Unit 1: AUDIT SAMPLING

1.1 Definition and purpose of sampling

1.2 The rationale for audit sampling
1.3 Methods of audit sampling
1.4 Statistical vs. non statistical sampling, sampling and non sampling risk
1.5 Approach to statistical sampling
1.6 Types of audit tests

1.1 Definition, purpose and rationale for audit sampling

Audit sampling: Process of obtaining information about an entire population or universe by
examining only part of it. The auditor seeks to obtain sufficient appropriate audit evidence as the
basis for his opinion on the information under audit. The auditor collects the evidence through
the performance of compliance procedures (i.e. tests to obtain reasonable assurance that those
internal controls on which audit reliance is to be placed are operating effectively) and substantive
procedures (i.e. tests of details of transactions and balances and analytical procedures). It is
important to note that the auditor does not normally apply either compliance procedures or
substantive procedures to all the items within an account balance or class of transactions. He
selects a sample of transactions from an account or class of transactions, applies his audit
procedures to such sample, and draws there from conclusions about the entire account or class of
transactions. This is known as audit sampling.
Purpose: To estimate characteristic of group without complete examination of all items
constituting the group.

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1.2 The underlying principle for audit sampling
Some people argue that to express a proper opinion an auditor should examine all the
transactions. They feel that an auditor cannot reach valid conclusions unless he has examined all
the transactions. This view is, however, not correct. (Imagine what it would be like if, to see
whether the rice has been cooked properly, housewives were to taste each and every grain!). An
auditor can obtain sufficient appropriate audit evidence even by performing his audit procedures
on a sampling basis, provided he exercises adequate skill and care. As a matter of fact,
application of sampling in auditing is a recognized practice not only in Ethiopia but throughout
the world.

Sampling is recognized as an acceptable auditing practice due to the rationales of:

1. Large number of Transactions
The number of transactions in modern enterprises is enormous. Take the case of a bank branch
where thousands of transactions may take place every day. If an auditor attempts to examine
each and every transaction, it will be almost impossible for him to complete the audit within the
stipulated time and the cost budget.

2. Objective of an audit
The objective of an audit is to enable the auditor to form and express an opinion on the
information under audit. In this regard, the auditor should obtain sufficient appropriate audit
evidence to enable him to draw reasonable conclusions there form to form the basis or his
opinion. In most auditing situations, the auditor can draw reasonable conclusions by carrying out
a selective examination of transactions, account balances and internal controls.

3. Internal control system

Generally, most of the medium and large-sized enterprises have sound systems of internal
control to ensure proper accounting and information processing. For example, for routine
payments of Cheques, a bank normally has adequate internal controls which minimize the
possibility of frauds and errors once the auditor has satisfied himself (through compliance
procedures) that the relevant internal controls are actually in force, it would be useless for him to

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examine 100 percent of the payments. Thus, where the auditor concludes that the internal control
system is effective, he can decide to apply his audit procedures on a sampling basis.

4. Computerized information Processing

In the last few years, there has been a tremendous growth in the use of electronic computers for
information processing. The use of computers has a significant effect on the manner of
processing of data. The traditional audit approach of checking vouchers, totals and posting on a
100 percent basis is not effective in a computerized accounting environment and is, therefore,
giving way to a new, more effective audit approach. Sampling is an important constituent of this
approach.

5. Audit in depth
An advantage of sampling is that it enables the auditor to conduct audit in depth-a process which
may not be possible due to time and cost constraints, if 100 percent checking is carried out.
Audit in depth refers to an intensive, step-by-step examination of selected transactions, tracing
all the links from the beginning to the end. While conducting an audit in depth, the auditor
reviews all the accounting and operational aspects of a transaction, from the beginning to the
end. This enables him to gain a complete understanding of the nature of the transaction, the
stages involved in its processing, and the controls at each stage.
1.3 Methods of audit sampling
An auditor can carry out a selective examination by way of:-
a) test checking (or judgmental sampling), or
b) statistical sampling

The main difference between these two approaches is that:-

In the case of statistical sampling, statistical tools and techniques are applied in determining the
sample size, in selecting the sample, and in evaluating the results of sample checking.

