Sampling- an Audit Tool

Presented by
Mr. Preman Dinaraj,
Prin. Director, RTI, Mumbai.
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 Need
Audit resources- man power or time are very
limited, scarce and costly.
Huge volume of entity records makes it not
possible or even advisable to examine each and
every transaction in audit.
It optimise the available resources without
compromising on the quality of its results.
Hence audit working procedures must prescribe
and rely on an effective system of sampling.
 Sampling tests less than 100% items in a given
population for specified characteristics & imposes
test results on the entire population which can be a
class of transactions or records.
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Advantages
 Saves valuable time, money and effort.
 The results are obtained on the basis of
objective criteria and hence defensible.
 Since sampling size is predetermined, the time
and money spent on individual audits can be
justified.
 Sampling provides more accurate results than
examination of complete population.
 The results can be objectively evaluated and
projected to known limits of reliability.
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Types of Sampling Techniques
 Can be statistical or non-statistical but the governing
principles are the same.
 Require professional judgement in planning, testing
and evaluation stages.

Non Statistical

Techniques

Statistical

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Non-Statistical Sampling
User does not apply statistical
measurements.
Forgoes the advantage of quantifying and
measuring the sampling results and risks.
Technique relies heavily upon the user’s
experience and judgment for conclusions.
One disadvantage- the element of
subjectivity and less precision in the results.

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Statistical Sampling
Relies on the Theory of Probability & provide a
measurable degree of sampling risk.
Has a measurable relationship between the size of
the sample and the degree of risk.
Decide the sample size selection method.
Based on testing & evaluation, the results are
presented mathematically.
Statistical sampling methods control the auditor’s
exposure to sampling risk
Drawback- to convert a statistical conclusion into
a value say 5%.

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Advantages of Statistical Sampling
Ensures that the results are measurable in
terms of the Theory of Probability.
The conclusions arrived at will apply to the
population as a whole.
It provides greater objectivity in sample
selection and audit conclusions.

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Categories of Statistical Sampling

Attribute

Sampling
Categories

Variable

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Attribute Sampling
Requires practitioner to identify the relevant
characteristics or attributes in a population.
Find out what proportion of the population ‘has’
or ‘does not have’ the selected attribute(s).
Then quantify the results & apply it to the
population as a whole, for e.g. 5 times out of 100.
Remember that by merely knowing the proportion
in the population is not enough but also required
to know the value of these ‘deviations’/ ‘errors’.
Widely used in financial audit.

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Variable Sampling
Examines ‘how much’ deviations or
‘errors’ have occurred within the selected
sample.
It provides an estimate based on the
measurement of the average or total value
of a population.
Due to complications in converting the
averages into values, variable sampling is
not generally resorted to in audit.

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Sampling Risk
Risk that the decision made based on the sample
differs from the decision that would have been
made by examining the population
Cause is a non-representative sample
Controlled by:
◦ Determining an appropriate sample size
◦ Ensuring that all items have an equal
opportunity of selection
◦ Mathematically evaluating sample results

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Summary of Sampling Risks
Effectiveness Losses (Major Risk)
◦ Risk of assessing control risk too low
(overreliance) - Attribute
◦ Risk of incorrect acceptance - Variables
Efficiency Losses (Minor Risk)

◦ Risk of assessing control risk too high

(underreliance) - Attribute
◦ Risk of incorrect rejection - Variables

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 Systematic Error vs. Random Error
Systematic Error :
 It has a definite cause and is uni-directional (i.e. either (+) or
(-) which typically reduce the accuracy without necessarily
lowering the result precision.
 To reduce it, identify the source of the error and remove it.
Random Error :
 Arises from inherent limits of any measuring devices and is
bi-directional (being randomly positive or negative) and
cannot be corrected.
 May occur for each measurement in a data set i.e. every time
a data point is taken it could be off target.
 Occur due to a wide variety of largely unpredictable reasons.

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Monetary-Unit or $ Sampling
 Used to assess the amount of monetary misstatement that
may exist in an account balance.
 Also known as dollar-unit or probability-proportional-to-
size sampling has been used for many years and is widely
accepted among auditors.
 MUS requires calculations that introduce the possibility of
error if made manually.
 Can be done on a Microsoft Excel spreadsheet that
automates and enhances the use of MUS and reduces the
chance of errors.
 Using MUS involves three key steps:
1) Determining the proper sample size.
2) Selecting the sample and performing the audit procedures.
3) Evaluating the results and arriving at a conclusion about
the recorded population value.

