L.H.

FACULTY OF BUSINESS MANAGEMENT SCIENCES AND ECONOMICS

DEPARTMENT OF FINANCE AND ACCOUNTING
STUDY NOTES (October, 2020)

Auditing 2
AC220
1. Introduction to Auditing Principles
2. Audit evidence
3. Audit working papers
4. The Business Cycles
5. Fraud and error and the auditor’s liability

6. Statistical sampling
7. Computer Assisted Audit Techniques

Topic 6 of 7

1
L.H.

Contents
1. Principles of sampling......................................................................................................................... 3
2. Definitions.......................................................................................................................................... 4
3. Tests of controls and sampling........................................................................................................... 5
4. Substantive procedures and sampling ................................................................................................ 6
5. Statistical versus non-statistical approaches ...................................................................................... 8
6. Steps in the sampling exercise ........................................................................................................... 8
6.1 Determine the objectives of the procedure.................................................................................... 9
6.2 Determine the procedure to be performed .................................................................................... 9
6.3 Confirm that the population is appropriate and complete ............................................................. 9
6.4 Define the units of the population ................................................................................................. 9
6.5 Determine the sample size ............................................................................................................ 9
6.6 Select the sample......................................................................................................................... 11
6.7 Perform the audit procedures ...................................................................................................... 12
6.8 Analyse the nature and cause of deviations and misstatements .................................................. 12
6.9 Project the sample results over the population............................................................................ 12
6.10 Evaluate..................................................................................................................................... 12
7. Exam practice questions and solutions ............................................................................................. 14
Question 1: Fergusson and Co .......................................................................................................... 14
Solution ......................................................................................................................................... 14
Question 2: Screens (Pvt) Ltd ........................................................................................................... 16
Solution ......................................................................................................................................... 17
Question 3 : Libvest Ltd ................................................................................................................... 18
Solution ......................................................................................................................................... 18
Question 4: Factors affecting sample size......................................................................................... 19
Solution ......................................................................................................................................... 19

2
L.H.

1. Principles of sampling
 An auditor rarely scrutinizes all items in a population due to limitations of the audit
function.
 However there are populations where all items in that population are audited e.g. all
minutes of shareholders meetings will be inspected.
 ISA 500 Audit Evidence - states that when designing tests of controls and tests of
details, the auditor shall determine means of selecting items for testing that are effective
in meeting the purpose of the audit procedure.
∙ An effective test provides appropriate audit evidence to an extent that will be
sufficient for the auditor’s purposes.
∙ In selecting items for testing, the auditor is required to determine the sufficiency
and appropriateness (relevance and reliability) of information to be used as audit
evidence.
∙ The means available to the auditor for selecting items for testing are:
a) Selecting all items (100% examination);
b) Selecting specific items; and
c) Audit sampling.

Selecting all items Selecting specific Audit sampling

(100% examination) items
Population constitutes a small High value or key Designed to enable
number of large value items items conclusion to be drawn
There is a significant risk and other Items over a certain about an entire
means do not provide sufficient amount. population on the basis
appropriate audit evidence. of testing a sample
The repetitive nature of a calculation Items to obtain drawn from it. (this
or other process performed information eg topic)
automatically by an information nature of entity or
system makes a 100% examination the nature of a
cost effective. transaction.

∙ The application of any one or combination of these means may be appropriate

depending on the particular circumstances, for example,
 the risks of material misstatement related to the assertion being tested, and
 the practicality and efficiency of the different means.

 ISA 530 –Audit Sampling requires that when designing audit procedures, the auditor
should determine appropriate means for selecting items for testing so as to gather
sufficient, appropriate audit evidence to be able to draw reasonable conclusions on which
to base the auditor’s opinion.
 The auditor uses statistical and non-statistical sampling when designing and selecting the
audit sample, performing tests of controls and tests of detail, and evaluating the results
from the sample.
 Results obtained from auditing a sample of items, will be corroborated with evidence
gained from other audit procedures, such as analytical procedures.

