DIRE DAWA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING
Unit 1: Sampling in Auditing

An audit is an independent examination of the financial accounts/records and procedures of a

firm or organization, by a qualified accountant. This is essential to form an opinion that the
organizations’ financial statements present a true and fair view at a particular point of time.

Audited accounts can be particularly relevant to creditors, potential investors and your bankers’
when they are looking at doing business with your organizations.

Meaning of Audit:

Audit was originally confined to ascertaining whether the accounting party had properly
accounted for all receipts and payments on behalf of his potential and was in fact merely a cash
audit. Modern audit not only examine cash transactions, but also verify the purpose / purport to
which the cash transactions relate. For example, the Ministry of Education has allocated sum
amount of Birr to the Dire Dawa University for the purpose of constructing administrative
building. The auditor is responsible to check whether the fund allocated to the university by the
Ministry is properly utilized or not.

According to L.R.Dicksea Audit is therefore an examination of accounting records undertaken

with a view to establishing whether they correctly and completely reflect the transactions to
which purport / purpose to relate.

The word audit is derived from the Latin word “AUDIRE” which means to hear. The literal
meaning of audit is to hear and the auditor is a person who hears the explanations from the
persons accountable for keeping accounts. Thus audit or auditing means that an act of checking
or examining the truth of accounts of an enterprise. The purpose, aim and objective of audit may
be depending on the type of business and ownership position of an organization.

Sampling in Auditing

A survey or study may be conducted by Census Method and Sample Method. When the whole
area or population of persons is contacted the method is known as Census Method. When a
small group is selected as representative of the whole mass it is known as Sampling Method.

Sampling is simply the process of learning about the population on the basis of a sample drawn
from it.

Process (Procedure) of Sampling:

• Selecting the sample

• Collecting the information and,
• Making an inference or conclusion about the populations
The size of the sample:

The size of the sample depends upon:

• The Nature of the universe (the totality of all created things) whether homogenous or
heterogeneous
• Nature of the study i.e., intensive/extensive
• Availability of finance, time and personnel
• Standard of accuracy
• Size of the schedule/questionnaire
• Nature of the cases to be contacted – geographically scattered
• Type of sampling used

Meaning of Audit Sampling

When the auditor decides to select less than 100 percent of the population for testing to make
inferences (conclusion) about the population, it is called audit sampling.

Definition

“The application of audit procedures to less than 100% of items within a population of audit
relevance such that all sampling units have a chance of selection in order to provide the auditor
with a reasonable basis on which to draw conclusions about the entire population”.

Representative Sample

When selecting a sample from a population, the auditor strives (to try hard) to obtain a
representative sample. A representative sample is one in which the characteristics in the
sample are approximately the same as those of the population. This means that the sampled
items are similar to the items not sampled.

For instance, a client’s internal controls require a clerk to attach a shipping document to every
duplicate sales invoice, but the clerk fails to follow the procedure exactly 3 percent of the time. If
the auditor selects a sample of 100 duplicate sales invoices and finds three are missing attached
shipping documents, the sample is highly representative. If two or four such items are found in
the sample, the sample is reasonably representative. If no or many missing items are found, the
sample is non-representative.

Sampling Risk

A sample result can be non-representative due to non-sampling error or sampling error. The risk
of these two types of errors occurring is called non-sampling risk and sampling risk. Both of
these can be controlled.
Non-sampling risk is the risk that audit tests do not uncover (find out/expose) existing
exceptions (not included) in the sample. The two causes of nonsampling risk are the auditor’s
failure to recognize exceptions and inappropriate or ineffective audit procedures.

An auditor might fail to recognize an exception because of exhaustion, (loss of strength)

boredom (dullness), or lack of understanding of what to look for. Careful design of audit
procedures, proper instruction, supervision, and review are ways to control nonsampling risk.

Sampling risk is the risk that an auditor reaches an incorrect conclusion because the sample is
not representative of the population. Sampling risk is an inherent part of sampling that result
from testing less than the entire population.

For example, assume the auditor decided that a control is not effective if there is a population
exception rate of 6 percent. Assume the auditor accepts the control as effective based on tests of
the control with a sample of 100 items that had two exceptions. If the population actually has an
8 percent exception rate, the auditor incorrectly accepted the population because the sample was
not sufficiently representative of the population.

How to control the sampling risk:

Auditors have two ways to control sampling risk:

1. Adjust sample size

2. Use an appropriate method of selecting sample items from the population

Increasing sample size reduces sampling risk, and vice versa. At one extreme, a sample of all the
items of a population has a zero sampling risk. At the other extreme, a sample of one or two
items has an extremely high sampling risk.

Using an appropriate sample selection method increases the likelihood (possibility / probability)
of representativeness. This does not eliminate or even reduce sampling risk, but it does allow the
auditor to measure the risk associated with a given sample size if statistical methods of sample
selection and evaluation are used.

