LECTURE 7.

AUDIT TESTS AND AUDIT SAMPLING

Objectives
After studying this chapter, you should be able to:
 Understand the nature of Test of controls.
 Understand the general nature of analytical procedures.
 Describe four general analytical procedures.
 Understand the nature of Test of details
 Understand the key concepts related to Audit sampling

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 Contents
 7.1. Overview of audit tests
 7.2. Test of controls
 7.3. Substantive procedures
 7.3.1. Analytical Procedures
 7.3.2. Test of details
 7.4. Audit sampling

7.1. OVERVIEW OF AUDIT TESTS

Types of Audit Tests

Substantive tests
Test of Controls (Substantive
procedures)

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 7.2. TEST OF CONTROLS

 Definition

Tests of controls: Audit procedures designed to evaluate the

operating effectiveness of the entity's internal controls in
preventing, or detecting and correcting, material
misstatements at the assertion level.

• When the auditor believes controls are operating effectively,

the auditor shall perform tests of controls to obtain sufficient
appropriate audit evidence that the controls were operating
effectively at relevant times during the period under audit.

7.2. TEST OF CONTROLS

 Timing to tests of controls

• Tested at year end or all time during the year.

• Some controls may have been tested in prior audits and the
auditor may choose to rely on that evidence of their
effectiveness. If the controls have changed, the test of
control must be tested. In any case, controls should be
tested for effectiveness at least once in every three audits.

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 7.3. SUBSTANTIVE PROCEDURES

 Definition

Substantive procedures: Audit procedures designed to

detect material misstatements at the assertion level.

There are two types of substantive procedures:

• Substantive analytical procedures (for example variance
analysis and ratio analysis)
• Tests of detail (of classes of transactions, account balances
and disclosures, for example vouching amounts back to
invoices, physical inspection of assets)
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7.3. SUBSTANTIVE PROCEDURES

 Analytical procedures

• Analytical procedures (AP) are evaluations of financial

information through analysis of plausible relationships
among both financial and non-financial data.
• AP encompass such investigation as necessary of identified
fluctuations or relationships that differ from expected
values by a significant amount.

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 7.3. SUBSTANTIVE PROCEDURES
 Analytical procedures (cont.)
For FS audit, analytical Procedures are performed in 3 stages:

Preliminary Analytical procedures in

1 planning (compulsory) (ISA 315)

Substantive Analytical procedures as

2 substantive procedures (optional)

3 Review Analytical procedures at the overall

review stage (compulsory) of an audit
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7.3. SUBSTANTIVE PROCEDURES

 Types of Analytical procedures

 Trend analysis
 Ratio analysis
 Reasonableness tests
 Statistical analysis
 Data mining analysis

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 7.3. SUBSTANTIVE PROCEDURES

 Types of Analytical procedures

 Trend analysis
Trend analysis is the analysis of changes in an account
balance over time.

 Trend analysis works best when the account or relationship

is fairly predictable (for example, rent expense in a stable
environment).
 The more stable the operations over time, the more
predictable the relations and the more appropriate the use
of multiple time periods.
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7.3. SUBSTANTIVE PROCEDURES

 Types of Analytical procedures

 Ratio analysis
Ratio analysis is the comparison of relationships between
financial statement accounts, the comparison of an account
with non-financial data or the comparison of relationships
between firms in an industry.

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 7.3. SUBSTANTIVE PROCEDURES

 Types of Analytical procedures

 Ratio analysis (cont.)
 Liquidity: Current ratio
Quick ratio
 Solvency: Debt to equity
Times interest earned
Debt to service coverage
 Profitability: Net profit margin
Gross margin
Return on investment
 Activity: Receivable turnover
Inventory turnover
Asset turnover
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7.3. SUBSTANTIVE PROCEDURES

 Types of Analytical procedures

 Reasonableness testing
Reasonableness testing is the analysis of account balances
or changes in account balances within an accounting period
in terms of their ‘reasonableness’ in light of expected
relationships between accounts.

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 7.3. SUBSTANTIVE PROCEDURES

 Types of Analytical procedures

 Reasonableness testing (cont.)
 Analysis of account balances or changes in account
balances in light of expected relationships between
accounts.
 Involves the development of an expectation based on
financial data, non-financial data or both.

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7.3. SUBSTANTIVE PROCEDURES

 Types of Analytical procedures

 Statistical analysis
 Statistical analysis is the analysis of data using statistical
methods.

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 7.3. SUBSTANTIVE PROCEDURES

 Types of Analytical procedures

 Data mining
 Data mining is a set of computer-assisted techniques that
use sophisticated statistical analysis, including artificial
intelligence techniques, to examine large volumes of data
with the objective of indicating hidden or unexpected
information or patterns.
 For these tests auditors generally use computer aided audit
software (CAATs).

