AUDITING PRINCIPLES AND PRACTICES-II

CHAPTER ONE
1. TESTING AND AUDIT SAMPLING

1.1 INTERNATIONAL STANDARD ON AUDITING (ISA 530) AUDIT SAMPLING

CONCEPT

1.1.1 Introduction
Scope of this ISA

This International Standard on Auditing (ISA) applies when the auditor has decided to
use audit sampling in performing audit procedures. It deals with the auditor’s use of
statistical and non-statistical sampling when designing and selecting the audit sample,
performing tests of controls and tests of details, and evaluating the results from the
sample.

This ISA complements ISA 500, which deals with the auditor’s responsibility to design
and perform audit procedures to obtain sufficient appropriate audit evidence to be able
to draw reasonable conclusions on which to base the auditor’s opinion. ISA 500
provides guidance on the means available to the auditor for selecting items for testing,
of which audit sampling is one means.
Effective Date
This ISA is effective for audits of financial statements for periods beginning on or after
December 15, 2009.
Objective
The objective of the auditor, when using audit sampling, is to provide a reasonable basis
for the auditor to draw conclusions about the population from which the sample is
selected.

1.1.2 Definitions
For purposes of the ISAs, the following terms have the meanings attributed below:

Sampling is the process of selecting and examining a portion of a group of related items
for the purpose of obtaining information or evaluation of some characteristics about the
group as a whole. The group as a whole is called the population.

Audit sampling (sampling) – The application of audit procedures to less than 100% of
items within a population of audit relevance such that all sampling units have a chance

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of selection in order to provide the auditor with a reasonable basis on which to draw
conclusions about the entire population.

• Audit sampling is used for both tests of controls and for tests of details of
transactions and balances.
• Sampling is performed because it is more efficient than testing 100% of a
population and it can save both parties time and money and is also widely
known to reduce the risk of ‘over-auditing’ in certain areas.
• In short a sample is preferred over a complete analysis because the information
can be obtained cheaply, accurately and quickly provided that a suitable methods
of selection is used.
A. Population – 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.
B. A Representative Sample When selecting a sample from a population, the auditor
attempt to obtain a representative sample.
A Representative Sample is one in which the characteristics in the sample are
approximately the same as those of the population. This means that the sampled
items are similar to the items not sampled. If the sample is not representative of the
population, the auditor will be unable to form a conclusion on the entire 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.)
• Types of Audit Tests in Which Sampling May Be Used
 Tests of controls are directed toward the design or operation of a control to
assess its effectiveness in preventing or detecting material misstatements in a
financial statement assertion.
 Substantive tests are used to obtain evidence about the validity and propriety of
the accounting treatment of trans actions and balances.
 Dual-purpose tests are those in which a single sample is used to test a control
and to serve as a substantive test of a recorded balance or class of transactions.
When a dual-purpose test is used, auditors select the sample size as the higher of
that required for the two purposes

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*Audit evidence choices that do not involve audit sampling include:

 Inquiry and Observation

 Analytical Review Procedures:
 One-Hundred Percent Examination
 Zero Percent Examination:
 Tests of controls where application is not documented
 Procedures from which the auditor does not intend to extend a conclusion to the
remaining items in the account
C. Sampling risk – The risk that the auditor’s conclusion based on a sample may be
different from the conclusion if the entire population were subjected to the same
audit procedure. Sampling risk can lead to two types of erroneous conclusions:
i. In the case of a test of controls, that controls are more effective than they actually
are, or in the case of a test of details, that a material misstatement does not exist
when in fact it does. The auditor is primarily concerned with this type of erroneous
conclusion because it affects audit effectiveness and is more likely to lead to an
inappropriate audit opinion.
ii. In the case of a test of controls, that controls are less effective than they actually
are, or in the case of a test of details, that a material misstatement exists when in
fact it does not. This type of erroneous conclusion affects audit efficiency as it
would usually lead to additional work to establish that initial conclusions were
incorrect.
D. Non-sampling risk – The risk that the auditor reaches an erroneous conclusion for
any reason not related to sampling risk.
E. Anomaly – A misstatement or deviation that is demonstrably not representative of
misstatements or deviations in a population.
F. Sampling unit – The individual items constituting a population.
General Approaches to AS—Non Statistical and Statistical
• Audit sampling methods can be divided into two broad categories:
statistical sampling and non statistical sampling.
 “Statistical sampling” means any approach to sampling that has the
following characteristics:
A. Random selection of a sample items; and

