Auditing and Assurance

(ACT 380)

Summer, 2020 1
 Auditing at a Glance:
 Basic Understanding of Auditing Process
 Assurance and auditing: An overview & Structure of Profession Ch1 & Ch 2 (Lecture 1)
 Auditor’s liability, Ethics and independence Ch 2 & Ch 3 (Lecture 2)
 The financial report audit process Ch 4 (Lecture 3)

 Client Acceptance, Plan and risk assessment

 Planning, understanding the entity and assessing business risk Ch 5 (Lecture 4)  
 Specific business risks and materiality Ch 6 (Lecture 5)

 Response to Assessed Risks

 Understanding Internal Control and Testing controls Ch 7 & 8 (Lecture 6)
 Substantive tests of transactions and balances Ch 9 (Lecture 7)
 Audit sampling Ch 10 (Lecture 8)

 Complete the Audit and Issue a Report plus Others

 Completing the audit Ch 11 (Lecture 9)
 The auditor’s reporting obligations Ch 12 (Lecture 10)
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This lecture will cover following topics
Topic 1: Audit Sampling: Definition
Topic 2: Sampling risk
Topic 3: Broad Categories of Sampling Methods
Topic 4: Sampling phases

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 Topic 1: Audit Sampling: Definition

 Audit sampling: the application of an audit procedure to less than 100% of the
items within a population to obtain audit evidence about particular characteristics of
the population.

 Audit sampling is important because it provides information on:

 How many items to examine
 Which items to select
 How sample results are evaluated and extrapolated to the population in order
to tell us something about the population (e.g. level of misstatement).

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 Inference

Sample Population
inference

Relevant characteristics of the sample are approximately the

same as those of the population

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 Tests of Control & Substantive testing
Sampling can be used for both:
 Tests of Control; and

 Substantive tests of details

 tests of transactions
 eg sales, purchases, payments

 tests of balances
 eg Accounts Receivable balances, inventory items

The difference is in the interpretation of “errors”:

• For Tests of Control “errors” relate to control deviations
(ie. The number of times a control wasn’t followed)
• For Substantive Tests “errors” relate to monetary misstatements
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 Topic 2: SAMPLING RISK is ….

…….the probability that the auditor has reached an

incorrect conclusion because audit sampling was used
rather than 100 per cent examination.

The risk the auditor makes the wrong decision even though
the evidence collected was done in accordance with
ISA530.

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 Sampling Risk

Non-sampling
Sampling Risk Risk

Human Mistakes
Test of Control Substantive tests
Other
 Sampling Risk:
…….the risk that the auditor has reached an incorrect conclusion because audit
sampling was used rather than 100 per cent examination.

• Tests of Control:
• Risk of Over reliance: Conclude the controls are more effective than they really are
• Risk of Under reliance: Conclude the controls are less effective than they really are

• Substantive Tests:
• Risk of incorrect Acceptance: Conclude that a material misstatement does not exist when one does
• Risk of incorrect Rejection: Conclude that a material misstatement exists when one does not exits

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 Non-sampling Risk:
…the risk arising from factors that cause the auditor to reach an incorrect conclusion
for any reason not related to the size of the sample

• Human Mistakes:
• Failing to recognise errors in documents
• Applying audit procedures that are inappropriate to the audit objective
• Misinterpreting the results of a sample

• Other:
• Reliance on wrong information received from another party

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 Topic 3: Broad Categories of Sampling Methods

1. Statistical Sampling/ Probabilistic sample selection

method

2. Non-Statistical sampling/ Non-Probabilistic sample

selection method

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 Sample Selection
methods

Probabilistic sample selection method Non- probabilistic sample selection method

(Statistical Sampling) (Non-Statistical Sampling)

Sample selected randomly Auditor uses professional

judgement
Methods

1) Simple random sample selection

1) Directed sample selection
2) Systematic sample selection
2) Block sample selection
3) Probability proportional to size (PPS)
3) Haphazard sample selection
sample selection/ MUS/ DUS
4) Stratified sample selection

Source: Essentials of Auditing, Assurance Services and Ethics in Australia.

Authors: Alvin A. Arens, Peter J. Best, Greg Shailer, Brenton Fiedler.
How do auditors select samples??
(Sample Selection Methods)

Non-probabilistic
Non-probabilistic

1. Directed sample selection

2. Block sample selection
3. Haphazard sample selection

(Note:
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1313
Biases from haphazard sampling

Include 10.1
Auditing in
the news . . Biases from haphazard
sampling Page 467.
 Unacceptable sample selection methods
 Block selection: the auditor selects all items of a specified type processed on a
particular day, week or month.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

 Judgmental selection (based on sample item characteristics): the auditor selects

large or unusual items from the population or uses some other judgmental criterion
for selection.
 This method has a conscious bias and sample cannot be considered representative of
population.
 Sample Selection Methods

Probabilistic
Probabilistic

1. Simple random sample selection

2. Systematic sample selection
3. MUS (Probability proportional to size sample selection)
4. Stratified sample selection

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 Random selection – random number generation
Invoice No. $ Amt Random No. Invoice No. $ Amt Random No.
1 234 9 17 234 1
2 576 4 13 798 2
3 456 26 29 735 3
4 246 19 2 576 4
5 897 27 6 678 5
6 678 5 23 234 6
7 3445 18 9 4556 7
8 567 29 24 567 8
9 4556 7 1 234 9
10 568 17 20 512 10
11 689 12 12 1245 11
12 1245 11 11 689 12
13 798 2 22 543 13
14 980 22 30 400 14
15 684 23 28 911 15
16 587 30 25 9623 16
17 234 1 10 568 17
18 423 28 7 3445 18
19 356 24 4 246 19
20 512 10 21 6778 20
21 6778 20 26 111 21
22 543 13 14 980 22
23 234 6 15 684 23
24 567 8 19 356 24
25 9623 16 27 265 25
26 111 21 3 456 26
27 265 25 5 897 27
28 911 15 18 423 28
29 735 3 8 567 29
17 30 400 14 16 587 30
 Steps in Systematic Selection
Eg. suppose the sample size is 20 and the number of items in the population is 10 000:

 Step 1: Calculate the sample interval:

No. of items in population 10 000
  500
Sample size 20

 Step 2: Give every item in population chance of selection by choosing a random number
(random start) within range of 1 and sampling interval (in this example, 500), e.g. 217.

 Step 3: Continue to add sampling interval to random start, and identify items to be sampled,
e.g. item nos. 217, 717, 1217. . . 9217, 9717.

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 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1+4 5+4 9+4 13 + 4

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

2+4 6+4 10 + 4 14 + 4

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

3+4 7+4 11 + 4 15 + 4

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

19 4+4 8+4 12 + 4 16 + 4
Dollar-unit sampling
 Sample unit is individual dollar units, not physical units (transactions or balances). A
population with $1 000 000 that contains 1000 physical units or accounts is viewed as a
population with 1 000 000 sample units.

 Individual dollar selected is attached to that physical unit or account in which it is contained,
and the unit or account will then be tested.

 Advantages:

 Directs auditor’s attention to material items.

For example, under traditional sampling, debtor A (owing $10 000) and debtor B (owing
$1000) have equal chance of selection. Under DUS, debtor A is ten times more likely to
be selected and tested.

 Directs auditor’s attention towards overstatement errors;

 However, a disadvantage is that it directs auditor’s attention away from

understatement errors.

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 Stratification
 Stratification is the process of dividing the population into a
series of sub-populations, each of which has an identifying
characteristic, such as dollar value (ISA 530 Appendix 1,
paragraphs 1–4).
 Can assist with audit efficiency as it allows the auditor to
reduce the sample size by reducing variability without
increasing the sampling risk.
 Can direct auditor’s attention to areas of audit interest,
especially risky or material items.
Topic 4: Sampling phases

1 2 3 4 5
 1. Planning and designing the sample
 Auditor must consider:

 Objectives of the audit test (usually related to an audit assertion of interest)

 Population from which to sample - Actual inventory items or Inventory sub-ledger

 Possible use of stratification;

JB Hi-FiProduct Listing
The auditor (Inventory)
divides the population into a series of sub-populations, each of which has an
identifying characteristic, such as dollar value:
Plasma, LED & LCD TVs, Home theatre, Computers & Laptops, iPod, MP3 & Portables,
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audio, in sample size without
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 Helps to direct auditor’s attention to areas of particular audit interest

 Definition of the sampling unit:

 Transactions or balances making up the account balance, or

 Individual dollars that make up an account balance or class of transactions (commonly DUS)
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 2. Determining Sample Size
 Sample size is affected by the degree of sampling risk (the probability that the
auditor has reached an incorrect conclusion because sampling, rather than 100%
examination) the auditor is willing to accept.
 Auditor's major consideration in determining appropriate sample size is whether,
given expected results from examining sample, sampling risk will be reduced to an
acceptably low level

 Common practice in Australia

 Sample size of 20 items => when a moderate level of testing is required
 Sample size of 30 items => when more extensive testing is required

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 Factors that influence sample size for
substantive testing
 Appendix 3 to ISA 530 outlines the factors that influence sample size for
substantive testing as follows:
‒ the auditor’s assessment of risk of material misstatement
‒ the use of other substantive procedures directed at the same assertion
‒ the auditor’s desired level of assurance that actual misstatement is not
greater than tolerable misstatement
‒ the tolerable misstatement
‒ the amount of misstatement the auditor expects to find in the
population (expected misstatement)
‒ stratification
‒ the number of sampling units in the population.
 3. Selecting the sample
 To draw conclusions about population or stratum, the sample needs to
be typical of characteristics of population or stratum.
 Sample needs to be selected without bias so that all sampling units in
the population or stratum have a chance of selection.

 The most common sampling techniques are:

 Random selection — random number generation
Representative
 Systematic selection
 Haphazard selection – select without conscious bias

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 4. Performing the audit procedures
 To ensure conclusions arising from tests on audit samples are
appropriate, auditor must perform testing on each item selected.

 If selected item is not appropriate for application of testing

procedure, a replacement item can be selected (ISA 530.9–10):

(eg. A voided cheque may be selected when testing for evidence of payment authorisation. If
the auditor is satisfied that the cheque had been properly voided such that it does not
constitute an error, an appropriately chosen replacement is examined).

 But, if the auditor is unable to perform test on a selected item (e.g.

loss of documentation), it is considered to be an error.

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 5. Evaluating sample results
 To evaluate sample results, auditor determines the level of misstatement found in
sample and directly projects this misstatement to relevant population.
 Eg. Sample 20% (1/5), find misstatement of $10 000.
 Therefore projected misstatement = $50 000 ($10 000/20%).
 Projected misstatement is then compared with tolerable misstatement for the audit
procedure to determine if characteristic of interest can be accepted or rejected.
 Auditor should consider both the nature and cause of any misstatement or deviations
identified.

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