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Acceptance- Rejection Sampling
 Using random sampling methods draw a sample
of a given size.
Examine it with reference to pre determined error/
deviation criteria & if they are less, accepted.
Otherwise the sample is rejected.
This type of sample allows for only an accept or
reject decision. The various types of acceptance
sampling plans are discussed in detail in the Arkin
text.

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Discovery Sampling
Also referred to as exploratory sampling.
Used where evidence of a single error or
instance of irregularity would call for
intensive investigation.
Discovery sampling is frequently of value
when fraud, avoidance of internal controls,
evasion of regulation or other critical
performance and quality control measures
are in question.

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 Major Steps in Sampling

1. Determine the objective

Planning 2. Define characteristic of interest
3. Define the population
4. Determine sample size
Performing
5. Select the sample
6. Measure sample items
Evaluating 7. Evaluate sample results

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Selecting the Sampling Method
Determine the ‘purpose’ of the sample and the
type of test it will be subjected to.
Understand the Unit’s accounting system, data
capture & retrieval, volume of transaction/ data
reliability.
The type of audit, its extent and intensity.
Ensure that sampling plans & selection techniques
to be used are precisely documented.
Since each sampling method has its practical use
and limitations, the auditor must judge & decide
the method best suited for his audit.

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 Judgmental

Random

Cluster
Sampling
Methods Convenience

Stratified

Systematic

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Test Checking
Done when the number of transactions are large.
Involves checking of a few selected transactions
& based on it forming an opinion.
Must be applied only if satisfied that the entity’s
internal control system is robust & working.
Precautions include:
 Checking of entries of all description.
Conduct random check of selected entries.
Ensure that periods & entries selected for test
check are different for different audits.

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Judgemental Sampling
Most commonly used method in audit.
Auditor relies largely on the previous experience
and knowledge of the Unit.
Sampling done on the basis of ‘test check’ of
selected accounts and is a non-statistical approach.
Involves checking a pre-determined proportion of
the population based on auditor’s judgement.
 Useful for testing small samples and can be
effective, if it is properly designed.
 Drawback - inability to measure sampling risk &
prone to allegations of auditor’s biases. Since the
sample size is generally small, the conclusions
may not be credible and difficult to extrapolate on
the entire population.

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Simple Random Sampling
Requires the entire population to be known before
the sample for testing is selected.
Each and every member of a given population has
an equal chance of being selected and hence
completely free of any bias.
The sample can be easily designed and
interpreted.
Leads to reliable estimates in the population and
reduces the chances of sampling errors.
To ensure reliability, the population listed must be
complete and accurate.

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Cluster Sampling
Selection of subjects are done in groups or
clusters.
Overcomes costs and time constraints associated
with highly dispersed populations & simplifies
selections from the entire multistage population,
e.g. boys and girls studying in schools in a region.
Population assigned to groups or clusters.
Define the clusters, take a random sample &
examine all its components.
Disadvantage- possibility of large sampling errors.

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Stratified Sampling
Identify the population based on shared
homogeneity or similar characteristics into
different stratums e.g. Students and non-students.
Since this method requires samples from each
identified main group to be included, it is more
reliable than random sampling due to the
reduction in sampling errors.
Main difficulty- sample selection is more complex
requiring reliable population information and
estimates involve complex calculations.

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Systematic Sampling
Also called the ‘n’th name selection technique.
Begin by selecting a starting point randomly,
between 1 and ‘n’ and thereafter select every ‘n’th
unit, where ‘n’ is derived by dividing the
population size by the sample size.
Facilitates easy extraction of sample and ensures
cases are spread across the population.
Disadvantage- can be a costly process both in
terms of time and costs & cannot be used where
there is periodicity in population.  

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Convenience Sampling
Relies on data or volunteers readily available.
Useful for preliminary audit examination to
get a general idea of the issue being tested.
The larger the group examined, the more the
information gathered.
Main disadvantage - likelihood of bias & the
sample results cannot be extrapolated to the
entire population.
Hence recommended only during preliminary
audit examination.
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Designing a Sample

Define Sample
Population
Determine
Sample Size
Decide Sample
Sample Selection Method
Designing
Perform Audit
Tests
Project Results
to
Entire Population

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Designing a Sample- (1) Defining the
Sample Population
Ensure all elements within the given population
are represented.
Identify the specification of the target population
clearly and completely.
Above step can be on the basis of the Unit’s data
already available with the auditor. E.g. Monthly
expenditure statements, pay rolls etc.
Identify the sample population & the target
population depending upon the sampling
technique.