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B. Use of probability theory to evaluate sample results, including measurement of

sampling risk.
 Sampling approach that does not have characteristics (A) and (B) is
considered non statistical sampling.
G. Statistical sampling – An approach to sampling that has the following
characteristics:
(i) Random selection of the sample items; and
(ii) The use of probability theory to evaluate sample results, including measurement
of sampling risk.

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

H. Stratification – The process of dividing a population into sub-populations, each of

which is a group of sampling units which have similar characteristics (often
monetary value).
I. Tolerable misstatement – A monetary amount set by the auditor in respect of
which the auditor seeks to obtain an appropriate level of assurance that the
monetary amount set by the auditor is not exceeded by the actual misstatement in
the population.
J. Tolerable rate of deviation – A rate of deviation from prescribed internal control
procedures set by the auditor in respect of which the auditor seeks to obtain an
appropriate level of assurance that the rate of deviation set by the auditor is not
exceeded by the actual rate of deviation in the population.

1.2 Sampling for Tests of Controls

1.2.1 Sample Design, Size, and Selection of Items for Testing

When designing an audit sample, the auditor shall consider the purpose of the audit
procedure and the characteristics of the population from which the sample will be
drawn. The auditor shall determine a sample size sufficient to reduce sampling risk to an
acceptably low level. The auditor shall select items for the sample in such a way that
each sampling unit in the population has a chance of selection.

Performing Audit Procedures

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The auditor shall perform audit procedures, appropriate to the purpose, on each item
selected. If the audit procedure is not applicable to the selected item, the auditor shall
perform the procedure on a replacement item. If the auditor is unable to apply the
designed audit procedures, or suitable alternative procedures, to a selected item, the
auditor shall treat that item as a deviation from the prescribed control, in the case of
tests of controls, or a misstatement, in the case of tests of details.

Nature and Cause of Deviations and Misstatements

The auditor shall investigate the nature and cause of any deviations or misstatements
identified, and evaluates their possible effect on the purpose of the audit procedure and
on other areas of the audit. In the extremely rare circumstances when the auditor
considers a misstatement or deviation discovered in a sample to be an anomaly, the
auditor shall obtain a high degree of certainty that such misstatement or deviation is not
representative of the population. The auditor shall obtain this degree of certainty by
performing additional audit procedures to obtain sufficient appropriate audit evidence
that the misstatement or deviation does not affect the remainder of the population.

Projecting Misstatements

For tests of details, the auditor shall project misstatements found in the sample to the
population.
Evaluating Results of Audit Sampling
The auditor shall evaluate:
(a) The results of the sample; and
(b) Whether the use of audit sampling has provided a reasonable basis for
conclusions about the population that has been tested.

1.2.2 Application and Other Explanatory Material

Definitions

 Non-Sampling Risk- Examples of non-sampling risk include use of

inappropriate audit procedures, or misinterpretation of audit evidence and failure
to recognize a misstatement or deviation.

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 Sampling Unit- The sampling units might be physical items (for example,
checks listed on deposit slips, credit entries on bank statements, sales invoices or
debtors’ balances) or monetary units.
 Tolerable Misstatement- When designing a sample, the auditor determines
tolerable misstatement in order to address the risk that the aggregate of
individually immaterial misstatements may cause the financial statements to be
materially misstated and provide a margin for possible undetected
misstatements. Tolerable misstatement may be the same amount or an amount
lower than performance materiality.

