CHAPTER TWO: AUDIT TESTING METHODOLOGY

• Chapter Objectives
• After completing this chapter you will be able to:

 Explain the meaning and types of audit sampling and

sample selection methods

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 Audit Sampling
• What is Sampling?
• Audit sampling is the application of an audit procedure
(test of control or substantive testing) to less than
100% of the items within an account balance or class
of transactions for the purpose of drawing a general
conclusion about the account balance or the entire
group of transactions based on the characteristics
detected in the sample.
• Sampling allows an auditor to draw conclusions about
the whole population without incurring more time and
cost of examining every transaction/account

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 Audit Sampling
 When is sampling used?
• Sampling is generally used in field audits
when it is not efficient to review 100% of
the records.
• Sampling may also be used if records are
missing or other circumstances make
reviewing all of the records difficult.

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 Audit Sampling
• Representative Sample
• A representative sample is one in which the
characteristics in the sample of audit interest
are approximately the same as those of the
population.
 There are two risks with regard to sampling:
► Non-sampling risk
► Sampling risk

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 Audit Sampling
 Non-Sampling Risk
• Non-sampling risk is the risk that the audit tests do
not detect existing exception/material misstatement in
the sample.
• The two causes are:
►Auditor failure to recognize exceptions due to
exhaustion, boredom, and lack of understanding of
what to look for.
►Inappropriate or ineffective audit procedures.
 Careful design of audit procedure, proper instruction,
supervision and review are ways to control non
sampling risk
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 Audit Sampling
 Sampling Risk
• Sampling risk is the risk that an auditor
reaches an incorrect conclusion because the
sample is not representative of the population.

• It is an inherent part of sampling that results

from testing less than the entire population.

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 Audit Sampling
• Sampling Risk (cont.)
• This can be controlled by:
► Adjusting the sample size. e.g. increasing
sample size.
► Testing the total population enables
sampling risk to be zero.
► Using an appropriate method of selecting
sample items

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 Audit Sampling
Statistical vs. Non-Statistical Sampling
 Statistical Sampling
• Statistical sampling provides a means of
mathematically evaluating the outcome of the
sampling plan by applying the laws of probability to
measure the likelihood that sample results are
representative of the population.
 Non-Statistical Sampling
• Is solely based on the auditor’s judgment.
• In non-statistical sampling, the auditor does not
quantify sampling risk.

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 Audit Sampling
 Probabilistic Sample Selection
 Probabilistic sample selection selects a sample
in a way that each population item has a
known probability of being included in the
sample and the sample is randomly selected.

 Common types:
• Simple Random sample Selection – all items of
the population have an equal chance of being
selected.
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 Audit Sampling
 Probabilistic Sample Selection (cont.)
• Systematic Sample Selection – auditor
determines an interval and selects items on the
basis of the interval.
• Probability Proportional to Size (PPS) –
probability of selecting an item is proportional
to its recorded amount.
• Stratified Sample – divided population in to
sub-populations and use different selection
criteria for each sub-population
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 Audit Sampling

Illustration of PPS -Accounts receivable population

Popu item (physical unit) Recorded amount Cumulative total

1 $357 $357
2 1281 1638
3 60 1698
4 573 2271
5 691 2962
6 143 3105
7 1425 4530
8 278 4808
9 942 5750
10 826 6576
11 404 6980
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Tamrat Ludego, Hawassa University 7376 11
 Audit Sampling
• Probability Proportional to Size (PPS)
(cont.)
• In the above table the population size is 7376
(the cumulative total) and each dollar has equal
chance of being included in the sample.
• If the auditor wants to select four physical
units, the auditor needs four random numbers
for instance: 6,586, 1,756, 850, and 6,499 . The
physical units are determined by referring to
the cumulative total. These are item 11
containing (6577 to 6980), 4 (1699 to 2271),
2(358 to 1638), and 10 (5751 to 6576)
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 Audit Sampling
Stratification Illustrated
• The process of dividing a population into
subpopulations that have similar
characteristics. Strata must be defined so that
each sampling unit can only be in one stratum.

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 Audit Sampling
• Accounts Receivable Stratification
Str siz Composition of Stratum Sample Selection
atu e
m
1 22 All accounts over $5,000 100%
examination
2 121 All accounts between Simple random
$1,000 and sampling
$5,000
3 85 All accounts under $1,000 Systematic
selection
4 14 All accounts with credit 100% examination
balances
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 Audit Sampling
 non-probabilistic sample selection
 In this case, those sample items that the auditor
believes will provide the most useful
information are selected judgmentally.
 Types of Non-probabilistic Sample Selection
► Direct sample selection – auditor selects
items based on judgmental criteria such as
likelihood of misstatement, characteristics such
as different time periods, or large dollar
amounts.
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 Audit Sampling
Non-probabilistic Sample Selection (cont.)

► Block sample selection – selection of a

number of items in sequence. Auditor must use
several blocks to obtain a representative sample.

► Haphazard sample selection – selection of

items without any conscious bias on the part of
the auditor. Selecting regardless of size, source,
and other distinguishing characteristics.
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 Audit Sampling
• Applications of Sampling in audit: two types

Variables Sampling
Attribute Sampling
(Test of Account
(Test of Controls)
Balances)
The use of sampling
The use of sampling for
for
substantive test on the
compliance testing
client’s account balances
(qualitative
(quantitative
characteristic)
characteristic)
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 Audit Sampling
 Sampling Risk in Attribute Sampling

The Risk of Assessing

The Risk of Assessing
Control Risk Too High (Risk
Control Risk Too Low
of Under – reliance)
(Risk of Over-
Not relying on the internal
reliance)
controls
Relying on internal
when, in fact, the
controls when it is
auditor should rely
not appropriate.
on internal control.

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 Audit Sampling
• Sampling Risk in Variable Sampling

Risk of Incorrect
Rejection Risk of Incorrect
Auditor’s sample Acceptance
Auditor’s sample indicates
indicates that
that the account balance is
the account balance is
fairly stated even though
materially misstated the account balance is
even though it is fairly materially misstated.
stated.

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 Audit Sampling
• The effect of sampling risk on audit efficiency and
effectiveness
Sampling risk The effect on The effect
efficiency on
effectiven
ess
The Risk of Assessing Control Negative Positive
Risk Too High
The Risk of Assessing Control Positive Negative
Risk Too Low
Risk of Incorrect Rejection Negative Positive

Risk of Incorrect acceptance Positive Negative

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 Audit Sampling
• The effect of sampling risk on audit efficiency and
effectiveness (cont.)
• If the auditors incorrectly reject an account
balance/under-rely on controls, their audit lacks
efficiency since they will perform additional audit
procedures that eventually reveal that the account
is not materially misstated/the control is effective.
• If auditors incorrectly accepts an account
balance/over-rely on controls, the effectiveness of
the audit is compromised.
• Therefore, the risk of incorrect acceptance is of the
primary concern to auditors as failure to detect a
material misstatement may lead to accusation of
negligence and to extensive legal liability,
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