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7.3. SUBSTANTIVE PROCEDURES

 Test of details

 Tests of details of transactions are audit procedures related

to examining the processing of particular classes of
transactions through the accounting systems.
 Tests of details of balances are substantive tests that provide
either reasonable assurance of the validity of a general
ledger balance or identifies a misstatement in the account.

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 For each of the following examples, select the type of
procedure illustrated.
1. Observation of opening the post
A. Test of control
B. Substantive procedure
2. Calculation of the gross profit margin and comparison with
that of the previous accounting period
C. Test of control
D. Substantive procedure
3. Reviewing invoices paid for evidence of authorisation
E. Test of control
F. Substantive procedure
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For each of the following examples, select the type of procedure

illustrated.
1. Observation of inventory counting at the year end
A. Test of control
B. Substantive procedure
2. Calculation of the quick ratio and comparison with that of the
previous accounting period
C. Test of control
D. Substantive procedure
3. Inquiring into the operation of the purchases transaction cycle
E. Test of control
F. Substantive procedure
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 Analytical procedures
A. focus on the ending balances for income
statement accounts.
B. are only performed during the planning stage of
the audit.
C. are required to be performed when auditing an
account balance.
D. provide substantive evidence.

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True/false:
1. Substantive tests of transactions affect control risk
but do not affect planned detection risk.
2. Auditors use substantive analytical procedures and
tests of details of balances to satisfy planned control
risk.
3. One factor that determines the amount of additional
evidence required for tests of controls is the planned
reduction in control risk.
4. Tests of controls are performed to support a reduced
assessment of detection risk.
5. Substantive tests are procedures designed to test for
money misstatements that directly affect the
correctness of financial statements. 22

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 7.4. AUDIT SAMPLING

 Definition

 ‘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.
 From the sample the auditor forms a conclusion about the
population from which the sample is drawn.

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7.4. AUDIT SAMPLING

 Sampling terms

 ‘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.
 ‘Error’ means either control deviations, when performing tests of
control, or misstatements, when performing substantive
procedures.
 ‘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.

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 7.4. AUDIT SAMPLING

 Types of sampling risk

There are two types of sampling risk:

 The risk the auditor will conclude, in the test of control, that
control risk is lower than it actually is, or in the case of a
substantive test, that a material error does not exist when in
fact it does.
 The risk the auditor will conclude, in a test of control, that
control risk is higher than it actually is, or in the case of a
substantive test, that a material error exists when in fact it
does not.

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7.4. AUDIT SAMPLING

 Statistical Sampling

 ‘Statistical sampling’ means any approach to sampling that

has the following characteristics:
a) Random selection of a sample
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.

https://www.youtube.com/watch?v=SgetJ-gb1eQ&ab_channel=Edspira

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 7.4. AUDIT SAMPLING

 More Sampling Terms

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

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7.4. AUDIT SAMPLING

 Audit Testing
 Audit sampling is used for both tests of controls (attributes
sampling) and for substantive procedures (usually, variables
sampling)
 For control sampling the auditor identifies:
o the characteristics or attributes that indicate performance of a
control
o possible deviations which indicate in-adequate performance.
o presence or absence of attributes by testing
 Substantive procedures, audit sampling is used to verify assertions
about a financial statement amount (for example, the existence of
accounts receivable), or to make an independent estimate of some
amount (for example, the value of obsolete inventories).
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 7.4. AUDIT SAMPLING

 Sampling Risk and Non-sampling risk

 Sampling Risk

 It is the risk that the auditor’s conclusion, based on a sample,

might be different from the conclusion that would be reached
if the test were applied in the same way to the entire
population
o Tests of controls risks include the risk of assessing control
risk too high or too low
o Substantive test risks include incorrect rejection and
incorrect acceptance

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7.4. AUDIT SAMPLING

 Sampling Risk and Non-sampling risk (cont.)

 Non-sampling Risk

 Includes all aspects of audit risk that are not due to sampling
 Examples are:
 The failure to select appropriate audit procedures
 The failure to recognize misstatements in documents
examined
 Misinterpreting the results of audit tests.

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 7.4. AUDIT SAMPLING

 Sampling Risk and Non-sampling risk (cont.)

 Sampling risk can be reduced by increasing sample size, while

 Non-sampling risk can be reduced by proper engagement
planning, supervision, and review.

https://www.youtube.com/watch?v=_4iFWZ5YxSo&t=94s&ab_ch
annel=Edspira

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7.4. AUDIT SAMPLING

 Selection of items for testing

Appropriate means of selecting items for testing are:

 Selecting all items (100% examination)
Rarely done – only for substantive tests
 Selecting specific items
(next slide)
 Audit sampling:
Audit sampling can be applied using either non-
statistical or statistical sampling methods.