In the case of judgmental sampling, on the other hand, these are determined by the auditor
primarily through the application of his judgment.

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Test checking or judgmental sampling
Test checking implies that the auditor does not apply his compliance procedures or substantive
procedures to 100 percent of the transactions. Instead, he selects and checks a certain proportion
of the transactions, such proportion being determined by the auditor on the basis of his
experience and judgment about the enterprise under audit. For example, the audit program
relating to a medium sized enterprise may contain one of the following instructions.
a) check 25 percent of the postings from journal to the ledger, or
b) select any three months (sometimes, even the months are specified) and check 100
percent postings from journal to ledger relating to transactions of these months,

Generally, an auditor considers the following factors in determining the extent of test checking:

1. Nature of the item

The nature of an item influences the judgment of the auditor regarding the extent of test checking
if the items are similar or of a repetitive nature, the auditor can draw conclusions regarding the
same on the basis of a small sample. On the other hand, if the items are of a diverse nature, the
auditor needs to carry out a more extensive checking. Thus, other things being the same, the
auditor can obtain the same degree of assurance by examining a smaller sample of sale
transactions in an enterprise manufacturing a standard product than in the case of an enterprise
which manufactures diverse types of goods against special orders.
It should also be recognized that some account balances or classes of transactions are more
susceptible to misstatement. For example, transactions with a firm in which a director of the
company under audit is a partner may have to be examined by the auditor to a greater extent as
compared to similar transactions with other parties. Examples of other item which are more
susceptible to misstatement are: accounts involving a high degree of management judgment (e.g.,
provision for doubtful debts), accounts involving highly valuable and movable assets (e.g.,
jewellery), and accounts that are particularly susceptible to changes in customer demand or
technology that could affect their value (e.g., realizable value of stock in the case of a dealer in
fashion garments).

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2. Effectiveness of internal controls
If, in relation to a class of transactions or an account balance, the auditor finds that the internal
controls are effective, he may limit the extent of test checking. If, on the other hand, the internal
controls are found not to be effective, the auditor may check a higher percentage of items.

3. Materiality of the item

An item is material if its misstatement could influence the economic decisions of a user of
financial information. Usually, materiality of an item depends on its size or magnitude (though
other factors may also affect the materiality of an item). Thus, in an audit of financial statements,
the amount of a transaction or an account balance often determines its materiality for the auditor.
Materiality of an item influences the judgments of the auditor regarding the extent of its test
checking.
In general, an auditor would carry out a more extensive checking of transactions of higher
amount as compared to transactions of lower amounts. For example, in an audit of a large
enterprise, the auditor may decide to examine 50 percent of the debtor account with outstanding
balances of more than Br 50,000, 30 percent of accounts with outstanding balances between Br
10,000 and Br 50,000 and ten percent of debtor accounts with balances below Br 10,000.

It should, however, be remembered that materiality of an item has to be judged in the particular
facts and circumstances of a case. What is material in one situation may not be so in another.
4. Previous experiences of the auditor
In most circumstances, the auditor determines the extent of test checking on the basis of his
previous experience with the enterprise in general and with the relevant class of transactions (or
account balance) in particular.

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5. Results of initial test checks
In many cases, the auditors initially carry out their audit procedures on a small sample and on the
basis of the results of such test checking, they decide whether they should carry out further audit
procedures. For example, an auditor may decide to initially check 20 percent of the sale invoices.
Suppose, his procedures reveal proper documentation, arithmetical accuracy, correct recording in
books of account, etc; he may then decide not to carry out further procedures. If, however, the
results of the initial test checking reveal material errors, the auditor may decide to carry out
further checking of sale invoices.
1.4 Non-statistical sampling vs. statistical sampling
Non-statistical (or judgmental) sampling:
 Use of samples which are chosen without regard for the statistical requirements that
govern the sample size and the method of selection.
 Used where statistical sampling will not satisfy the audit purpose.
 Major limitation – provides no mathematical basis for projecting sample results to the
entire population.
Statistical sampling: A technique or methodology for selecting items to be tested and of
evaluating the results of the test on the basis of mathematical laws of probability.

