MCQ 5 Flashcards
An auditor established a $60,000 tolerable misstatement for an asset with an account balance of $1,000,000. The auditor selected a sample of every twentieth item from the population that represented the asset account balance and discovered overstatements of $3,700 and understatements of $200. Under these circumstances, the auditor most likely would conclude that
A.
There is an unacceptably high risk that the actual misstatements in the population exceed the tolerable misstatement because the total projected misstatement is more than the tolerable misstatement. (50%)
B.
There is an unacceptably high risk that the tolerable misstatement exceeds the sum of actual overstatements and understatements. (5%)
C.
The asset account is fairly stated because the total projected misstatement is less than the tolerable misstatement. (30%)
D.
The asset account is fairly stated because the tolerable misstatement exceeds the net of projected actual overstatements and understatements
Choice A (Correct): With a detected overstatement of $3,700 and a detected understatement of $200, the auditor would conclude that the sample has a total misstatement of $3,900. If the sample represents 1/20 of the population, the $3,900 must be multiplied by 20 to find the $78,000 total projected misstatement in the population, which exceeds the tolerable misstatement of $60,000, suggesting that the error in the population will be unacceptably high.
Note: There are several ways to project misstatements from a sample to a population, and textbooks do not all agree on which is most appropriate. Whether you net or total the overstatements and understatements here does not change the answer.
Which of the following is the primary objective of probability proportional to sample size?
A.
To identify overstatement errors. (57%)
B.
To increase the proportion of smaller-value items in the sample. (23%)
C.
To identify items where controls were not properly applied. (14%)
D.
To identify zero and negative balances
A
Overstating assets or understating liabilities is generally done to improve an entity’s financial position. Overstatements tend to be performed in large amounts and understatements in smaller amounts. For example, overstating a $2,000 asset transaction may be recorded as $20,000, whereas an understated liability for the same amount could be recorded as $20.
Probability proportional to size (PPS) is a sample selection method in which items are chosen based on their dollar value; therefore, larger (not smaller) values have a greater chance of selection (Choice B). An advantage of this method is that it helps to identify overstatement errors.
(Choice C) PPS sampling is a variables sampling method used to reach conclusions about reasonableness of dollar amounts. In contrast, control testing is normally performed using attribute sampling, which is used to reach conclusions about the rate of occurrence for a specific qualitative characteristic (eg, properly signing checks).
(Choice D) Classical variables sampling treats individual items as a sampling unit, regardless of dollar amount. Because dollar amount is not factored into the method, it can be easily applied to identify zero and negative balances, which is useful to test for understatements.
Things to remember:
Probability proportional to size (PPS) is a sample selection method in which items are chosen based on their dollar value. Because larger values have a greater chance of selection, PPS is used to test for overstatements. In contrast, classical variables sampling treats individual items as a sampling unit, regardless of dollar amount, which is useful to test for understatements.
Which of the following characteristics most likely would be an advantage of using classical variables sampling rather than probability-proportional-to-size (PPS) sampling?
A.
The selection of negative balances requires no special design considerations. (53%)
B.
The sampling process can begin before the complete population is available. (16%)
C.
The auditor need not consider the preliminary judgments about materiality. (10%)
D.
The sample will result in a smaller sample size if few errors are expected.
A
There are two statistical sampling plans primarily used for substantive testing. These are classical variables sampling (CVS) and monetary unit sampling (MUS). When MUS is applied using probability proportional to size (PPS), the population is automatically stratified; items are selected proportional to dollar values (ie, larger values have a greater chance of selection). Zero and negative balances require special attention because their chance of selection is reduced.
CVS, by contrast, treats each item as a sample unit, regardless of dollar amount. Because dollar amount is not factored into the method, all items have an equal chance of being selected. Therefore, zero and negative balances require no special consideration.
(Choice B) Because the standard deviation is needed to apply CVS, it requires the complete population. In contrast, PPS does not require such information from the entire population.
(Choice C) Both PPS and variables sampling require a preliminary judgment about materiality because the materiality level determines the sample size.
(Choice D) When using PPS or CVS, there is generally a direct relationship between expected errors and sample size. When many errors are expected, a larger sample size is needed. This is not an advantage.
Things to remember:
Classical variable sampling treats individual items as a sampling unit, regardless of dollar amount; therefore, zero and negative balances do not require special consideration. In contrast, when using probability proportional to size sampling, the population is automatically stratified, and items are selected proportional to dollar values.
An auditor performs attribute sampling to test for proper cancellation of payment vouchers. In a sample population of 100, two vouchers are missing the proper cancellation and one voucher cannot be located. In addition, the auditor selected one voided item and replaced it after determining it was properly voided. The error rate of the sample is
A.
1%
B.
2%
C.
3%
D.
4%
C
When testing controls, auditors look for deviations from control procedures (ie, instances when established processes are not followed). The error rate (ie, sample deviation rate) of a given sample is calculated by dividing the number of deviations by the sample size.
A deviation occurs when items are improperly canceled. If auditors select voided items, they can replace the items only after verifying that they were properly voided in adherence with relevant control procedures. In this scenario, the item that was properly voided and replaced does not constitute a deviation. A lack of documentation is also considered a deviation from the control because there is no evidence that the procedure took place. Therefore, the error rate is 3% (ie, 3 deviations / 100 sampled vouchers).
Things to remember:
When testing controls, auditors look for deviations from control procedures. A deviation occurs when items are improperly cancelled or lack proper documentation showing that control procedures were followed. Items voided in adherence with control procedures are not considered deviations.
Each of the following is a type of known misstatement, except
A.
An inaccuracy in processing data. (20%)
B.
The misapplication of accounting principles. (4%)
C.
Differences between management and the auditor’s judgment regarding estimates. (66%)
D.
A difference between the classification of a reported financial statement element and classification according to generally accepted accounting principles.
Choice C (Correct) and Choices A, B (Incorrect): A known misstatement is a disagreement between the client and the auditor in a circumstance where the auditor believes that the client’s position results in a departure from GAAP. This would be the case if there is a known inaccuracy in processing data as that type of error affects the financial statements. The misapplication of accounting principles and a classification that is different from that required from GAAP would also represent departures. If the auditor disagrees with a client estimate, the auditor will not necessarily conclude that the financial statements are misstated unless the amount estimated by the client is outside of what the auditor considers an acceptable range.