Methods of Sampling or Sampling Procedure

• Statistical Vs Non-Statistical sample selection (Step 1)

• Probabilistic Vs Non-Probabilistic Sample Selection (Step 2)
1. Statistical Vs Non-Statistical Sample selection:

Audit sampling methods can be divided into two broad categories: statistical sampling and non-
statistical sampling. These categories are similar in that they both involve three phases (stage of
growth):
1. Plan the sample
2. Select the sample and perform the tests
3. Evaluate the results
The purpose of planning the sample is to make sure that the audit tests are performed in a
manner that provides the desired sampling risk and minimizes the likelihood of nonsampling
error. Selecting the sample involves deciding how a sample is selected from the population. The
auditor can perform the audit tests only after the sample items are selected. Evaluating the
results is the drawing of conclusions based on the audit tests. Assume that an auditor selects a
sample of 100 duplicate sales invoices from a population, tests each to determine whether a
shipping document is attached, and determines (decide) that there are three exceptions. Let’s
look at those actions step-by-step:

Action Step
Decide that a sample size of 100 is needed. 1. Plan the sample
Decide which 100 items to select from the population
Perform the audit procedure for each of the 100 items and 2.Select the sample
Perform the tests determine that three exceptions exist.
Reach conclusions about the likely exception rate in the 3.Evaluate the results
total population when the sample exception rate equals 3
percent.

Statistical Sampling:

It differs from non-statistical sampling in that, by applying mathematical rules, auditors can
quantify (measure) sampling risk in planning the sample (step 1) and in evaluating the results
(step 3). (You may remember calculating a statistical result at a 95 percent confidence level in a
statistics course. A 95 percent confidence level provides a 5 percent sampling risk.)

Non-statistical sampling:

In non-statistical sampling, auditors do not quantify sampling risk. Instead, auditors select
sample items they believe will provide the most useful information, given the circumstances, and
reach conclusions about populations on a judgmental basis. For that reason, the use of non-
statistical sampling is often termed judgmental sampling.

Probabilistic Vs Non-probabilistic sample selection:

When using probabilistic sample selection, the auditor randomly selects items such that each
population item has a known probability of being included in the sample. This process requires
great care and uses one of several methods.

In non-probabilistic sample selection, the auditor selects sample items using professional
judgment rather than probabilistic methods. Auditors can use one of several non-probabilistic
sample selection methods.

Auditing standards permit auditors to use either statistical or non-statistical sampling methods.
However, it is essential that either method be applied with due care. All steps of the process must
be followed carefully.
Probability sampling:

A probability sampling scheme is one in which every unit in the population has a chance
(greater than zero) of being selected in the sample, and this probability can be accurately
determined.
When every element in the population does have the same probability of selection, this is known
as an 'equal probability of selection' (EPS) design. Such designs are also referred to as 'self-
weighting' because all sampled units are given the same weight.

Types of Probabilistic sample selection:

There are four types which includes Simple random sample selection, Systematic sample
selection, Probability proportional to size sample selection and Stratified sample selection.

Simple random sample selection:

A simple random sample is one in which every possible combination (mixture) of elements in the
population has an equal chance of constituting the sample.

For example, auditors want to sample a client’s cash disbursements for the year. They might
select a simple random sample of 60 items from the cash disbursements journal, apply
appropriate auditing procedures to the 60 items selected, and draw conclusions about all
recorded cash disbursement transactions.

Systematic sample selection:

Systematic Sampling: Used in those cases where a complete list of the population from which
sampling is to be drawn is available. The method is to select every k th item from the list where
‘k’ refers to the sampling interval.
k=N/n
Where N = Total Number of population and
n = sample size

The starting point between the first and the kth items is selected at random.

In systematic sample selection (also called systematic sampling), the auditor calculates an
interval and then selects the items for the sample based on the size of the interval. The interval is
determined by dividing the population size by the desired sample size.

For example, In a population of sales invoices ranging from 652 to 3,151, with a desired sample
size of 125, the interval is 20 [(3,151 – 651)/125]. The auditor first selects a random number
between 0 and 19 (the interval size) to determine the starting point for the sample. If the
randomly selected number is 9, the first item in the sample will be invoice number 661 (652 + 9).
The remaining 124 items will be 681 (661 + 20), 701 (681 + 20), and so on through item 3,141.

Probability Proportional to size Sample (PPS) Selection:

Take a sample in which the probability of selecting any individual population item is
proportional to its recorded amount. This method is called sampling with probability
proportional to size (PPS), and it is evaluated using non - statistical sampling or monetary unit
statistical sampling.

For example, suppose we have six schools with populations of 150, 180, 200, 220, 260, and 490
students respectively (total 1500 students), and we want to use student population as the basis
for a PPS sample of size three. To do this, we could allocate the first school numbers 1 to 150,
the second school 151 to 330 (= 150 + 180), the third school 331 to 530, and so on to the last
school (1011 to 1500). We then generate a random start between 1 and 500 (equal to 1500/3)
and count through the school populations by multiples of 500. If our random start was 137, we
would select the schools which have been allocated numbers 137, 637, and 1137, i.e. the first,
fourth, and sixth schools.

Stratified Sample Selection:

The population be divided into homogenous groups called strata’s, then a sample may be drawn
from each group by simple random method, and the resulting sample is called Stratified Random
Sampling.