Advantages of using statistical sampling;

 Auditors may be able to design more efficient samples and avoid “over auditing” or
“under auditing.”
 Permits auditors to optimize sample size, given the acceptable sampling risk.
 Enables auditors to objectively measure the reliability of the evidence obtained from the
sample.

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Selection of sample items: An unbiased sample must be obtained before statistical sampling can
be used to evaluate and interpret the results of sample data. Sampling Techniques:
A. Unrestricted random sampling- Selection of a sample from a population of items in
such a manner that each item in the population has an equal chance of being chosen
for examination.
1. Random number table or random number generators are generally used for
applying this selection approach.
2. Population items must be numbered.
B. Systematic selection – sample items are selected according to some predetermined
fixed interval (selection of every n th item). The first sample item is selected at random
thus establishing the sequential pattern.
1. Population items should be arranged in random order or the auditor should use
multiple random starts.
2. Population items do not need to be numbered.
C. Stratified selection – Population is divided into classes or strata which are more
homogeneous than the population as a whole.
1. Generally used to control variability in the population and reduce sample size.
2. Enables auditor to relate sample selection to materiality.

Non sampling risk vs. sampling risk – risks that auditor may reach
erroneous conclusions about a population.

Non sampling risk – risks due to factors not related to sampling. Failure to recognize error in a
document or transaction or failure to apply appropriate audit procedures.

Sampling risk – Risk that sample results may not be representative of population. Sample risk
varies inversely with sample size.
1. Sample efficiency – The risk of under reliance on internal control and the risk of
incorrect rejection of the account or population.
a) risk of assessing control risk too high
b) risk of incorrect rejection of the account

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 2. Sample effectiveness – The risk of overreliance on internal control and the risk of
incorrect acceptance of the account or population.
a) risk of assessing control risk too low
b) risk of incorrect acceptance of the account
1.6 Audit Testing
1. Tests of controls
2. Substantive tests of transactions

1. Tests of controls
A procedure to obtain an understanding of internal control enables the auditor to determine the
presence or absence of adequate controls. This procedure helps to make initial control risk
assessment. This assessment is a measure of the auditor’s expectation that internal controls will
neither prevent material misstatements from occurring nor detect and correct them if they have
occurred. However, the auditor does not have to make the initial assessment in a formal, detailed
manner. Thus, to determine the degree of reliance on the internal control system, additional
evidence must be obtained about their operating effectiveness.
In other words, in assessing control risk, the auditor has to consider the design of controls and
placement in operation. Same evidence will have been gathered in support of the design of the
controls, as well as evidence that they have been in operation, during the understanding phase.
To use specific controls as a basis for reliance, however, specific evidence must be obtained
about their operating effectiveness throughout all, or at least most, of the period under audit. This
additional evidence about the effectiveness of controls is obtained through tests of controls. It
should, however, be noted that the auditor performs tests of controls only if the initial control
risk assessment is below maximum. In many audits, such as audits of smaller companies, the
auditor assumes that the control risk is at the maximum whether or not it actually is. The
auditor’s reasons for taking this approach is that he or she has concluded that it is more
economical to more extensively audit the financial statement balances than to test related internal
controls. In such cases the auditor does not perform tests of controls.

