A5: Audit Sampling

Question 1

What is the difference between nonstatistical sampling and statistical sampling?

Answer 1

Statistical sampling:

• Uses laws of probability for selection and evaluation of a sample.
• Allows for quantification of audit risk and sufficiency of audit evidence

Nonstatistical sampling:

• Does not utilize statistical models in calculations
• Auditors use their judgment to determine sample sizes to evaluate the selected samples.

Question 2

When is professional judgment necessary in the use of statistical or nonstatistical sampling by an auditor?

Answer 2

The auditor must use professional judgment to:

• Define the population and sampling unit
• Select the appropriate sampling method
• Evaluate whether the audit evidence is appropriate
• Evaluate the nature of deviations or errors
• Consider sampling risk
• Evaluate sample results and project to the population

Question 3

Define sampling risk.

Answer 3

Sampling risk is the risk that the auditor’s conclusion based on a sample is different from the conclusion that would have been reached if the tests had been applied to all items in the population.

Question 4

Define the two aspects of sampling risk for tests of controls.

Answer 4

Risk of assessing control risk too low:
Deciding the control is more effective/reliable than it really is; affects audit effectiveness.

Risk of assessing control risk too high:
Deciding the control is less effective/reliable than it really is; affects audit efficiency.

Question 5

ID two aspects of sampling risk that the auditor would be concerned with when performing substantive testing.

Answer 5

Risk of incorrect acceptance:
Deciding from the sample that the balance is correct when it is really materially misstated; affects audit effectiveness

Risk of incorrect rejection:
Deciding from the sample that the balance is materially misstated when it is really correct; affects audit efficiency.

Question 6

What is the relationship b/t sampling risk and reliability (confidence level)?

Answer 6

Sampling risk + confidence level = 100%

Question 7

What is attribute sampling?

Answer 7

Attribute sampling is a statistical sampling method used to estimate a rate of occurrence in a sample. It is used in tests of controls.

Question 8

Define tolerable deviation rate (for attribute sampling) and tolerable misstatement (for variables sampling).

Answer 8

Tolerable deviation rate: The maximum rate (%) of deviation from a control procedure that the auditor is willing to accept while still relying on the control.

Tolerable misstatement: The largest amount of misstatement the auditor believes can exist in a balance or class of transactions w/o causing the F/S to be material misstated.

Question 9

What factors affect sample size for an attribute sampling application?

Answer 9

• Risk of assessing control risk too low (inverse relationship)
• Tolerable deviation rate (inverse relationship)
• Expected deviation rate (direct relationship)

Question 10

What rates are compared in drawing a conclusion about an attribute sampling application?

Answer 10

The auditor compares the upper deviation rate to the tolerable deviation rate in drawing conclusions about an attribute sampling application. If the upper deviation rate exceeds the auditor’s tolerable deviation rate, the auditor will not rely on the control. (The upper deviation rate is the sample deviation rate plus an allowance for sampling risk.)

Question 11

What factors affect sample size for a variables sampling application?

Answer 11

• Standard deviation or population variability (direct relationship)
• Tolerable misstatement (inverse relationship)
• Acceptable level of risk (inverse relationship)
• Expected size and frequency of misstatements (direct relationship)
• Assessed level of risk (direct relationship)

Question 12

Describe variables sampling.

Answer 12

Variables sampling is a statistical method used to estimate the numerical amount of a population. It may be used to substantiate MGT’s assertions in the F/S by determining whether amounts are reasonable. Often, this is accomplished by developing independent estimates of F/S amounts. Variable sampling is used primarily in substantive testing.

Question 13

What amounts are compared in drawing a conclusion about a variables sampling application?

Answer 13

The auditor compares the client’s book value to the calculated range in a variables sampling application. If the recorded book value is within the acceptable rang, the book value is considered fairly stated. (The calculated range is the point estimate, as determined from the sample, plus/minus an allowance for sampling risk.)

Question 14

What is discovery sampling?

Answer 14

Discovery sampling is a type of attribute sampling used when the expected deviation rate is zero or near zero.

Question 15

What are the sampling plans commonly used for variables estimation?

Answer 15

Mean-per-unit estimation: The sample mean is multiplied by the number of items in the population to estimate population value.

Ratio estimation: The ratio b/t book value and audited value (from a sample) is used to estimate population value.

Difference estimation: The difference b/t book value and audited value (from a sample) is used to estimate population value.

Question 16

Define Probability-Proportional-to-Size (PPS) sampling.

Answer 16

PPS sampling is a hybrid sampling technique that used attribute sampling theory to express a conclusion in dollar amounts rather than as a rate of occurrence. The sampling unit is defined as an individual dollar in a population, which creates the effect of stratified sampling (the unit’s chance of being selected increases as its amount increases).

Question 17

What are the advantages and disadvantages of using PPS sampling?

Answer 17

Advantages: Automatic stratification; efficient (smaller sample)

Disadvantages: May require special considerations for negative, zero, and understated balances

Question 18

How is the sampling interval determined in a PPS sampling application?

Answer 18

Sampling interval = Tolerable misstatement/reliability factor

(The reliability factor comes from a table and is based on the risk of incorrect acceptance.)

Question 19

What is a control deficiency?

Answer 19

A control deficiency exists when the design or operation of a control does not allow MGT or employees, in the normal course of performing their assigned functions, to prevent or detect/correct misstatements on a timely basis.

Question 20

What is a significant deficiency?

Answer 20

A significant deficiency is a deficiency, or a combination of deficiencies, in I/C over financial reporting that is less sever that a material weakness, yet important enough to merit attention by those charged with governance (responsible for oversight of the company’s financial reporting).

Question 21

What is a material weakness?

Answer 21

A material weakness is a deficiency, or a combination of deficiencies, in I/C over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim F/S will not be prevented or detected/corrected on a timely basis.

Question 22

What is the auditor’s responsibility w/ respect to control deficiencies identified during an audit of a nonissuer?

Answer 22

• The auditor has a responsibility to evaluate control deficiencies identified during the audit to determine whether they represent significant deficiencies or material weaknesses.
• Significant deficiencies and material weaknesses should be communicated in writing to MGT and those charged w/ governance w/in 60 days of the report release date.
• The communication w/ MGT and those charged w/ governance should be restricted use.

Question 23

What is an integrated audit. When is an integrated audit required?

Answer 23

An integrated audit requires the auditor to audit both the F/S and I/C over financial reporting. The two audits must be performed together, and two opinions (one on the F/S and one on effectiveness of I/C) will be rendered. An integrated audit is required:

1. For all audits of issuers.
2. When an auditor is engaged to examine the I/C of a nonissuer.

Question 24

How are control deficiencies, significant deficiencies, an material weaknesses communicated by the auditor to the issuer in an integrated audit?

Answer 24

All I/C deficiencies over financial reporting that were identified during the audit should be communicated to MGT in writing. The audit committee should be informed when the communication was made.

Any significant deficiencies identified during the audit should be communicated in writing to the audit committee.

Any material weaknesses identified during the audit should be communicated in writing to both MGT and the audit committee prior to the issuance of the auditor’s report on I/C over financial reporting.

Question 25

What are the three primary purposes for obtaining written representations from MGT?

Answer 25

• To confirm representations explicitly or implicitly given to the auditor.
• To indicate and document the continuing appropriateness of such representations
• To reduce the possibility of misunderstanding concerning matters that are the subject of the representations