Chapter 5: Audit Sampling and Communications

Question 1

what is the difference between non-statistical 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

Non-statistical sampling:

• does not utilize statistical models in calculations
• Auditors use their judgement 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 2 aspects of sampling risk for tests of controls

Answer 4

1. Risk of assessing control risk too low:
   deciding the control is more effective/reliable than it really is; affects audit effectiveness
2. Risk of assessing control risk too high:
   deciding the control is less effective/reliable than it really is; affects audit efficiency

Question 5

Identify 2 aspects of sampling risk that the auditor would have concerned with when performing substantive testing

Answer 5

1. Risk of incorrect acceptance:
   deciding from the sample that the balance is correct when is really materially misstated; affects audit effectiveness
2. Risk of incorrect rejection:
   deciding form the sample that the balance is materially misstated when it is really correct; affects audit efficiency

Question 6

What is the relationship between 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 without causing the financial statements to be materially misstated.

Question 9

what factors affect sample size for an attribute sampling application?

Answer 9

the following factors affect sample size in an attribute sampling application:

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

Question 10

what rates are compared in drawing 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

the following factors affect the sample size in a variables sampling application:

• standard deviation or population variability (direct relationship)
• tolerable misstatement (inverse)
• acceptable level of risk (inverse)
• expected size and frequency of misstatements (direct)
• assessed level of risk (direct)

Question 12

describe Variables Sampling

Answer 12

Variables Sampling is a statistical sampling method used to estimate the numerical amount of a population. It may be used to substantiate management’s assertions in the financial statements by determining whether amounts are reasonable. Often, this is accomplished by developing independent estimates of financial statement 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 range, the book value is considered fairly stated. (the calculated range is the point estimate, as determined form 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 between book value and audited value (from a sample) is used to estimate population value
Difference estimation: the difference between book value and audited value (from a sample) is used to estimate population value

Question 16

What is a control deficiency?

Answer 16

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

Question 17

what is a significant deficiency?

Answer 17

a significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those charged with governance (responsible for oversight of the company’s financial reporting)

Question 18

what is a material weakness?

Answer 18

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

Question 19

what is the auditor’s responsibility with respect to control deficiencies identified during an audit of a nonissuer?

Answer 19

• 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 management and those charged with governance within 60 days of the report release date.
• the communication with management and those charged with governance should be restricted use.

Question 20

what is an integrated audit. when is an integrated audit required?

Answer 20

an integrated audit requires the auditor to audit both the financial statements and internal control over financial reporting. The two audits must be performed together, and two opinions (one on the financial statements and one on the effectiveness of internal control) will be rendered. An integrated audit is required:

1. for all audits of issuers
2. when an auditor is engaged to examine the internal control of a nonissuer

Question 21

describe the top-down approach used to select controls to test for issuer/nonissuer clients

Answer 21

The top-down approach includes the following chronological levels:

• Financial statement level - the auditor evaluates overall risks
• Entity level - the auditor identifies and tests controls pertaining to: Control environment, management override, monitoring the results of operations and other controls, period-end financial reporting, centralized operations
• Accounts, Disclosure, and Assertions level - the auditor evaluates qualitative and quantitative risk factors to identify significant accounts, disclosures, and assertions for which there is a reasonable possibility of material misstatement. Once identified, the controls are tested.

Question 22

what is the accountant’s responsibility with respect to control deficiencies identified during an engagement to examine the internal control of a nonissuer?

Answer 22

Significant deficiencies and material weaknesses should be communicated in writing to management and those charged with governance by the report release date.
Control deficiencies that are not significant deficiencies or material weaknesses should be communicated in writing to management within 60 days of the report release date
A material weakness results in an adverse opinion

Question 23

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

Answer 23

All internal control deficiencies over financial reporting that were identified during the audit should be communicated to management 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 management and the audit committee prior to the issuance of the auditor’s report on internal control over financial reporting

Question 24

How does the extent of testing of internal controls differ between a financial statement audit and an examination of internal control for nonissuers?

Answer 24

the extent of testing of internal controls for a financial statement audit is more limited than in an internal control examination

When rendering an opinion on internal control for an examination of internal controls, the auditor should obtain evidence regarding the effectiveness of selected controls over all relevant assertions. This level of testing is not require for a financial statement audit.