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Designing a Sample- (2) Determining the
Sample Size
 Requires consideration of the 5 key factors mentioned
below. All these factors are considered together to achieve
the right balance & objectivity.
(1) Margin of Error (Tolerable error):
 Recognises that sample estimates will not be exact and its
inference to the population will have a margin of error.
 Possible to reduce this margin with better designing and
larger sample sizes.
 The tolerable error is the maximum acceptable error for
certifying that the Unit is following the procedures
properly.
 Requires the auditor to prescribe an ‘upper error limit’
(UEL) which is equal to the rate of control failure that he
is willing to accept.
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(1) Margin of Error (Tolerable error) Contd.:
 At the evaluation stage, the auditor compares the
actual results with the ‘UEL’ to arrive at the
estimate of ‘true error’ for the population.
 The acceptability of the sample results depends
upon the extent of variation between the UEL
and the ‘true error’ and the level of precision
desired in arriving at defensible conclusions i.e.
the higher the precision requirement, the lower
must this variation be and vice versa.
Components of UEL:
 Projected misstatement
 Incremental allowance for sampling risk
 Basic allowance for sampling risk

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Designing a Sample-
(2) Amount of variability: This factor explains the range of
values or opinions in the population. This in turn affects
the accuracy of the results and consequently the size of
sample required when estimating a value. Hence, as the
amount of variability increases, the accuracy of the
estimate decreases requiring larger sample size to be used.
(3) Confidence level: Confidence level states how certain the
auditor is, that the actual population measure is within the
sample estimate and its associated precision level. In other
words, confidence level indicates the likelihood that the
sample results are within the defined precision levels.
Further, confidence level is directly proportional to the
sample size i.e. higher the required confidence level, the
larger the size of the sample required.

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Designing a Sample-
(4) Population size: This provides an indication of the total number of
items in the population. Normally, the sample size is not influenced by
the population size, but by practical limitations such as time, easy
availability of data, competent software etc. Generally, a sample
between 50 and 100 will ensure that the results are sufficiently reliable
though the upper limit may be restricted to 5 percent, especially while
dealing with large volume data. Though case study samples by its very
nature tend to be smaller in size, they still form a defensible and
reliable audit methodology.
(5) Proportion of population: This is useful for attribute sampling. Here,
the proportion of items in the population displaying the pre-
determined attributes is determined rather than the calculation of their
average values. This can be estimated from the information already
known about a population e.g. the proportion of infrastructural
projects having time and (or) cost overruns.

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Designing a Sample- (3) Method for
Sample Selection
 Selection of sample will depend upon the sampling method
proposed to be applied. If the intention is to do non-statistical
sampling, due care must be taken by the auditor to ensure that the
representative sample selected is unbiased by the auditors
perception of the organization or activity being audited. Generally,
sample selection is closely dependent upon the circumstances.
 The first step here is to determine the extent of precision required in
the sample results. If tight precision is required, then simple
random, systematic or cluster sampling can be adopted. If tight
precision is not required, apart from simple random sampling,
judgment and convenience sampling can be resorted to. Audit
software like IDEA is an ideal tool for selection of the sample.

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Designing a Sample- (4) Perform
Substantive Audit Tests
Once the sampling method has been decided,
identified audit tests will have to be done on the
sample to determine the selected sample
characteristics. These audit tests have to be
designed keeping the sampling objective and
population characteristics in mind. He must also
consider the specific objectives of these tests
and define what will constitute an error, before
the examination commences.

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Designing a Sample- (5) Projection of Results

 Interpretation and projection of the test results on the population

is the last critical step in sampling. To arrive at reliable results:
 ·        Define the conditions that constitute an error (with
reference to the audit objectives) at the sample design stage
itself and what the UEL is.
 ·        Evaluate the test results for each characteristic
independently. Also consider the qualitative aspects of the error
like its nature, cause and its likely effect on other phases of
audit.
 ·        Superimpose the error results on the population as a whole
to determine the total possible error in the population and to
determine whether the test results are acceptable or otherwise.
 ·       

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Projection of results
 Then assess the significance of such errors for the entire
population. If it exceeds the UEL, do not derive assurance
from it. Instead, subject a larger population of the relevant
control system to substantive testing and based on the
results obtained, arrive at audit findings. 
 In conclusion, it is important to mention that the reporting
procedure must identify the key factors considered during
the evaluation process. These include the sample size, the
sample selection methodology, the substantive tests
performed and their results along with such parameters
like the precision levels, reliability factor and confidence
levels.

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