Chapter One: 1. Audit Sampling

CHAPTER ONE
1. AUDIT SAMPLING
1.1. Rationale for and methods of Audit sampling
Audit sampling is the application of an audit procedure to less than 100 percent of the items
within an account balance or class of transactions for the purpose of evaluating some
characteristic of the items selected in order to form or assist in forming a conclusion
concerning the population.
 In an audit, sampling procedures are used because it is not practical to examine every single
item in a population.
 A representative sample is one in which the characteristics in the sample of audit interest are
approximately the same as those of the population.
 In practice, auditors never know whether a sample is representative, even after all testing is
complete. (The only way to know if a sample is representative is to subsequently audit the
entire population.) However, auditors can increase the likelihood of a sample being
representative by using care in designing the sampling process, sample selection, and
evaluation of sample results.
 A sample result can be non representative due to non sampling error or sampling error.
The risk of these two types of errors occurring is called non sampling risk and sampling
risk respectively.
 Non sampling risk is the risk that audit tests do not uncover existing exceptions in the
sample.
The two causes of non sampling risk are:
i. The auditor’s failure to recognize exception because of exhaustion, boredom, or lack of
understanding of what to look for.
ii. Inappropriate or ineffective audit procedures.
 Sampling risk is the risk that an auditor reaches an incorrect conclusion because the sample
is not representative of the population. Sampling risk is an inherent part of sampling that
result from testing less than the entire population.
 Auditors have two ways to control sampling risk:

a. Adjust sample size
b. Use an appropriate method of selecting sample items from the population
Statistical Versus Non-statistical Sampling

o Audit sampling methods can be divided into two broad categories: statistical sampling
and non-statistical sampling.
1
Similarities:
Step 1: Plan the sample
Step 2: Select the sample and perform the tests
Step 3: Evaluate the results
Differences:
 Statistical sampling allows the quantification of sampling risk in planning the sample (Step
1) and evaluating the results (Step 3). Or by applying mathematical rules, auditors can
quantify (measure).
Advantages of Statistical Sampling
 Design efficient samples
 Measure sufficiency of evidence
 Objectively evaluate sample results
 In non-statistical sampling those items that auditors do not quantify sampling risk. Instead,
the auditor believes will provide the most useful information are selected. Non statistical
sampling is often termed judgmental sampling.
Probabilistic Versus Non-probabilistic Sample Selection

 Probabilistic sample selection is a method of selecting a sample such that each
population item has a known probability of being included in the sample. It is
commonly associated with statistical sampling.
 Non-probabilistic sample selection is a method in which the auditor uses
professional judgment rather than probabilistic methods. It is commonly
associated with non-statistical audit sampling.
 Non probabilistic (judgmental) sample selection methods include the following:
1. Directed sample selection
2. Block sample selection
3. Haphazard sample selection
1. Directed sample selection is the selection of each item based on auditor judgmental criteria.
(I.e. auditors deliberately select each item in the sample based on their own judgmental
criteria instead of using random selection).
Commonly used approaches include:
 Items most likely to contain misstatements
 Items containing selected population characteristics
 Large dollar coverage
2. Block sample selection is the selection of several items in sequence. (I.e. auditors select the
first item in a block, and the remainder of the block is chosen in sequence). For example,
2
assume the block sample will be a sequence of 100 sales transactions from the sales journal
for the third week of March. Auditors can select the total sample of 100 by taking 5 blocks of
20 items, 10 blocks of 10, 50 blocks of 2 or one block of 100.
3. Haphazard sample selection is the selection of items without any conscious bias on the part
of the auditor.
 In this method, the auditor selects the sample items without intentional bias to include or
exclude certain items in the population.
 Haphazard selection, in which the auditor selects the sample without following a
structured technique.
 In such cases, the auditor selects population items without regard to their size, source, or
other distinguishing characteristics.
 Probabilistic sample selection methods include the following:

1. Simple random sample selection
2. Systematic sample selection
3. Probability proportional to size sample selection
4. Stratified sample selection
1. A simple random sample is one in which every possible combination of elements in the
population has an equal chance of constituting the sample.
 Selection of random sample includes:
i. Random number tables
ii. Computer generation of random numbers
2. Systematic sample selection: (also called systematic sampling) the auditor calculates an
interval and then selects the items for the sample based on the size of the interval.
 The interval is determined by dividing the population size by the number of sample
items desired. The advantage of systematic selection is its ease of use.
3. Probability proportional to size: A sample is taken where the probability of selecting any
individual population item is proportional to its recorded amount (PPS). It is evaluated using
non - statistical sampling or monetary unit statistical sampling.
4. Stratified sample selection: The population is divided into subpopulations by size and larger
samples are taken of the larger subpopulations. It is evaluated using non statistical sampling
or variables statistical sampling.
In many auditing situations, it is advantageous to select samples that emphasize population
items with larger recorded amounts. Thus, this done by probability Proportional to Size
and Stratified Sample Selection.
3
Attributes versus variable sampling
Attributes sampling enables the auditors to estimate the rate of occurrence of certain
characteristics in the population. It is frequently used in performing tests of controls. For
example, the auditor might use attributes sampling to estimate the percentage of the cash
disbursements processed during the year that were not approved.
Variables sampling on the other hand provide the auditors with an estimate of a numerical
quantity, such as the dollar balance of an account. This technique is primarily used by auditors to
perform substantive tests. For example, variables sampling might be used to plan, perform, and
evaluate a sample of accounts receivable selected for confirmation.
Sample Size
There is no specific standard on how to compute samples size to be selected from a population in
a given examination. However, size of sample selected for examination is affected by the amount
of sampling risk allowable and characteristics of the population being tested. To reduce
sampling risk to a desired level, auditors have to increase sample size. Similarly, sample size
increases when the population size increases.
Audit Sampling for Exception Rates

The occurrence rate, or exception rate, is the ratio of the items containing the specific attribute
to the total number of population items. Or Exception rate — the percent of items in a
population that include exceptions in prescribed controls or monetary correctness
Following are types of exceptions in populations of accounting data:
1. Deviations from client’s established controls
2. Monetary misstatements in populations of transaction data
3. Monetary misstatements in populations of account balance details
Audit Sampling for Tests of Controls

Test of controls are used to determine whether the client’s internal control system is effective
enough to prevent or detect material misstatements in the financial statements. Besides the
results of tests of controls are vital in determining whether controls prescribed by management
are properly followed or not. Auditors are concerned with the risk of assessing control risk too
high and risk of assessing control risk too low. This is because of the fact that the tests of
controls have an impact on the efforts (substantive tests) auditors have to perform in discovering
material misstatements in the financial statements.
4
9-7
S a mpling Ris ks --Te s ts of Controls
Actual Exte nt of Ope rating Effe ctive ne s s

of the Control Proce dure is
Ade quate Inade quate
The Te s t of Controls
S ample Indicate s :
Incorrect
Exte nt of Ope rating
Correct Decision
Effe ctive ne s s is (Risk of Assessing
Ade quate Decision
Control Risk
Too Low)
Exte nt of Ope rating Incorrect
Effe ctive ne s s Decision
Inade quate Correct
(Risk of Assessing
Decision
Control Risk
Too High)
McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Audit Sampling for Substantive Tests

Substantive tests are designed to detect material misstatements that may exist in the financial
statements. Hence the sampling techniques should be designed in such a way that auditors are
able to estimate the amount of misstatement in a particular account balance. Based on the sample
results therefore auditors are able to conclude whether there is high risk of material misstatement
in the account balance.
5
9-8
S a mpling Ris ks --S ubs ta ntive Te s ts
The Population Actually is

Not Mate rially Mate rially
Mis s tate d Mis s tate d
The S ubs tantive
Proce dure S ample
Indicate s
Mis s tate me nt in Incorrect

Account Exce e ds Decision Correct
Tole rable Amount (Risk of Incorrect Decision
Rejection)
Mis s tate me nt in Incorrect
Account Is Le s s
Than Tole rable Correct Decision
Amount Decision (Risk of Incorrect
Acceptance)
McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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CHAPTER ONE

 Auditors have two ways to control sampling risk:

Statistical Versus Non-statistical Sampling

Probabilistic Versus Non-probabilistic Sample Selection

 Probabilistic sample selection methods include the following:

Audit Sampling for Exception Rates

Audit Sampling for Tests of Controls

S a mpling Ris ks --Te s ts of Controls

Actual Exte nt of Ope rating Effe ctive ne s s

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Audit Sampling for Substantive Tests

S a mpling Ris ks --S ubs ta ntive Te s ts

The Population Actually is

Mis s tate me nt in Incorrect

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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