1.2.3 Sample Design, Size, and Selection of Items for Testing of Details
1. Sample Design: Audit sampling enables 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 be applied using either non-statistical or statistical sampling
approaches. When designing an audit sample, the auditor’s consideration includes
the specific purpose to be achieved and the combination of audit procedures that is
likely to best achieve that purpose. Consideration of the nature of the audit evidence
sought and possible deviation or misstatement conditions or other characteristics
relating to that audit evidence will assist the auditor in defining what constitutes a
deviation or misstatement and what population to use for sampling. For example, in
a test of details relating to the existence of accounts receivable, such as
confirmation, payments made by the customer before the confirmation date but
received shortly after that date by the client, are not considered a misstatement.
Also, a misposting between customer accounts does not affect the total accounts
receivable balance. Therefore, it may not be appropriate to consider this a
misstatement in evaluating the sample results of this particular audit procedure, even
though it may have an important effect on other areas of the audit, such as the
assessment of the risk of fraud or the adequacy of the allowance for doubtful
accounts.

In considering the characteristics of a population, for tests of controls, the auditor makes
an assessment of the expected rate of deviation based on the auditor’s understanding of
the relevant controls or on the examination of a small number of items from the

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population. This assessment is made in order to design an audit sample and to determine
sample size. For example, if the expected rate of deviation is unacceptably high, the
auditor will normally decide not to perform tests of controls. Similarly, for tests of
details, the auditor makes an assessment of the expected misstatement in the population.
If the expected misstatement is high, 100% examination or use of a large sample size
may be appropriate when performing tests of details. In considering the characteristics
of the population from which the sample will be drawn, the auditor may determine that
stratification or value-weighted selection is appropriate. The decision whether to use a
statistical or non-statistical sampling approach is a matter for the auditor’s judgment;
however, sample size is not a valid criterion to distinguish between statistical and non-
statistical approaches.

2. Sample Size: The level of sampling risk that the auditor is willing to accept affects
the sample size required. The lower the risk the auditor is willing to accept, the
greater the sample size will need to be. The sample size can be determined by the
application of a statistically-based formula or through the exercise of professional
judgment.
3. Selection of Items for Testing: With statistical sampling, sample items are selected
in a way that each sampling unit has a known probability of being selected. With
non-statistical sampling, judgment is used to select sample items. Because the
purpose of sampling is to provide a reasonable basis for the auditor to draw
conclusions about the population from which the sample is selected, it is important
that the auditor selects a representative sample, so that bias is avoided, by choosing
sample items which have characteristics typical of the population.

The principal methods of selecting samples are the use of random selection, systematic
selection and haphazard selection

1.2.4 Performing Audit Procedures

An example of when it is necessary to perform the procedure on a replacement item is

when a voided check is selected while testing for evidence of payment authorization. If
the auditor is satisfied that the check has been properly voided such that it does not
constitute a deviation, an appropriately chosen replacement is examined.

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An example of when the auditor is unable to apply the designed audit procedures to a
selected item is when documentation relating to that item has been lost.

An example of a suitable alternative procedure might be the examination of subsequent

cash receipts together with evidence of their source and the items they are intended to
settle when no reply has been received in response to a positive confirmation request.

1.2.5 Nature and Cause of Deviations and Misstatements

In analyzing the deviations and misstatements identified, the auditor may observe that
many have a common feature, for example, type of transaction, location, product line or
period of time. In such circumstances, the auditor may decide to identify all items in the
population that possess the common feature, and extend audit procedures to those items.
In addition, such deviations or misstatements may be intentional, and may indicate the
possibility of fraud.

1.2.6 Projecting Misstatements

The auditor is required to project misstatements for the population to obtain a broad
view of the scale of misstatement but this projection may not be sufficient to determine
an amount to be recorded. When a misstatement has been established as an anomaly, it
may be excluded when projecting misstatements to the population. However, the effect
of any such misstatement, if uncorrected, still needs to be considered in addition to the
projection of the non-anomalous misstatements. For tests of controls, no explicit
projection of deviations is necessary since the sample deviation rate is also the projected
deviation rate for the population as a whole. ISA 303 provides guidance when
deviations from controls upon which the auditor intends to rely are detected.