3
L.H.

2. Definitions
 ISA 530 –Audit Sampling provides the following definitions.
a. Audit sampling –the application of audit procedures to less than 100% of the items
within a population of audit relevance such that all sampling units have a chance of
selection in order to provide the auditor with a reasonable basis on which to draw
conclusions about the entire population.

b. Anomaly –a misstatement or deviation that is evidently not representative of

misstatements or deviations in the population.

c. Population –means the entire set of data from which a sample is selected and about
which the auditor wishes to draw conclusions.

d. Sampling risk – the risk that the auditor’s conclusion based on a sample may be
different from the conclusion that would be reached if the entire population were
subjected to the same audit procedure.
∙ There are two types of sampling risk:
* The risk that the auditor will conclude,
 in the case of a test of controls that controls are more effective than they
actually are, or
 in the case of tests of detail, 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.
* The risk that the auditor will conclude,
 in the case of a test of controls, that controls are less effective than they
actually are, or
 in the case of a tests of detail, that a material misstatement exists when in
fact is does not does not.
 This type of erroneous conclusion affects audit efficiency because
it will usually lead to additional audit work being carried out to
establish that the initial conclusion were incorrect.

e. Non-sampling risk - is the risk that the auditor arrives at, an erroneous conclusion for
any reason not related to sampling risk, e.g. because he has
∙ applied his sampling plan incorrectly,
∙ adopted an inappropriate procedure, or
∙ misunderstood the results of his sampling exercise.

f. Sampling unit - means the individual items constituting a population, for example,
∙ credit entries on bank statements,
∙ sales invoices listed in the sales journal,
∙ inventory line items, or
∙ individual debtors balances in the debtors ledger.

g. Statistical sampling- means any approach to sampling that has the following
characteristics:
* Random selection of a sample; and

4
L.H.

* Use of probability theory to evaluate sample results, including measurement of

sampling risk.
A sampling approach that does not have these characteristics, is considered non-
statistical sampling.

h. Stratification- is the process of dividing a population into sub-populations, each of

which is a group of sampling units which have similar characteristics e.g. debtors
balances from:
∙ $1 to $10 000,
∙ $10 001 to $25 000,
∙ $25 001 to $50 000.

i. Tolerable rate of deviation –a number or percentage of deviations 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 number/percentage set by the auditor
is not exceeded by actual deviations in the population.

j. 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.

3. Tests of controls and sampling

 After having obtained an understanding of the accounting and internal control
systems, the auditor will be in a position to identify the characteristics or attributes
which indicate the performance of a control procedure, for example, the signature of
the credit controller on a customer order indicating credit approval.
 Once the indicators have been identified, the auditor can test the control by extracting
a sample from the entire population of customer orders and inspecting the authorising
signature.

5
L.H.

Examples of Factors Influencing Sample Size for Tests of Controls

 The following are factors that the auditor may consider when determining the sample size
for tests of controls.

Factor Effect on sample

size
An increase in the Increase  The more assurance the auditor intends to obtain from the
extent to which the operating effectiveness of controls, the lower the auditor’s
auditor’s risk assessment of the risk of material misstatement will be,
assessment takes into and the larger the sample size will need to be.
account relevant  When the auditor’s assessment of the risk of material
controls misstatement at the assertion level includes an expectation
of the operating effectiveness of controls, the auditor is
required to perform tests of controls.
 Other things being equal, the greater the reliance the
auditor places on the operating effectiveness of controls in
the risk assessment, the greater is the extent of the
auditor’s tests of controls.
An increase in the Decrease  The lower the tolerable rate of deviation, the larger the
tolerable rate of sample size needs to be.
deviation
An increase in the Increase  The higher the expected rate of deviation, the larger the
expected rate of sample size needs to be so that the auditor is in a position
deviation of the to make a reasonable estimate of the actual rate of
population to be deviation.
tested  Factors relevant to the auditor’s consideration of the
expected rate of deviation include the
 Auditor’s understanding of the business,
 Changes in personnel or in internal control,
 The results of audit procedures applied in prior periods
and
 The results of other audit procedures.
An increase in the Increase  The greater the level of assurance that the auditor desires
auditor’s desired that the results of the sample are in fact indicative of the
level of assurance actual incidence of deviation in the population, the larger
that the tolerable rate the sample size needs to be.
of deviation is not
exceeded by the
actual rate of
deviation in the
population
An increase in the Negligible effect  For large populations, the actual size of the population has
number of sampling little, if any, effect on sample size.
units in the  For small populations however, audit sampling may not be
population as efficient as alternative means of obtaining sufficient
appropriate audit evidence.

4. Substantive procedures and sampling

 Substantive procedures are concerned with balances and amounts.
 Sampling may be used to gather evidence about one or more assertions relating to the
balance or amount, or to make an independent estimate of some amount.

