection. This objective cannot be achieved if the auditor deliberately avoids items that

are difficult to locate or deliberately avoids certain items.

15. What is stratification?

Stratified sampling involves dividing the population into subpopulations that may

differ in important ways. It allows you draw more precise conclusions by ensuring that

every subgroup is properly represented in the sample.

16. What is value-weighted selection?

Value weighted sample selection is used when the population consists of

monetary amounts that the amounts in the account balance contain the selected dollar

units are picked as the samples. Amounts with a higher value have a greater chance or

probability of being selected.

17. Give the steps involved in an attribute sampling plan.

Attribute sampling is a statistical process used in audit procedures that aims to

analyze the characteristics of a given population. This practice is often used to test

whether or not a company's internal controls are being correctly followed.

 Step-1. Anticipates the deviation rate for the control activity (or other application)

being tested. Expected rate is based on difficulty of activity, experience of person

performing the control, results found in previous audits, etc. The more deviations that are

anticipated the larger the sample must be.

Step-2. Sets a tolerable deviation rate. This is the maximum error rate that the

auditor could tolerate and still believe the control activity was operating effectively and

efficiently. As the rate that the auditor can tolerate gets smaller, sample size must get

larger.

Step-3. Sets allowable level of risk that the sample will be misleading. For this

particular testing, auditor is especially worried that the sample will look better than the

actual population. In that case, auditor may think that the control activity is functioning

properly and will set control risk too low and do less substantive testing than is needed.

To reduce the level of risk that the sample will be misleading, the size of the sample must

be increased.

Step-4. Based on these three figures, a calculation or a chart is used to determine

proper sample size. Except with very small populations, the number of items in the

population has little or no effect on the sample size.

Step-5. The appropriate number of items is selected from the population. Items

must be picked randomly; each item should have an equal chance of selection.

Step-6. Sample items are examined, and the number of deviations (usually errors)

is determined. That number is restated as a percentage based on sample size.

 Step-7. Another chart is used to convert the actual deviation rate of the sample to

the potential upper deviation rate of the population. Difference between the actual rate

and upper deviation rate is called the allowance for sampling risk.

18. Give at least three determinants of the sample size for tests of controls. Relate each

determinant to sample size.

Sample size refers to the number of participants or observations included in a study. This

number is usually represented by n.

(1) the risks of assessing control risk too low

(2) the tolerable deviation rates

(3) the expected population deviation rate.

19. Give the steps involved in a variable sampling plan.

Step-1. Sets the level of a tolerable misstatement. This is the size of the largest

misstatement in the account being examined that (when combined with misstatements in

all other accounts) would still not cause the financial statements to be materially

misstated. If auditor reduces the size of a misstatement that can be tolerated, a bigger

sample will be required.

Step-2. Sets allowable risk levels that sample will be misleading. To reduce these risk

levels, a larger sample size must be selected:

 A misleading sample can cause incorrect acceptance. There is a risk that a sample

will substantiate client figure when the population is actually materially misstated.

This problem leads to an unqualified opinion being given on statements that are

not fairly presented.

 A misleading sample can cause incorrect rejection. There is a risk that a sample

will not substantiate the client figure even though the population is not materially

misstated. This problem leads to additional (unnecessary) testing being

performed.

Step-3. Estimates the amount of misstatement in the population. This figure is

usually affected by the efficiency of the accounting system and staff. The bigger the

expected misstatement, the larger the sample size required. Again, population size has

only a little impact on sample size.

Step-4. Auditor takes a preliminary sample to estimate the variability of the items in

the population. If the items are all about the same amount, variability is low. Variability

is measured by estimating the standard deviation. The higher the variability, the more

items that have to be selected to get a representative sample.

Step-5. Auditor randomly selects items for the sample and measures the average

value of these items. The average of the sample is then extended to the entire population

to give a total. Difference between this total and client figure is the projected

misstatement. If projected misstatement is less than tolerable misstatement, the test has
 provided evidence that reported balance is fairly presented. If projected misstatement is

more, the test has not provided evidence that balance is fairly presented.

20. Give at least three determinants of the sample size for substantive tests. Relate each

determinant to sample size.

The statistical sampling method most commonly used for tests of controls and

substantive tests of transactions is attributes sampling. It is a frequency distribution of the

results of all possible samples of a specified size that could be obtained from a population

containing some specific parameters.

1. If auditor assesses risk of material misstatement greater.

2. If auditor also using other substantive procedures for same assertion.

3. If auditor requires greater confidence from results of tests if auditor requires greater

confidence from results of tests.

21. What are other sampling considerations mentioned in PSA 530?

Philippine Standards on Auditing (PSAs) are to be applied in the audit of financial

statements. PSAs are also to be applied, adapted as necessary, to the audit of other

information and to related services. PSAs contain the basic principles and essential
 procedures (identified in bold type black lettering) together with related guidance in the

form of explanatory and other material. The basic principles and essential procedures are

to be interpreted in the context of the explanatory and other material that provide

guidance for their application. To understand and apply the basic principles and essential

procedures together with the related guidance, it is necessary to consider the whole text

of the PSA including explanatory and other material contained in the PSA not just that

text which is black lettered. In exceptional circumstances, an auditor may judge it

necessary to depart from a PSA in order to achieve the objective of an audit more

effectively. When such a situation arises, the auditor should be prepared to justify the

departure. PSAs need only be applied to material matters.

22. When is projection necessary?

It is necessary when no explicit of error is the sample error rate is also the

projected rate of error for the population as a whole. Projection is only necessary when

there is an error for test of controls and substantive tests.

23. Discuss the following projection techniques:

a. Difference estimation. To measure the estimated total misstatement amount in a

population when there is both a recorded value and an audited value for each item in the

sample.

b. Ratio estimation. Similar to difference estimation except that the point estimate of the

population misstatement is determined by multiplying the portion of sample amount

misstated times the total recorded population book value.

 c. Mean-per-unit estimation. The auditor is concerned with the audited value rather than

the misstatement amount of each item in the sample.

24. What is probability-proportional-to-size (PPS) sampling?

Probability proportional to size (PPS) sampling is a method of sampling from a

finite population in which a size measure is available for each population unit before

sampling and where the probability of selecting a unit is proportional to its size.