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Chapter Outline

»Testing and Audit Sampling

» 1: Audit Sampling Concepts
» 2: Sampling for Tests of Controls
» 3: Sampling for Substantive Tests

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 Introduction and Scope of ISA 530

»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.
»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.
»This ISA is effective for audits of financial statements for periods
beginning on or after December 15, 2009.
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 1.1. AUDIT SAMPLING CONCEPTS

»Audit sampling (sampling), Meaning (ISA 530)

»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
of selection in order to provide the auditor with a reasonable basis on
which to draw conclusions about the entire population.
»Population – The entire set of data from which a sample is selected and
about which the auditor wishes to draw conclusions.
»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.
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 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.
»In an audit, sampling procedures are used because it is not practical to
examine every single item in a population.
»Two things cause a sample to be non-representative:
»Non-sampling risk caused by non-sampling error
»Sampling risk caused by sampling error 5
 Non-sampling risk (Slide 1/2)

»The risk of auditor error that arises from the possibility that the
auditor failure to detect a misstatement

»Non-sampling risk is the risk that the audit tests do not uncover
existing exceptions in the sample.

»The two causes of non-sampling risk are:

» Auditor failure to recognize exceptions

» Inappropriate or ineffective audit procedures

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 Non-sampling risk (Slide 2/2)

» An auditor might fail to recognize an exception because of exhaustion,

boredom, or lack of understanding of what might constitute an exception.
» For example, let's say one of your controls is that all employees use a password
manager like Last Pass to store passwords securely. If your auditor finds that
three out of 50 employees they reviewed as part of a sample are not using
LastPass, that would be listed as an exception
» ways to control non-sampling risk:
» Careful design of audit procedures,
» Proper instruction,
» Proper supervision, and Careful review 7
 Sampling Risk

» 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 results from testing less than
the entire population.
» Auditors have two ways to control sampling risk:
1. Adjust sample size
2. Use an appropriate method of selecting sample items from the population
» Increasing sample size reduces sampling risk, and vice versa.
» Using an appropriate sample selection method increases the likelihood of
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representativeness.
 Audit Sampling Methods

»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. (Para. 4 of ISA 530)
»The auditor may decide to apply audit sampling to an account balance or
class of transactions.
»Before discussing the methods of sample selection to obtain
representative samples, it is useful to make distinctions between:
»statistical versus non-statistical sampling, and
»probabilistic versus non-probabilistic sample selection.

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 Statistical Versus Non-statistical Sampling (slide 1of 3)

» Paragraph 5 (g) of ISA 530 States that:

» 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.
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 Statistical Versus Non-statistical Sampling (slide 2 of 3)

»Audit sampling methods can be divided into two broad categories:

statistical sampling and non-statistical sampling.
»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). 11
 Statistical Versus Non-statistical Sampling (slide 3 of 3)

»In non-statistical sampling, 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.
»Advantages of Statistical Sampling
»Design efficient samples
»Measure sufficiency of evidence
»Objectively evaluate sample results
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 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.

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 Non-probabilistic Sample Selection Methods (1/3)

» Non probabilistic (judgmental) sample selection methods:

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.
» 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 14
 Non-probabilistic Sample Selection Methods (2/3)

2. Block sample selection is the selection of several items in sequence.

» auditors select the first item in a block, and the remainder of the block is
chosen in sequence.

» For example, 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.
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 Non-probabilistic Sample Selection Methods (3/3)

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.
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 Probabilistic sample selection Methods (1/4)

»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:
»Random number tables
»Computer generation of random numbers 17
 Probabilistic sample selection Methods (2/4)

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).
» This is also known as monetary unit sampling or dollar unit sampling. This
method is somewhat similar to systematic sampling.
» It is evaluated using non - statistical sampling or monetary unit statistical
sampling. 18
 Probabilistic sample selection Methods (3/4)

» Objective of using probability proportional to size sampling (PPS) to test

account balances
» -PPS tests the reasonableness of a recorded account balance or class of
transactions.
» -Probability Proportional to Size (PPS) is used to determine the accuracy of
financial accounts i.e. to test for overstatements.
» Under this method, a large value item will have a greater chance of being
picked from the sample than a relatively small value item.
» Example: An account receivable with a $9,000 balance has ten times greater
probability of selection than one with $900 balance

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 Probabilistic sample selection Methods (4/4)

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.
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 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.
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 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.

