FEU MAKATI - INTEGRATED ACCOUNTING REVIEW

Auditing Theory Prof. F. H. Villamin

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MODULE 6C
AUDIT SAMPLING

1. The purpose of Philippine Standard on Auditing (PSA) 530 Redrafted “Audit

Sampling” is to establish standards and provide guidance on the use of audit sampling procedures
and other means of selecting items for testing to gather audit evidence.
2. When designing audit procedures, the auditor should determine appropriate means for selecting items
for testing so as to gather audit evidence to meet the objectives of audit tests.

Selecting Items for Testing to Gather Audit Evidence

3. When designing audit procedures, the auditor should determine appropriate means of selecting items
for testing. The means available to the auditor are:
(a) Selecting all items (100% examination);
(b) Selecting specific items, and
(c) Audit sampling.

4. The decision as to which approach to use will depend on the circumstances, and the application of any
one or combination of the above means may be appropriate in particular circumstances. While the
decision as to which means, or combination of means, to use is made on the basis of audit risk and
audit efficiency, the auditor needs to be satisfied that methods used are effective in providing sufficient
appropriate audit evidence to meet the objectives of the test.

Selecting all items

5. The auditor may decide that it will be most appropriate to examine the entire population of items that
make up an account balance or class of transactions (or a stratum within that population). 100%
examination is unlikely in the case of tests of control; however, it is more common for substantive
procedures. For example, 100% examination may be appropriate when the population constitutes a
small number of large value items, when both inherent and control risks are high and other means do
not provide sufficient appropriate audit evidence, or when the repetitive nature of a calculation or other
process performed by a computer information system makes a 100% examination cost effective.

Selecting Specific Items

6. The auditor may decide to select specific items from a population based on such factors as knowledge
of the client’s business, preliminary assessments of inherent and control risks, and the characteristics
of the population being tested. The judgmental selection of specific items is subject to non-sampling
risk. Specific items selected may include:
a) High value or key items. The auditor may decide to select specific items within a population
because they are of high value, or exhibit some other characteristic, for example items that are
suspicious, unusual, particularly risk-prone or that have a history of error.
b) All items over a certain amount. The auditor may decide to examine items whose values exceed
a certain amount so as to verify a large proportion of the total amount of an account balance or
class of transactions.
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c) Items to obtain information. The auditor may examine items to obtain information about matters
such as the client’s business, the nature of transactions, accounting and internal control systems.
d) Items to test procedures. The auditor may use judgment to select and examine specific items to
determine whether or not a particular procedure is being performed.

7. While selective examination of specific items from an account balance or class of transactions will often
be an efficient means of gathering audit evidence, it does not constitute audit sampling. The results
of procedures applied to items selected in this way cannot be projected to the entire population. The
auditor considers the need to obtain appropriate evidence regarding the remainder of the population
when that remainder is material.

Audit Sampling
8. The auditor may decide to apply audit sampling to an account balance or class of transactions. Audit
sampling can be applied using either non-statistical or statistical sampling methods.

The following three conditions must be met for an application to be classified as an audit sampling:
1. Less than 100 % of the items composing the population must be examined.
2. The results of the sample must be projected to the population being examined.
3. The projected results must be compared to some existing criterion.

Definition of Terms

a. “Audit sampling” (sampling) involves the application of audit procedures to less than 100% of items
within an account balance or class of transactions such that all sampling units have a chance of
selection. This will enable the auditor to obtain and evaluate audit evidence about some characteristic
of the items selected in order to form or assist in forming a conclusion concerning the population from
which the sample is drawn. Audit sampling can use either a statistical or a non-statistical approach.
Auditors use audit sampling in one of the two situations during their examination:

1. Studying and evaluating the client’s internal control

2. Performing substantive procedures on account balances and classes of transactions.

b. “Error” means either control deviations, when performing tests of control, or misstatements,
when performing substantive procedures. Similarly, total error is used to mean either the rate
of deviation or total misstatement.