1.2.7 Evaluating Results of Audit Sampling

For tests of controls, an unexpectedly high sample deviation rate may lead to an increase
in the assessed risk of material misstatement, unless further audit evidence
substantiating the initial assessment is obtained. For tests of details, an unexpectedly
high misstatement amount in a sample may cause the auditor to believe that a class of
transactions or account balance is materially misstated, in the absence of further audit
evidence that no material misstatement exists.

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In the case of tests of details, the projected misstatement plus anomalous misstatement,
if any, is the auditor’s best estimate of misstatement in the population. When the
projected misstatement plus anomalous misstatement, if any, exceeds tolerable
misstatement, the sample does not provide a reasonable basis for conclusions about the
population that has been tested. The closer the projected misstatement plus anomalous
misstatement is to tolerable misstatement, the more likely that actual misstatement in the
population may exceed tolerable misstatement. Also if the projected misstatement is
greater than the auditor’s expectations of misstatement used to determine the sample
size, the auditor may conclude that there is an unacceptable sampling risk that the actual
misstatement in the population exceeds the tolerable misstatement. Considering the
results of other audit procedures helps the auditor to assess the risk that actual
misstatement in the population exceeds tolerable misstatement, and the risk may be
reduced if additional audit evidence is obtained.

If the auditor concludes that audit sampling has not provided a reasonable basis for
conclusions about the population that has been tested, the auditor may: Request
management to investigate misstatements that have been identified and the potential for
further misstatements and to make any necessary adjustments; or

Tailor the nature, timing and extent of those further audit procedures to best achieve the
required assurance. For example, in the case of tests of controls, the auditor might
extend the sample size, test an alternative control or modify related substantive
procedures.

1.2.8 Stratification and Value-Weighted Selection

In considering the characteristics of the population from which the sample will be
drawn, the auditor may determine that stratification or value-weighted selection is
appropriate.

Stratification

Audit efficiency may be improved if the auditor stratifies a population by dividing it

into discrete sub-populations which have an identifying characteristic. The objective of
stratification is to reduce the variability of items within each stratum and therefore allow
sample size to be reduced without increasing sampling risk.

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When performing tests of details, the population is often stratified by monetary value.
This allows greater audit effort to be directed to the larger value items, as these items
may contain the greatest potential misstatement in terms of overstatement. Similarly, a
population may be stratified according to a particular characteristic that indicates a
higher risk of misstatement, for example, when testing the allowance for doubtful
accounts in the valuation of accounts receivable, balances may be stratified by age.

The results of audit procedures applied to a sample of items within a stratum can only
be projected to the items that make up that stratum. To draw a conclusion on the entire
population, the auditor will need to consider the risk of material misstatement in relation
to whatever other strata make up the entire population. For example, 20% of the items in
a population may make up 90% of the value of an account balance. The auditor may
decide to examine a sample of these items. The auditor evaluates the results of this
sample and reaches a conclusion on the 90% of value separately from the remaining
10% (on which a further sample or other means of gathering audit evidence will be
used, or which may be considered immaterial).

If a class of transactions or account balance has been divided into strata, the
misstatement is projected for each stratum separately. Projected misstatements for each
stratum are then combined when considering the possible effect of misstatements on the
total class of transactions or account balance.

Value-Weighted Selection

When performing tests of details it may be efficient to identify the sampling unit as the
individual monetary units that make up the population. Having selected specific
monetary units from within the population, for example, the accounts receivable
balance, the auditor may then examine the particular items, for example, individual
balances, that contain those monetary units. One benefit of this approach to defining the
sampling unit is that audit effort is directed to the larger value items because they have a
greater chance of selection, and can result in smaller sample sizes. This approach may
be used in conjunction with the systematic method of sample selection and is most
efficient when selecting items using random selection.

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