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 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

given controls or monetary correctness

» Following are types of exceptions in populations of accounting data:

» Deviations from client’s established controls
» Monetary misstatements in populations of transaction data
» Monetary misstatements in populations of account balance details
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 Audit Sampling for Exception Rates

» Knowing the exception rate is particularly helpful for the first two types of
exceptions, which involve transactions.
» Therefore, auditors make extensive use of audit sampling that measures the
exception rate in doing tests of controls and substantive tests of
transactions.
» With the third type of exception, auditors usually need to estimate the total
dollar amount of the exceptions because they must decide whether the
misstatements are material.
» When auditors want to know the total amount of a misstatement, they use
methods that measure dollars, not the exception rate.
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 Audit Sampling for Exception Rates

» The exception rate in a sample is used to estimate the exception rate in the
entire population, meaning it is the auditor’s “best estimate” of the
population exception rate.
» The term exception should be understood to refer to both deviations from
the client’s control procedures and amounts that are not monetarily correct,
whether because of an unintentional accounting error or any other cause.
» The term deviation refers specifically to a departure from prescribed
controls.

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Terms used in Audit Sampling

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 1.2. 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.
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 Audit Sampling for Test of Controls

»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.

»Attribute sampling which is a statistical process helps determine

whether internal controls are being followed.

»The process involves taking samples of certain activities, such as

paying an invoice of a certain amount then analyzing that process.
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 Audit Sampling for Test of Controls

» Tests of controls are performed to determine the effectiveness of both the

design and operations of specific internal controls.
» These tests include the following types of procedures:
» Make inquire of appropriate client personnel
» Examine documents, records, and reports
» Observe control-related activities
» Re-perform client procedures
» The first two are the same as those used for understanding of internal control.
» Thus, performing tests of controls can be thought of as a continuation of the
audit procedures used to obtain the understanding of internal control.

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 1.3. 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.

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 Cont.…

»In other words, Substantive audit test is a procedure designed to test

for birr misstatements directly affecting the correctness of financial
statement balances.
»Monetary misstatements are clear indication of the misstatement of
accounts.
»There are three types of substantive tests:
1. substantive tests of transactions,
2. analytical procedures, and
3. tests of details of balances

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 Cont..

1. Substantive Tests of Transactions

» The purpose of substantive tests of transaction is to determine whether all six
transaction-related audit objectives have been satisfied for each class of
transactions.
» The transaction-related audit objectives are: existence, completeness, accuracy,
classification, timing, and posting and summarization
2. Analytical Procedures (Tests)
» Analytical procedures involve comparisons of recorded amounts to
expectations developed by the auditor.
» They often involve the calculation of ratios by the auditor for comparison with
previous year’s ratios and other data.

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 Cont.…

3. Tests of Details of Balances

»Focus on the ending general ledger balances for both balance sheet
and income statement accounts.
»But, the primary emphasis in most tests of details of balances is on
balance sheet.
»Examples: confirmation of customers accounts statements for account
receivable, physical examination of inventory, examination of vendors’
statements for account payables.
»Typically, auditors use all five types of tests when performing an audit,
but certain types are emphasized depending on the circumstances.
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 Differences Among Tests

»The main differences among tests of controls, substantive tests of

transactions, and tests of details of balances are in what the auditor
wants to measure.

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 Cont..

»Auditors perform tests of controls and substantive tests of transactions:

1. To determine whether the exception rate in the population is
sufficiently low
2. To reduce assessed control risk and thereby reduce tests of details
of balances
3. For larger public companies, to conclude that the control is
operating effectively for purposes of auditing internal control over
financial reporting 35
END OF CHAPTER ONE
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