6
L.H.

 For example,
 a sample of debtors may be selected for positive verification to obtain
evidence about the existence of debtors,
 the total value of inventory, based upon a sample selected, may be projected
for comparison with the value represented by the directors in the financial
statements.

Examples of Factors Influencing Sample Size for Tests of Details

 The following are factors that the auditor may consider when determining the sample
size for tests of details.

Factor Effect on
Sample
Size
An increase in the Increase  The higher the auditor’s assessment of the risk of
auditor’s assessment of material misstatement, the larger the sample size
the risk of material needs to be.
misstatement  The auditor’s assessment of the risk of material
misstatement is affected by inherent risk and
control risk.
 For example, if the auditor does not perform tests
of controls, the auditor’s risk assessment cannot
be reduced for the effective operation of internal
controls with respect to the particular assertion.
 Therefore, in order to reduce audit risk to an
acceptably low level, the auditor needs a low
detection risk and will rely more on substantive
procedures. The more audit evidence that is
obtained from tests of details (that is, the lower
the detection risk), the larger the sample size
will need to be.
An increase in the use Decrease  The more the auditor is relying on other
of other substantive substantive procedures (tests of details or
procedures directed at substantive analytical procedures) to reduce to an
the same assertion acceptable level the detection risk regarding a
particular population, the less assurance the
auditor will require from sampling and, therefore,
the smaller the sample size can be.
An increase in the Increase  The greater the level of assurance that the auditor
auditor’s desired level requires that the results of the sample are in fact
of assurance that indicative of the actual amount of misstatement
tolerable misstatement in the population, the larger the sample size
is not exceeded by needs to be.
actual misstatement in
the population
An increase in Decrease  The lower the tolerable misstatement, the larger
tolerable the sample size needs to be.
misstatement
An increase in the Increase  The greater the amount of misstatement the
amount of auditor expects to find in the population, the
misstatement the larger the sample size needs to be in order to
auditor expects to make a reasonable estimate of the actual amount
find in the population of misstatement in the population.

7
L.H.

Stratification of the Decrease  When there is a wide range (variability) in the

population when monetary size of items in the population, it may
appropriate be useful to stratify the population.
 When a population can be appropriately
stratified, the aggregate of the sample sizes from
the strata generally will be less than the sample
size that would have been required to attain a
given level of sampling risk, had one sample
been drawn from the whole population.
The number of Negligible  For large populations, the actual size of the
sampling units in the effect population has little, if any, effect on sample size.
population  Thus, for small populations, audit sampling is
often not as efficient as alternative means of
obtaining sufficient appropriate audit evidence.

5. Statistical versus non-statistical approaches

 The decision as to whether to use statistical or non-statistical sampling is a matter of
professional judgement.
 Statistical sampling and non-statistical sampling are not mutually exclusive, certain
aspects of statistical sampling may be used when performing a non-statistical sample.
 Eg, the sample size may be decided upon on a judgmental basis (non-statistical) but
the items to be selected may be chosen using computer generated random numbers
(statistical approach).
 Valid evaluation of the sampling results (statistically based) can only take place where
all the characteristics of statistical sampling have been adopted, e.g.
∙ Sample size,
∙ Selection of items,
∙ Extrapolation,
∙ Evaluation, are properly applied in terms of probability theory.

6. Steps in the sampling exercise

 An important consideration in undertaking a sampling exercise is whether it will be
statistically or non-statistically based.
 The decision will be one of professional judgement, but will be based on
 the level of assurance required by the auditor,
 the skills and time available, and
 the “defensibility” of the results which the auditor might require.
 Regardless of this decision the steps to be taken remain broadly the same.
 The steps are as follows:
6.1 Determine the objectives of the procedure
6.2 Determine the procedure to be performed
6.3 Confirm that the population is appropriate and complete
6.4 Define the units of the population
6.5 Determine the sample size
6.6 Select the sample
6.7 Perform the audit procedures
6.8 Analyse the nature and cause of deviations and misstatements
6.9 Project the sample results over the population
6.10 Evaluate

8
L.H.

6.1 Determine the objectives of the procedure

 For example, the auditor may wish to establish:
* (Example A)That for every entry in the purchase journal, there is a signed goods
received note (test of controls), or
* (Example B)That the individual debtor’s balances in the debtors ledger pertain to
debtors who exist (substantive).

6.2 Determine the procedure to be performed

 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.