For example, the auditor has to investigate cash receipt of “Biniyam company plc” during the
period of 2001-02. He has to divide all the transaction into 4 categories namely April - June,
July – Sep, October-Dec and Jan-March. After that he may draw from each quarter by simple
random method.

Non-probabilistic sample selection:

Non-probabilistic sample selection methods are those that do not meet the technical
requirements for probabilistic sample selection. Because these methods are not based on
mathematical probabilities, the representativeness of the sample may be difficult to determine.

- Directed Sample Selection

- Block Sample Selection
- Haphazard Sample Selection

Directed sample selection:

In directed sample selection auditors deliberately select each item in the sample based on their
own judgmental criteria instead of using random selection. Commonly used approaches include:

Items Most Likely to Contain Misstatements: Auditors are often able to identify which
population items are most likely to be misstated.

For examples, an accounts receivable outstanding for a long time, purchases from and sales to
officers and affiliated companies, and unusually large or complex transactions. The auditor can
efficiently investigate these types of items and the results can be applied to the population
judgmentally. In evaluating such samples, auditors typically reason that if none of the items
selected are misstated, it is unlikely that the population is materially misstated.

Items Containing Selected Population Characteristics: By selecting one or more items with
different population characteristics, the auditor may be able to design the sample to be
representative.
For example, the auditor might select a sample of cash disbursements that includes some from
each month, each bank account or location, and each major type of acquisition.

Large Dollar Coverage Auditors can sometimes select a sample that includes a large portion of
total population dollars and thereby reduce the risk of drawing an improper conclusion by not
examining small items. This is a practical approach on many audits, especially smaller ones,
where a few population items make up a large portion of the total population value. Some
statistical sampling methods are also designed to accomplish the same effect.

Block Sample selection:

This method of sampling involves selecting a block (or blocks) of contiguous

(nearby/neighboring) 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.

An example of block selection is where the auditor may examine all the remittances from
customers in the month of January. Similarly, the auditor may only examine remittance advices
that are numbered 300 to 340.

Haphazard sample selection

Haphazard sample selection is the selection of items without any conscious bias by the auditor.
In such cases, the auditor selects population items without regard to their size, source, or other
distinguishing characteristics.

The most serious shortcoming of haphazard sample selection is the difficulty of remaining
completely unbiased in the selection. Because of the auditor’s training and unintentional bias,
certain population items are more likely than others to be included in the sample.

For example, assume that the auditor wants to trace credits from the accounts receivable master
files to the cash receipts journal and other authorized sources as a test for fictitious credits in the
master files. In this situation, many auditors use a haphazard or block approach, because it is
simpler and much less costly than other selection methods.

However, for many non-statistical sampling applications involving tests of controls and
substantive tests of transactions, auditors prefer to use a probabilistic sample selection method
to increase the likelihood of selecting a representative sample.
Purpose of audit test:
The purpose of audit tests, or audit procedures, is to allow the auditor to collect sufficient
appropriate audit evidence to be able to conclude with reasonable assurance that the financial
statements (FS) are free of material misstatement.

If sufficient appropriate audit evidence cannot be obtained, or the evidence points to a material
misstatement in the Financial Statements, the auditor will have to issue a modified audit opinion.

Test of Control:

• Test of control involve the auditor testing processes or procedures carried out by staff at
the client.
• In every organisation, there will be business and accounting systems which should have
appropriate controls in place.
• There are a variety of different controls that can be broadly classified into five
categories. The categories of control activities are; Authorization, Performance Reviews,
Information Processing, Physical, and Segregation of Duties (‘APIPS’).
• Testing controls involve the auditor selecting some of these controls that the client
carried out during the year, and checking to make sure that they operated effectively. An
example of a control could be where the client had a control whereby the monthly
payroll summary had to be approved by the finance director before payment was made.
• As a test of control, the auditor would look for evidence of that authorization – most
commonly the signature / initials of the Finance Director on a copy of the payroll
summary.

Test of Control can be grouped into:

• Enquiry and confirmation. For example, ask the credit controller about the way in
which customers are encouraged to pay and ask how these customers are identified and
how often they are followed up. This is a relatively weak source of evidence because the
credit controller might exaggerate his or her efforts.

• Inspection. For example, the credit references or notes made by the credit controller of
conversations.

• Observation. For example, observing the credit controller at work.

• Recalculation and Reperformance. For example, ensuring that the aged receivables

analysis seems to be accurate.

What is substantive test?

Substantive testing is an audit procedure that examines the financial statements and supporting
documentation to see if they contain errors. These tests are needed as evidence to support the
assertion that the financial records of an entity are complete, valid, and accurate.
Auditor can use the following substantive test:
• Conduct a bank confirmation to test ending cash balances
• Contact customers to confirm that accounts receivable balances are correct
• Observe the period-end counting of inventory
• Confirm the validity of inventory valuation calculations
• Confirm with experts that the fair values assigned to assets obtained through a business
combination are reasonable
• Physically match fixed assets to fixed asset records
• Contact suppliers to confirm that accounts payable balances are correct
• Contact lenders to confirm that loan balances are correct
• Review board of directors minutes to verify the existence of approved dividends

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