1. Deviation – difference between what was expected, based on the documentation of

controls, and what was actually occurred. Deviations are stated in terms of percentages.
2. Misstatement – difference between what the amount computed by the auditor and the amount
actually recorded or reflected in the accounting records. Misstatements are stated in terms of
monetary amount.

c. “Anomalous error” means an error that arises from an isolated event that has not recurred other
than on specifically identifiable occasions and is therefore not representative of errors in the
population.

d. “Population” means the entire set of data from which a sample is selected and about which the
auditor wishes to draw conclusions. For example, all of the items in an account balance or a class of
transactions constitute a population. A population may be divided into strata, or sub-populations,
with each stratum being examined separately. The term population is used to include the term
stratum.
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e. “Sampling risk” arises from the possibility that the auditor’s conclusion, based on a sample may be
different from the conclusion reached if the entire population were subjected to the same
audit procedure.

f. “Non-sampling risk” arises from factors that cause the auditor to reach an erroneous conclusion
for any reason not related to the size of the sample. For example, most audit evidence is
persuasive rather than conclusive, the auditor might use inappropriate procedures, or the auditor
might misinterpret evidence and fail to recognize an error.

g. “Sampling unit” means the individual items constituting a population, for example checks listed
on deposit slips, credit entries on bank statements, sales invoices or debtors’ balances, or a monetary
unit.

h. “Statistical sampling” means any approach to sampling that has the following characteristics:

(a) Random selection of a sample; and

(b) Use of probability theory to evaluate sample results, including measurement of sampling risk.

A sampling approach that does not have characteristics (a) and (b) is considered non-
statistical sampling.

i. “Stratification” is the process of dividing a population into subpopulations, each of which is a group of
sampling units which have similar characteristics (often monetary value).

j. “Tolerable error” means the maximum error in a population that the auditor is willing to accept

Risks in Sampling
When performing audit procedures, the auditor is faced with an uncertainty of not detecting material errors
in an account balance or class of transactions. This uncertainty arises because of sampling and non-
sampling risks.

1. Sampling risk
Sampling risk refers to the possibility that the auditor’s conclusion, based on a sample may be different
from the conclusion reached if the entire population were subjected to the same audit procedures.

This exists because the sample selected for testing may not be truly representative of a
population.

This is an inherent part of sampling that result from testing less than the entire population. It is the risk
of wrong conclusion from the sample.

There are two types of sampling risk that could adversely affect the audit. The alpha risk and the beta
risk.

a) Alpha Risk (Type I ) is the risk the auditor will conclude,

a) In the case of tests of control, that internal control is not reliable when in fact it is effective and
can be relied upon (risk of under reliance or risk of assessing control risk too high); or
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b) In the case of substantive test, that material misstatement exists in an account balance or
transaction class when in fact such misstatement does not exist (risk of incorrect rejection).

This type of sampling risk results in an auditor performing audit procedures more than what is
necessary, thus affecting audit efficiency

b) Beta Risk (Type II) is the risk the auditor will conclude,
a) In the case of tests of control, the internal control is reliable when in fact it is not effective and
cannot be relied upon (risk of over reliance or risk of assessing control risk too low); or

b) In the case of substantive test, the material misstatement does not exist when in fact material
misstatement does not exist (risk of incorrect acceptance).

This type of sampling risk results in an auditor performing audit procedures less than what is
necessary thereby affecting the auditor’s ability to detect material misstatements in the financial
statements. Beta risk affects the audit effectiveness.

Components of Sampling Risk

Audit Tests Audit Efficiency Audit Effectiveness
Tests of Controls Risk of assessing control risk Risk of assessing control risk
too high too low
Risk of under reliance Risk of over reliance
Substantive Tests Risk of incorrect rejection Risk of incorrect acceptance
Statistical Term Alpha risk Beta risk

2. Non-sampling risk
Non-sampling risk refers to the risk that the auditor may draw incorrect conclusions about the account
balance or class of transactions because of human errors such as, application of inappropriate audit
procedures, failure to recognize errors in the sample tested, and misinterpretation of evidence obtained.
This includes all aspects of audit risk that are not due to sampling.

This occurs when audit tests do not uncover existing exceptions in the sample.