* In summary, the procedures include specifying clearly the error condition. So in

Example A above, the procedure will be to select a sample of entries in the
purchase journal and trace to the purchase invoice and see whether it has a signed
GRN attached. The deviation is the absence of a GRN.
* In Example B above, the procedure may be to select debtors' balances for positive
circularisation. The misstatement will be the inclusion in the client's debtors
ledger of any debtor who does not exist.

6.3 Confirm that the population is appropriate and complete

* This is the population from which the sample is to be selected and the population
upon which an audit conclusion is to be made.
∙ In Example A, the population will be all purchase journal entries and
∙ In Example B, the population will be all debtors balances as per the
debtors ledger.
* All units in the population must be available for selection.

6.4 Define the units of the population

 In example A, the units would be entries in the purchase journal, and
 In example B, the units would be each debtor in the general ledger.

6.5 Determine the sample size

 The overriding requirement for determining the sample size is whether the sampling
risk will be reduced to an acceptably low level. For example, if you have a population
of 10 000 items and you select a sample of only 15 items, sampling risk would be
very high.
 With non-statistical approaches, the sample size is virtually entirely based on
professional judgment.

9
L.H.

With statistical approaches, the auditor is forced into making judgements

about specific matters which are then applied to a formula or table which will
give the sample size.
 These specific judgments are described as follows:
a. Confidence level:
b. Tolerable misstatement/tolerable rate of deviation:
c. Expected misstatement/rate of deviation
d. The population size (the number of sampling units):

* Confidence level: confidence indicates, as a percentage, how often a sample will

correctly represent the population.
∙ The auditor must decide how “confident” he wants to be about his
conclusions.
∙ The more confident he wishes to be, the larger the sample needs to be.
∙ The auditor must draw his conclusion on the population, and therefore wants
the sample to be representative of the population.
∙ In examples A and B, a 90% confidence level would mean that if 100 random
samples were selected, 90 of them would be expected to give a reliable
representation of the extent to which purchase journal entries are supported by
GRNs, and 10 may not.
* Tolerable misstatement/tolerable rate of deviation: this is the maximum extent
of “error” that the auditor is willing to accept and still feel that the objective of the
sampling procedure has been achieved.
∙ The converse of this is the extent of misstatement or rate of deviation which
the auditor decides is unacceptable.
∙ In example A, if the auditor wishes to rely on a GRN supporting purchase
journal entries (i.e. goods were received) he or she must be sure that it happens
in, say, 97% of cases.
∙ The tolerable deviation will then be 3%.
∙ In example B, the tolerable misstatement would be expressed in Dollars e.g.
$10000 of the balance pertains perhaps to debtors for which the auditor cannot
prove existence.
∙ The less deviation or misstatement the auditor is prepared to tolerate, the
larger the sample size.
* Expected misstatement/rate of deviation: most sampling plans require an
estimate of the expected “error rate” to be made because the greater the
anticipated misstatement/rate of deviation, the larger the sample size will be in
order to achieve sufficient assurance.
∙ The estimate is based either on
 past experience,
 knowledge of the business or
 a pilot sample.
* The population size: some sampling plans require that the population size be
known to be able to arrive at the sample size.
∙ In example A, the population will be every entry in the purchase journal, or
∙ In example B, the population will be every debtor in the debtors ledger.

10
L.H.

6.6 Select the sample

 Having calculated the sample size, the decision has to be taken as to how to select
these items.
 The following methods are suggested:
* Random: Every unit must have an equal chance of selection and the selection can
be made manually by using random number tables, or by computer using random
number generation software.

* Systematic: The number of sampling units in the population is divided by the

sample size to give a sampling interval, for example 50, and having determined a
starting point within the first 50, each 50th sampling unit thereafter is selected.
When using systematic selection, the auditor would need to determine that
sampling units within the population are not structured in such a way that the
sampling interval corresponds with a particular pattern in the population.

* Haphazard: The auditor selects the sample without following a structured

technique.
∙ In a non-statistical sample it is an acceptable technique.
∙ It is not a valid method of selection if using statistical sampling as guaranteed
randomness is a prerequisite of the statistical sampling approach.
∙ Although no structured technique is used, the auditor would nonetheless avoid
any conscious bias or predictability and thus attempt to ensure that all items in
the population have a chance of selection.
∙ Haphazard selection is not appropriate when using statistical sampling