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 7.4. AUDIT SAMPLING

 Specific items (judgemental) sampling

 A judgemental sample is selected 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.
 Specific items selected may include:
o High value or key items
o All items over a certain amount
o Items to obtain information
o Items to test procedures.
 This does not constitute audit sampling because it cannot be
projected to the entire population.
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7.4. AUDIT SAMPLING

 Factors influencing sample size

Tests of controls
Tests of details

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 7.4. AUDIT SAMPLING

 Factors influencing sample size

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7.4. AUDIT SAMPLING

 Factors influencing sample size (cont.)

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 7.4. AUDIT SAMPLING

 Sample selection methods

 Random selection ensures that all items in the population

have an equal chance of selection eg, by use of random
number tables or computerized generator.
 Systematic selection involves selecting items using a
constant interval between selections, the first interval
having a random start.

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Systematic Sample Selection

Population size
Interval =
Desired sample size

For example:
Auditor need to select 125 items from a population of sales invoices
ranging from 652 to 3,151
(3,151-651)
Interval = = 20
125
Starting point (1st item): randomly selected in a range from 652 to (652
+ 20).
=> if randomly selected number is (652+9) = 661
The remaining 124 items will be:
661 + 20 = 681
681 + 20 = 701
701 + 20 = 721
….

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 7.4. AUDIT SAMPLING

 Sample selection methods (cont.)

 Haphazard selection may be an alternative to random

selection provided assurance providers are satisfied that the
sample is representative of the entire population.
 Block selection involves selecting a block(s) of contiguous
items from within the population. Block selection cannot
ordinarily be used in audit sampling.
 Monetary Unit Sampling (MUS): This ensures that every
£1 in a population has an equal chance of being selected
for testing.

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Block Sample Selection

For example:
When testing the sales invoice for the year 2022:
- The total number of invoice is 20,000
- Need to select 100 items to tests

Auditor separate into blocks of 20 items => 1,000 blocks

Need to select: 100 items to tests => Select 5 blocks
(randomly)
If the first item in the block is chosen=> all items of the block
will be selected automatically

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 7.4. AUDIT SAMPLING

 Nature and cause of errors

The auditor should consider the sample results, the nature and
cause of any errors identified and their possible effect on the
particular test objective and on other areas of the audit.

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7.4. AUDIT SAMPLING

 Projecting errors

For substantive procedures, the auditor should project

monetary errors found in the sample to the population, and
should consider the effect of the projected error on the particular
test objective and on other areas of the audit.

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 One of the causes of nonsampling risk is
A) choosing the wrong sample size.
B) ineffective audit procedures.
C) inadequate sample size.
D) exceptions being found in the sample.

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Which two of the following are factors that an

assurance provider should take into account when
determining the sample size for a test of details?
A. The time available to complete the test
B. The skill of the team member assigned to carry
out the test
C. A decrease in the assurance provider’s
assessment of the risk of material misstatement
D. An increase in the level of expected
misstatement

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 When determining a sample size for tests of controls,
there are a number of factors which an auditor should
take into account.
For each of the following factors, select whether it
would cause the sample size to increase, decrease, or
to have negligible effect.
1. An increase in tolerable misstatement
2. An increase in the number of invoices in the
population
3. A decrease in the auditor’s required confidence
level

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Which two of the following statements are correct

regarding factors which influence sample sizes for tests
of controls?
A. An increase in the number of sampling units within
the population will increase the sample size.
B. A decrease in the expected misstatement will
decrease the sample size.
C. A decrease in the tolerable misstatement will decrease
the sample size.
D. An increase in the extent to which the risk of material
misstatement is reduced by the operating
effectiveness of controls will decrease the sample
size.
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 When determining a sample size for tests of details
there are a number of factors which an auditor should
take into account.
For each of the following factors, select whether it
would cause the sample size to increase or to decrease.
1. An increase in the auditor’s assessment of the risk
of material misstatement
2. An increase in the use of analytical procedures to
test the same assertion
3. An increase in the level of misstatements that the
auditor expects to find when testing the assertion

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Paula is checking whether purchase invoices have been

authorised for payment. She has selected all the
November purchase invoices as her sample and has
reviewed them for an authorization signature. Select the
method is used:
A. Monetary unit sampling
B. Block selection
C. Systematic selection
D. Haphazard selection

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 The assurance provider is using statistical sampling.
Which three of the following methods would be most
appropriate to use to select a sample of accounts
receivable?
A. Random selection
B. Systematic selection
C. Haphazard selection
D. Sequence/block selection
E. Monetary unit selection

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End of lecture
Any Questions?

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