Controlling the Risks

The only way to eliminate sampling risk is to examine the entire population. Doing this, however, would
not be feasible because of time and cost constraints. Accordingly, auditors do not normally attempt to
eliminate sampling risk. Instead, auditors control sampling risk by
1. Increasing the sample size; and
2. Using an appropriate sample selection method.

By increasing the sample size and carefully selecting the sample, the sample becomes more representative
of the population, thus, decreasing the sampling risk.
Non-sampling risk, on the other hand, is something that can not be eliminated even if the auditor examines
the entire population. This risk, however, can be minimized by
1. Proper planning; and
2. Adequate direction, review, and supervision of the audit team.
General Approaches to Audit Sampling
There are two sampling approaches that can be used by the auditor to gather sufficient appropriate
evidence; the statistical and non-statistical sampling.
1. Statistical Sampling is a sampling approach that
a. Uses random based selection of sample; and
b. Uses the law of probability to measure sampling risk and evaluate sample results.
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2. Non-statistical sampling (Judgmental) , is a sampling approach that purely uses auditor’s

judgment in estimating sampling risks, determining sample size, and evaluating sample results. The
auditor evaluates the results of an audit sample without using statistical theory to measure the
sampling risk.

Both statistical and non-statistical sampling methods are acceptable. Both approaches will require the use
of auditor’s judgment in designing and selecting the sample, in performing audit procedures and in
evaluating the results. Most of all, both approaches cannot assure that the sample will be representative
of the population.

The choice between a statistical and a non-statistical sampling plan is based primarily on the auditor’s
assessment of the relative costs and benefits.

The only difference between the two methods is that statistical sampling allows auditor to measure or
quantify the sampling risks by using mathematical formula.

Advantages of Statistical Sampling

1. Design an efficient sample;
2. Measure the sufficiency of evidence obtained; and
3. Objectively evaluate the sample results.
4. Quantify sampling risk

Disadvantages of Statistical Sampling

1. Danger of accepting statistical evidence at face value, without sufficient skepticism.
2. Cost of statistical sampling could exceed the benefits.
3. May be less appropriate in some cases than non-statistical sampling or other audit procedures for
gathering evidence.

Audit Sampling Plans

Audit sampling may be used when performing tests of controls or substantive tests. When
statistical sampling is used, the auditor may use either attribute or variable sampling plan.

1. Attribute sampling
a. This is a sampling plan used to estimate the frequency of occurrence of a certain characteristic in
a population (occurrence rate).
b. It is generally used when performing tests of controls to estimate the rate of deviations from
prescribed internal control policies or procedures.

2. Variable sampling
a. This is a sampling plan used to estimate a numerical measurement of a population such as peso
value.
b. It is generally used in performing substantive tests to estimate the amount of misstatements
in the financial statements.

Basic Steps in Audit Sampling

The following seven-step procedure used in any sampling application:
1. Determine the objective of sampling.
2. Define the characteristics of interest.
3. Define the population.
4. Determine the sample size.
5. Select sample items.
6. Measure sample items.
7. Evaluate the sample results.
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1 – 3 Planning
4 – 6 Performing
7 Evaluating

1 – 3 Planning

In the planning stages, auditors determine the objective of the sampling application and define the
characteristic of interest and the population.

Attribute sampling – the objective is to assess the operating effectiveness of a key control, the characteristic
of interest is the extent to which the control is functioning effectively (performed by client personnel), and
the population includes all possible applications of the control by client personnel.

Variable sampling – the objective is to determine an extent of the misstatement in an account balance or
class of transactions, the characteristic of interest is the extent of misstatement in the account balance or
class of transaction, and the population includes all components or transactions composing the account
balance or class of transaction.

Performing

4. Determine the sample size

In either type of sampling application, four (4) key factors affect the auditor’s determination of sample size:
1. Population size
2. Expected deviation rate (or expected error)
3. Tolerable deviation rate (or tolerable error)
4. Auditor’s acceptable exposure to sampling risks.

For certain types of variable sampling application, the population variability also affects the sample size.