* Block: Involves selection of a block of numerically consecutive items from within

the population.
∙ This is not often an appropriate selection technique where the auditor wishes
to draw valid inferences about the entire population.
∙ Block selection cannot ordinarily be used in audit sampling because most
populations are structured such that items in a sequence can be expected to
have similar characteristics to each other, but different characteristics from
items elsewhere in the population.
∙ Although in some circumstances it may be an appropriate audit procedure to
examine a block of items, it would rarely be an appropriate sample selection
technique when the auditor intends to draw valid inferences about the entire

* Monetary unit sampling is a value weighted selection method in which the

sampling unit is every dollar in the population.
∙ Every nth dollar is then selected.
∙ This will result in larger amounts being selected because larger amounts have
more dollar units.
∙ If we are selecting a sample of debtors from the debtor’s list, we do not
consider the individual debtors to be the sampling unit, we regard each dollar
in each balance to be the sampling unit.
∙ Therefore we select every nth dollar, the chances are greater that the nth dollar
will be contained in large balances than in small balances. The debtors
balances into which the nth dollars fall, will be selected for the sample.

11
L.H.

∙ Therefore this is a type of value-weighted selection in which sample size,

selection and evaluation results in a conclusion in monetary amounts.

6.7 Perform the audit procedures

As determined in (6.2) above.
* This includes specifying clearly the error (deviation or misstatement) condition.
∙ In example A the procedure will be to select a sample of entries in the
purchase journal and trace to the purchase invoice and see whether it has a
signed GRN attached. The deviation is the absence of a GRN.
∙ In example B, the procedure may be to select debtors' balances for positive
circularisation. The misstatement will be the inclusion in the client's debtors
ledger of any debtor who does not exist.

6.8 Analyse the 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.
 Two examples will illustrate the importance of this procedure.

a. Example 1: When performing tests of controls, the analysis of deviations

discovered in the sample indicates the presence of management override.
∙ This may suggest to the auditor that fraudulent activity is taking place leading
to a reassessment of all information supplied by management and the
extention of testing to other areas of the audit.
b. Example 2: On analysis the auditor may establish that certain errors in the sample
arose out of an isolated or unique event (anomaly).
∙ Eg where the errors can be tied back to a temporary staff member who had
made the errors whilst standing in for the permanent staff member for a short
period during the year.
∙ If this unique situation is projected over the population, the result will be very
misleading and may result in the performance of unnecessary procedures.

6.9 Project the sample results over the population

 For tests of details, the auditor shall project misstatements found in the sample to the
population.
∙ 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.
 At this point the auditor will calculate the actual number of misstatement/deviations in
the sample.

6.10 Evaluate
The auditor shall evaluate:
a. The results of the sample;

12
L.H.

 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.

b. Whether the use of audit sampling has provided a reasonable basis for conclusions
about the population that has been tested.
 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 a test of controls,
the auditor might
 extend the sample size,
 test an alternative control or modify related substantive procedures

 Once the sample result is projected over the population, it is compared to the tolerable
deviation/misstatement.
 The auditor then concludes on the sample in terms of his confidence level and
precision if these have been set.
 Should the results of a sampling exercise be unsatisfactory, the auditor may:
* Request management to investigate the deviations/misstatements and the potential
for further deviations/misstatements, and to make any necessary adjustments;
and/or
* Modify planned audit procedures.

13
 L.H.

7. Exam practice questions and solutions

Question 1: Fergusson and Co
You are an audit manager at Fergusson and Co. You are reviewing the plan of the audit of a
manufacturing company, Rowz (Pvt) Ltd. The planning has been done by Steven Denham,
the senior on the audit. This is his first large audit as senior. Fergusson and Co, as part of
their standard planning procedures, requires the completion of a pre-printed document titled
"Sampling Methods", which details the sampling methods to be used on all major areas of
an audit.
Steven Denham's completed "Sampling Methods" form for the upcoming Rowz (Pvt) Ltd
audit, part of which, is reproduced below:

Area Method Reasoning

1. Inventory count I will choose large value As the auditor’s concern is generally over-
items from the inventory. I statement of assets, inventory items must
will continue doing this be selected with the emphasis on large
until 50% of the inventory items.
value has been counted.
2.Purchases A haphazard selection of By making a totally random selection, we
200 purchases of $5000 or can, at a later stage, evaluate the results on
more made by the junior a statistical basis should we want to.
trainee working on the
purchases section
3. Completeness of The completeness of I can use our firm’s step by step
Creditors creditors’ balances at year instructions to implement this statistically
end will be tested using based sampling plan as completeness is an
monetary unit sampling. important assertion for creditors.
4.Directors I suggest a statistical There is a directors meeting held every
Minutes sample here but need two weeks other than when the company
advice on which one is shut down for holiday periods. This year
would be appropriate. there were 24 meetings. I know that we
usually review all directors minutes but
this seems excessive. A statistical sample
would give us a better result quicker.
5. Cost of Plant To verify the cost of plant If we agree the opening balance on the
and Equipment and equipment, all we need cost of plant and equipment accounts to
to do is full verification our prior year work papers and verify all
procedures on all additions additions, the year end balance will be
for the year. No sampling correct.
required.