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Procedures for tests of controls
The following procedures are employed while performing tests of controls:
1. Make Inquires of Appropriate Client Personnel
Although inquiry is not generally a strong source of evidence about the effective operation of
controls, it is an appropriate form of evidence. For example, the auditor may determine that
unauthorized personnel are not allowed access to computer files by making inquiries of the
person who controls the computer library.
2. Examine Documents, Records and Reports
Many controls leave a clear trail of documentary evidence and evaluation of such documents
helps to judge the operating effectiveness of controls.
3. Observe Control- Related Activities
Other types of control related activities do not leave an evidential trial. For example, separation
of duties relies on specific persons performing specific tasks and there is typically no
documentation of the separate performance. For controls that leave no documentary evidence,
the auditor generally observes them being applied at various points during the year.
4. Re perform Client Procedures
There are also control – related activities for which there are related documents and records, but
their content is insufficient for the auditor’s purpose of assessing whether controls are operating
effectively. For example, assume that prices on sales invoices are to be verified with a standard
price list by client personnel as an internal verification procedure, but no identification of
performance is entered on the sales invoices. In these cases, it is common for the auditor to
actually re perform the control activity to see whether the proper results were obtained. For this
example, the auditor can re perform the procedure by tracing the sales prices to the authorized
price list in effect at the date of the transaction. If no misstatements are found, the auditor can
conclude that the procedure is operating as intended.

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 2. Substantive Tests of Transactions
Substantive tests are procedures designed to test for dollar misstatements directly affecting the
correctness of financial statement balances. Such misstatements (often termed monetary
misstatements) are a clear indication of the misstatement of the accounts. There are three types of
substantive tests; substantive tests of transactions, analytical procedures, and tests of details of
balances. The purpose of substantive tests of transactions is to determine whether all six
transaction – related audit objectives have been satisfied for each class of transactions.
The six transactions related audit objectives will be made:
1. Existence: Recorded Transactions Exist. This objective deals with whether recorded
transactions have actually occurred. Inclusion of a sale in the sales journal when no sale
occurred violates the existence objective. The purpose is to examine whether there has
been recorded transactions which actually doesn’t exist (overstatement)
2. Completeness: Existing transactions are recorded. This objective deals with whether all
transactions that should be included in the journals have actually been included. Failure
to include a sale in the sale journal and general ledger when a sale occurred violates the
completeness objective.
The existence and completeness objectives emphasize opposite audit concerns; existence
deals with potential overstatement and completeness with unrecorded transaction
(understatement)

3. Accuracy: Recorded transactions are stated at the correct amounts. This objective deals
with the accuracy of information for accounting transactions. For sales transactions, there
would be a violation of accuracy objective if the quantity of goods shipped was different
from the quantity billed, the wrong selling price was used for billing, extension or adding
errors occurred in billing or the wrong amount was included in the sales journal.

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 It is important to distinguish between accuracy and existence or completeness. For
example, if a recorded sales transaction should not have been recorded because the
shipment was on consignment; the existence objective has been violated, even if the
amount of the invoice was accurately calculated. If the recorded sale was for a valid
shipment but the amount was calculated incorrectly, there is a violation of the accuracy
objective but not of existence. The same relationship exists between completeness and
accuracy.
4. Classification: transactions included in the client’s journals are properly classified.
Examples of misclassifications for sales are including cash sales as credit sales, and
recording a sale of operating fixed assets as revenue:
5. Timing:- Transactions are recorded on the correct dates. A timing error occurs if
transactions are not recorded on the dates the transactions took place. A sales
transaction, for example, should be recorded on the date of shipment.
6. Posting and Summarization:- Recorded transactions are properly included in the master
files and are correctly summarized. This objective deals with the accuracy of the transfer
of information from recorded transactions in journals to subsidiary records and the
general ledger. For example, if a sales transaction is recorded in the wrong customer’s
record or at the wrong amount in the master file; it is a violation of this objective.
Because the posting of transactions from journals to subsidiary records, the general
ledger, and other related master files is typically accomplished automatically by
computerized accounting systems, the risk of random human error in posting is minimal.
Once the auditor can establish that the computer is functioning properly, there is a
reduced concern about posting process errors.

Remember that both tests of controls and substantive tests of transactions are performed
for transaction in the cycle, not on the ending account balances.

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