Factors affecting sample size

Factor Effect on sample size

1. Population size Direct (as population size increases, sample size increases)
2. Expected deviation rate
(Expected error) Direct (as expected deviation rate or expected error
increases, sample size increases)

3. Tolerable deviation rate Inverse (as tolerable deviation rate or tolerable error
increases, sample size decreases)

4. Sampling risk Inverse (as acceptable sampling risk increases, sample size
decreases)

5. Population variability Direct (as variability increases, sample size increases)

5. Select sample items

Once the sample has been determined, the sample needs to be selected from the population.
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Sample Selection method

The auditor should select items for the sample with the expectation that all sampling units in the population
have a chance of selection. PSA 530 Redrafted has identified three principal methods of selecting samples
namely, (a) random number selection, (b) systematic selection, and (c) haphazard selection.

a. Simple Random Sample selection

Under this method, the auditor selects the sample by matching random numbers, generated by a
random number table or a computer software generator, with the population numbering system such
as document number. An advantage of this selection technique is that it gives each item in the
population an equal opportunity to be selected.

b. Systematic Sample selection

Another method of selecting sample that is easier to use compared to random number selection is the
systematic selection. This method involves determining a constant sampling interval and then selects
the sample based on the size of that interval.

c. Haphazard selection
When using this method, the sample is selected without following an organized or structured technique.
Haphazard selection is useful for non-statistical sampling, but it is not used for statistical sampling
because the auditor cannot measure the probability of an item being selected when using this method.

Other sample selection method

d. Block selection or cluster sampling

This involves selecting a series of contiguous (or adjacent) items from the population.
Block selection is less desirable because it is difficult to efficiently obtain a representative sample;
ordinarily, a relatively large number of blocks needs to be selected to be representative.

e. Stratified sampling
In addition, the auditor may divide or stratify the population into meaningful groups in order to decrease
the effect of variance within the population. When selecting a stratified sample, the sample size should
be determined for each stratum and selected from that stratum. Stratification is useful to the auditor
when performing substantive tests because
1. It decreases the effect of variance in the population and as a result, decreases the sample
size, and
2. It allows the auditor to give more emphasis to those items with higher monetary value.

f. Value weighted selection

Like the other sample selection methods, value weighted selection also gives each item in the
population an opportunity to be selected. However, the probability of an item to be selected, in this
method of selection, is directly proportional to the monetary value of such item.

Under value weighted selection, each peso is treated as one sampling unit. For example, if the auditor
plans to select one customer from a total accounts receivable balance of P1,000,000, a customer’s
account balance of P100,000 will have a 10% (P100,000 ÷ P 1,000,000) probability of being selected.

This method of sample selection is similar to stratified sampling in that large monetary values are given
greater representation in the sample and it is appropriate when the auditor anticipates overstatement
errors because the greater the overstatement in an account, the greater the probability that the account
will be selected and the overstatements detected.
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In selecting the sample and applying the appropriate audit procedures, the auditor may encounter the
following situations.

1. Voided documents. The auditor may occasionally select a voided or cancelled document in a
sample. If the document has been properly voided, such document should be replaced by another
sample item.

2. Missing documents. If the auditor encounters missing document and he is unable to determine
whether the control has been properly performed, such item should be treated as a deviation for
the purpose of evaluating sample results.

6. Measure the sample items

Once the sample size has been determined and the sample has been selected, the next step is
to measure the sample items. It is at this point that non sampling risk can occur.

Other Sampling Applications for Tests of Controls

1. Sequential Sampling
Sequential sampling can be used as an alternative form of testing controls when an auditor expects
very few deviations within the population.
Under this method, the auditor does not use fixed sample size. It is sometimes called stop-or-go
sampling because after testing the sample, the auditor makes a decision of whether to stop or go on
with the sampling plan.

2. Discovery Sampling
This form of attribute sampling is most appropriate when no deviations are expected in the
population and therefore even one deviation would cause concern. This is normally used when the
auditor suspects that an irregularity might have been committed. Under this method, the auditor
determines a sample size sufficient to discover at least one deviation to confirm whether an
irregularity has occurred.

7. Evaluating the Sample Results – Tests of Control

When evaluating sample results, both the qualitative and the quantitative factors of deviation should
be considered. These are some general guidelines that may be used when evaluating sample results
for tests of controls.