Required.
In your capacity as audit manager, evaluate, with full explanation, Steven Denham's planned
sampling methods and reasoning. (25 marks)

Solution
1. Inventory count
 There is no reference to any risk assessment pointing to a particular risk of overstatement.

14
L.H.

 There is usually risk associated with the existence of inventory (overstatement) but the
level of testing being suggested does not seem warranted unless there is very material and
specific risk to existence.
 In a general sense, emphasis can be placed on higher value items provided there is also
some coverage of low and nil value inventory items. A sample should be representative of
the population but can be stratified.
 No rationale is given for aiming at 50% of the total value - this seems to be a particularly
poorly considered approach with no indication of how many test counts will be needed!
 By testing only from the records to the physical inventory, no evidence will be gathered
about the completeness of inventory. A small sample for testing the other way should be
selected. In addition, the trainee’s method and reasoning do not make it absolutely clear
whether he will be selecting from the records or from the physical inventory.

2. Purchases
 There seems to have been no evaluation of the risk of misstatement in purchases.
 There is no indication of what testing the junior trainee will be carrying out
∙ is he conducting tests of controls or tests of detail?
 Haphazard selection is not a totally random method of selection so this immediately
negates the possibility of introducing statistical evaluation.
 Furthermore, statistical analysis requires that a proper statistical sampling plan be used.
This requires setting out objectives, setting parameters, defining the population etc. None
of this has been done.
 There is no indication of the population size or what document(s) is actually being
tested. Even without this information, 200 items selected is a very big sample.
 Boredom is very likely to set in resulting in non-sampling error.
 A proper statistical sample is likely to be smaller and by using random tables, a far
more representative sample will be obtained.
 Audit efficiency and effectiveness is improved if statistical sampling is used on large
populations.
 There is no indication of how the audit senior arrived at $5000 as a cut-off. Again, whilst
stratification is perfectly acceptable, there must be some justification for setting the
different strata. As it stands, every purchase under $5000 will be ignored and when
combined, could make up a large percentage of purchases. Note: the sampling plan must
match the objective of the test.

3. Completeness of creditors
 Completeness is the assertion relating to creditors which tends to attract the greatest audit
risk so the senior is correct with regard to its importance.
 However, MUS (monetary unit sampling) is not a sampling plan which matches to the
objective of testing completeness.
 MUS tends to “hook out” the larger creditors balance from the list of creditors. In testing
for completeness we are more interested in creditors which are not on the list at all or
which are understated. Therefore MUS is not a suitable sampling plan.
 The audit team should be concentrating on all the other completeness of creditors tests,
e.g.
 comparison with prior year balances,
 nil balances,
 cut-off testing for purchases, etc.

15
L.H.

 The results of purchases testing will usually have a bearing on completeness of creditors
testing (e.g. purchases cut-off). The senior does not consider this but that is probably
because he has not decided on, or defined, what tests he is conducting on purchases.
 Successful statistical sampling (including MUS) is not just a matter of following step-by-
step instructions in the audit manual. It is essential that the audit team in the field has a
good understanding of the technique. Steven Denham clearly lacks the understanding to
make the sound professional judgement calls which are also required when applying
MUS.

4. Directors minutes
 The reason that all directors’ minutes are reviewed is that important decisions which the
auditor may not discover any other way may be contained in the minutes.
 Although 24 sets of minutes may seem excessive (it is not really) it is not possible to
extract any meaningful samples, statistical or otherwise because …
* Directors meetings do not necessarily deal with the same matters from meeting to
meeting, i.e. The sampling units are too dissimilar and their characteristics are too
varied
* The population is far too small to perform a suitable sample
* Furthermore before the auditor reviews minutes, he does not know exactly what he is
looking for. Of course he has an idea of matters which may arise, but there could be
any number of matters which the auditor did not expect.