1. Determine the sample deviation rate.

a. The sample deviation rate is computed by dividing the number of deviations found in the
sample by the sample size.
b. This sample deviation rate represents the auditor’s best estimate of the deviation rate in
the population.

2. Compare the sample deviation rate with the tolerable deviation rate and draw an overall
conclusion about the population.

a. The next step is to compare the sample deviation rate with tolerable deviation rate.

This comparison may result to the following situations:

▪ The sample deviation rate exceeds the tolerable deviation rate.

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This means that the sample results do not support the auditor’s planned degree of reliance on
internal control. Hence, control risk will be assessed at a high level and more extensive substantive
tests should be performed.

▪ The sample deviation rate is less than the tolerable deviation rate.

If the sample deviation rate is less than the tolerable rate, the auditor should consider the allowance
for sampling risk – that is, the possibility that these sample results could have occurred even if the
actual population deviation rate is higher than the tolerable rate.

Upper Deviation Rate = Sample Deviation Rate + Allowance for Sampling Risk

3. Compare upper deviation rate and the tolerable rate of deviation and evaluate the effectiveness of
a control accordingly.

a. If Upper Deviation Rate < or = Tolerable Deviation Rate

It is implied that a control is effective and the results would support assessing control
risk below the maximum or 100%.

b. If Upper Deviation Rate > Tolerable Deviation Rate

It would suggest that a control is not effective and the results would support assessing control
risk at maximum level or 100%.

7. Evaluating the Sample Results – Substantive Tests

Evaluating sample results for substantive tests will involve the following steps:
1. Project the misstatements to the population

After performing the audit procedures to the sample, the auditor may have identified
misstatements in the sample selected. It is important to note that such misstatements are valid
only in so far as the sample selected is concerned. Hence, the auditor should project these
misstatements to the population to determine whether the account balance is materially misstated.
Projecting misstatements can be accomplished using:
a) Mean per unit estimation - a classical variable sampling technique that projects the sample
average to the total population by multiplying the sample average by the number of items in
the population.
1. Determine audit values for each sample item.
2. Calculate the average audit amount.
3. Multiply this average audit amount times the number of units in the population to obtain
the estimated population value.
b) Difference estimation - a classical variable sampling technique that uses the average
difference between audited amounts and individual recorded amounts to estimate the
audited amount of a population and an allowance for sampling risk.
1. Determine audit values for each sample item.
2. Calculate the difference between the audit value and book value for each sample item.
3. Calculate the average difference.
4. Determine the estimated population value by multiplying the average difference by the
total population units and adding or subtracting this value from the recorded book value.
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c) Ratio estimation - a classical variable sampling technique that uses the ratio of audited
amounts in the sample to estimate the total peso amount of the population and an allowance
for sampling risk.
1. Determine the audit values for each sample item.
2. Calculate the ratio between the sum of sample audit values and sample book values.
3. Determine the estimated population value by multiplying the total population book value
times this ratio.
d) Regression approach is similar to the difference and ratio approaches. This approach has
the effect of using both the average ratio and the average difference in calculating an
estimate of the total amount of the population.

2. Compare the projected misstatements together with the tolerable misstatements and
draw an overall conclusion.

After projecting the sample misstatements to the population, the auditor will have to
compare the projected misstatement with the tolerable misstatement.
If the projected misstatement is greater than the tolerable misstatement, the auditor will
conclude that the account balance is materially misstated. In this case, the auditor may:
a) Examine additional units;
b) Perform suitable alternative procedures, or
c) Request the client to adjust the account balance.

8. Documenting the Sampling Procedures.

Comparison of PPS Sampling to Classical Variable Sampling

Advantages of PPS Sampling

1. Generally easier to use.
2. Size of sample not based on variation of audited amounts.
3. Automatically results in a stratified sample.
4. Individually significant items are automatically identified.
5. Usually results in a smaller sample size if no misstatements are expected.
6. Can be easily designed and sample selection can begin before the complete population is available.

Advantages of CVS Sampling

1. May result in a smaller sample size if there are many differences between audited and book values.
2. Easier to expand sample size if that becomes necessary.
3. Selection of zero balances does not require special sample design consideration.
4. Inclusion of negative balances does not require sample design consideration.

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