5. Cost of plant and equipment

 Again no mention of any risk evaluation in respect of plant and equipment.
 It is not necessary to do such extensive verification of additions unless there is serious
risk of overstatement.
 It appears as if only substantive work will be done on fixed assets. Is there any rationale
for this decision? Why will there be no tests of controls over the acquisition of fixed
assets including plant and equipment. For example, if the authorising controls over
additions (and disposals) of fixed assets are good and strictly applied, substantive work
can be significantly reduced.
 Whatever the amount of testing is decided upon, there should be some physical inspection
of a sample of all assets, not just additions, for existence (and physical
condition/impairment purposes). Assets included in the opening balance may no longer
exist or be owned by the company. The cost of any such assets should be removed from
the plant and equipment accounts.
 Furthermore a sample of disposals will need to be verified to ensure that costs are
properly removed from the records where necessary.

Question 2: Screens (Pvt) Ltd

You are the auditor in charge of the audit of Screens (Pvt) Ltd, a company which rents out
television sets. At the financial year-end 30 April 2020, the company's records revealed
inventory of 14000 television sets on hand, valued on average at $2500 each, of which 12321
were out on rental. Rental payments are received monthly and are identified in the cash book,
and debtors ledger by name and the rental agreement number.
The trainee on the job, Elvis Adams, decided that he should perform tests on the existence
assertion relating to television sets owned by Screens (Pvt) Ltd. To achieve this he selected
12 (twelve) clients from the list of rental agreements on a random basis and drafted a

16
L.H.

confirmation letter to each of them requesting that they positively confirm the existence of
the TV set they had rented. The results were as follows:
1. 10 of the 12 confirmation letters were returned.
2. Of the 10 returned 9 confirmed that the television set did exist.
3. The tenth confirmation letter stated that the television set had been returned.
The workpaper presented by Elvis Adams revealed that his response had been as follows:
1. For the two confirmations not returned, he had sent a second letter but had not received
any reply. Follow up by fax and phone had also not provided any response.
2. For the letter which revealed that the television set had been returned, he checked the
rental agreement and established that it had expired.

The workpaper also revealed the following conclusion:

"I am satisfied with the existence assertion for television sets owned by Screens (Pvt) Ltd. Of
the 12 positive confirmations sent out, in effect ten of the twelve confirmed the existence of
the television set. This equates to an 83% positive response which is excellent for a
circularisation. No further tests are necessary."

Required
Explain fully why you would not be satisfied with the work performed by Elvis Adams.

Solution
I would not be satisfied with the work of Elvis Adams for the following reasons:
1. Despite the selection of the twelve clients to be circularised being made on a random
basis, the size of the sample is far too small to be representative of the population.
2. In effect Elvis Adams has disregarded (or never considered) sampling risk.
3. The population from which he has selected his sample is incorrect; the full population
of sets owned by Screens (Pvt) Ltd (14 000) should have been used; not the
population of rented sets (alternatively, further existence tests should be carried out on
sets on hand).
4. He clearly gave no thought to the appropriate sampling plan to be used to achieve his
objective, nor did he give any considerations to the parameters which should be set,
e.g. confidence level.
5. This further suggests that he gave very little consideration to the risks that may affect
the existence assertion for television sets.
6. His response to the sample results is totally inadequate
6.1. He has failed to follow up adequately on the no replies - it could be that these
rentees are fictitious and that the televisions do not in fact exist -precisely what
the test is attempting to prove.
6.2. The follow up procedure for the returned television was not appropriate, he
should have
* Established details of the return (e.g. date, documentation) number and
inspected the television set if it was "in stock" or sought positive
confirmation from the new rentee.
6.3. 83% return is excellent for a circularisation BUT …
* the circularisation is not, on its own, sufficient evidence and
* the results must be analysed in relation to the population as a whole not in
terms of the sample
* it is a very small sample.
6.4. There is a chance that the sample is representative of the population of rented
out sets - in which case there could be as many as 1/6 of 12321 sets which do

17
L.H.

not exist i.e. are with fictitious rentees. This would mean a possible overstatement
of inventory of approximately $5 million (total value $35 million) which is very
material - further tests must be performed to reduce this risk to an acceptable
level.

Question 3 : Libvest Ltd

You have been assigned to the audit of salaries on the audit of Libvest Ltd, a large listed
investment company. The company has approximately 15000 employees, located in 78
offices around the country. As a result of information gathered when conducting “identifying
and assessing the risk of material misstatement” procedures, it has been decided that a
physical verification of employees country wide, should take place. You have been requested
to select a sample of employees for verification. All salaried employees are listed in the
salaried employees database. The masterfile contains the following fields:
1. Surname and initials
2. Bank account number (salaries are paid by EFT)
3. Taxation Reference number
4. Identity number
5. Grade, e.g. grade 1 – company director, grade 12 – junior clerk
6. Permanent or temporary
7. Date of employment
8. Date of Resignation, Dismissal, Retirement
9. Home address
10. Work location – e.g. Harare office
11. Gross Remuneration
12. UIF
Your senior has instructed you not to simply extract a single statistically based sample from
the total population on the database. He requires that you use your audit software to:
i. Extract lists of employees (if any) whose records on the masterfile reveal information
which may raise uncertainty about their existence and
ii. To extract any other samples you might consider necessary to carry out a successful
physical verification.

Required
Identify the lists of employees and samples which you would extract to comply with the
instructions from your senior. Explain briefly why each list or sample would be selected.

Solution
As physical verification is part of testing for occurrence of salaries (i.e. fictitious employees),
I would select the following:
1. All employees who have the same bank account number as another employee. This is
abnormal so I would want to physically verify such employees (note: there may be valid
account sharing e.g. husband and wife).
2. All employees for whom there is
1. No tax reference number
2. No identity number
All employees should have a tax and identity number and it is possible that employees
with missing tax and identity numbers are fictitious.

18
L.H.

3. A sample of temporary staff still on the database. It is easier to include “fictitious”

employees by “engaging” and “dismissing” temporary workers.
4. Any employees whose names and identity numbers or taxation numbers are identical. It
may have been deliberately listed twice.
5. A sample of employees from all locations in order to physically verify employees at each
location.
6. A sample of employees appointed during the year and who are still employed. There is a
higher risk that these employees were fictitiously appointed.
7. A random sample (or possibly a random sample after stratification by grade) of the entire
population. We need a representative sample but there are likely to be many more
employees in the grades say 8 to 12.

Question 4: Factors affecting sample size

The following are factors that the auditor considers when determining the sample size for a
substantive procedure:
1. An increase in the auditor’s assessment of the risk of material misstatement.
2. An increase in the use of other substantive procedures directed at the same assertion.
3. An increase in the amount of misstatement the auditor expects to find in the
population
4. Stratification of the population when appropriate.
5. The number of sampling units in the population.

Required:
Explain the effect, with reasons, on the sample size of each of the factors listed above.

Solution
1. Increase of sample size due to increase in the auditor’s assessment of
misstatement. The higher the auditor’s assessment of risk of misstatement, the larger
the sample size needs to be. For example, an assessment of material misstatement as
high indicates that the auditor cannot place much reliance on the effective operation
of internal controls with respect to the particular assertion. Therefore, in order to
reduce audit risk to an acceptably low level, the auditor needs a low detection risk and
will rely more on substantive tests. The more audit evidence that is obtained from
substantive tests (that is, the lower the detection risk), the larger the sample size will
need to be.

2. Decrease - The use of other substantive procedures directed at the same assertion.
The more the auditor is relying on other substantive procedures (tests of detail or
analytical procedures) to reduce to an acceptable level the detection risk regarding a
particular account balance or class of transactions, the less assurance the auditor will
require from sampling and, therefore, the smaller the sample size can be.

3. Increase - The amount of misstatement the auditor expects to find in the population
(expected misstatement). The greater the amount of misstatement the auditor expects
19
L.H.

to find in the population, the larger the sample size needs to be in order to make a
reasonable estimate of the actual amount of misstatement in the population. Factors
relevant to the auditor’s consideration of the expected misstatement amount include
the extent to which item values are determined subjectively, the results of risk
assessment procedures, tests of controls, the results of audit procedures applied in
prior periods, and the results of other substantive procedures.

4. Decrease - Stratification. When there is a wide range (variability) in the monetary

size of items in the population, it may be useful to group items of similar size into
separate sub-populations or strata. This is referred to as stratification. When a
population can be appropriately stratified, the aggregate of the sample sizes from the
strata generally will be less than the sample size that would have been required to
attain a given level of sampling risk, had one sample been drawn from the whole
population.

5. Negligible effect/none - The number of sampling units in the population. For large
populations, the actual size of the population has little, if any, effect of sample size.
For small populations, however, audit sampling is often not as efficient as alternative
means of obtaining sufficient appropriate audit evidence.

20