Chapter 9

Audit Sampling: An Application to Substantive Tests of

Account Balances

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

To determine if a financial statement

account is fairly stated.

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Sampling Techniques

Statistical
- Monetary Unit Sampling ( MUS)
- Classical variable sampling

Non-statistical

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 LO# 1

Substantive Tests of Details of Account

Balances
The statistical concepts we discussed in the last
chapter apply to this chapter as well. Three important
determinants of sample size are
1. Desired confidence level.
2. Tolerable misstatement.
3. Estimated misstatement.
Population plays a bigger role in some of the sampling
techniques used for substantive testing.
Misstatements discovered in the audit sample must be
projected to the population, and there must be an
allowance for sampling risk. 9-4
 LO# 1

Substantive Tests of Details of Account

Balances
Consider the following information about the inventory
account balance of an audit client:
Book value of inventory account balance $ 3,000,000
Book value of items sampled $ 100,000
Audited value of items sampled 98,000
Total amount of overstatement observed in audit sample $ 2,000

The ratio of misstatement in the sample is 2%

($2,000 ÷ $100,000)
Applying the ratio to the entire population produces a best
estimate of misstatement of inventory of $60,000.
($3,000,000 × 2%)
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 LO# 1

Substantive Tests of Details of Account

Balances
The results of our audit test depend upon
the tolerable misstatement associated
with the inventory account. If the tolerable
misstatement is $50,000, we cannot
conclude that the account is fairly stated
because our best estimate of the
projected misstatement is greater than
the tolerable misstatement.

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 LO# 2

Monetary-Unit Sampling (MUS)

MUS uses attribute-sampling theory to
express a conclusion in dollar amounts rather
than as a rate of occurrence. It is commonly
used by auditors to test accounts such as
accounts receivable, loans receivable,
investment securities, and inventory.

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 LO# 2

Monetary-Unit Sampling (MUS)

MUS uses attribute-sampling theory (used
primarily to test controls) to estimate the
percentage of monetary units in a population
that might be misstated and then multiplies
this percentage by an estimate of how much
the dollars are misstated.

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 LO# 2

Monetary-Unit Sampling (MUS)

Advantages of MUS
1. When the auditor expects no misstatement, MUS
usually results in a smaller sample size than classical
variables sampling.
2. The calculation of the sample size and evaluation of
the sample results are not based on the variation
between items in the population.
3. When applied using the probability-proportional-to-size
procedure, MUS automatically results in a stratified
sample.

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 LO# 2

Monetary-Unit Sampling (MUS)

Disadvantages of MUS
1. The selection of zero or negative balances generally
requires special design consideration.
2. The general approach to MUS assumes that the
audited amount of the sample item is not in error by
more than 100%.
3. When more than one or two misstatements are
detected, the sample results calculations may
overstate the allowance for sampling risk.

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 LO# 2

Steps in MUS Sampling

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
• Define the population.
• Define the sample unit.
• Define a misstatement.
3. Determine the sample size, using the following inputs:
• The desired confidence level or risk of incorrect acceptance.
• The tolerable misstatement.
• The expected population misstatement.
• Population size.
Performance
4. Select sample items.
5. Perform the auditing procedures.
• Understand an alayzye any missstatements observed.
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement.
7. Draw final conclusions.
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 LO# 2

Steps in MUS Sampling

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
• Define the population.
• Define the sample unit.
• Define a misstatement.

Sampling may be used for substantive testing to:

1. Test the reasonableness of assertions about a
financial statement amount (i.e., is the amount fairly
stated). This is the most common use of sampling for
substantive testing.
2. Develop an estimate of some amount.
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 LO# 2

Steps in MUS Sampling

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
• Define the population.
• Define the sample unit.
• Define a misstatement.

For MUS the population is defined as the

monetary value of an account balance,
such as accounts receivable, investment
securities, or inventory.

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 LO# 2

Steps in MUS Sampling

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
• Define the population.
• Define the sample unit.
• Define a misstatement.

An individual dollar represents the sampling unit.

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 LO# 2

Steps in MUS Sampling

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
• Define the population.
• Define the sample unit.
• Define a misstatement.

A misstatement is defined as the difference between

monetary amounts in the client’s records and
amounts supported by audit evidence.

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 LO# 2

Steps in MUS Sampling

Steps in MUS Sampling Application
3. Determine the sample size, using the following inputs:
• The desired confidence level or risk of incorrect acceptance.
• The tolerable misstatement.
• The expected population misstatement.
• Population size.

Relationship Change Effect on

Factor to Sample Size in Factor Sample
Lower Decrease
Desired confidence level Direct
Higher Increase
Lower Increase
Tolerable mistatement Inverse
Higher Decrease
Lower Decrease
Expected mistatement Direct
Higher Increase
Lower Decrease
Population size Direct
Higher Increase

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 LO# 2

Steps in MUS Sampling

Steps in MUS Sampling Application
Performance
4. Select sample items.
5. Perform the auditing procedures.
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement.
7. Draw final conclusions.

The auditor selects a sample for MUS by using a

systematic selection approach called probability-
proportional-to-size selection. The sampling interval can
be determined by dividing the book value of the
population by the sample size. Each individual dollar in
the population has an equal chance of being selected
and items or “logical units” greater than the interval will
always be selected. 9-17
 LO# 3

Steps in MUS Sampling

Assume a client’s book value of accounts receivable is $2,500,000, and the
auditor determined a sample size of 93. The sampling interval will be
$26,882 ($2,500,000 ÷ 93). The random number selected is $3,977 the
auditor would select the following items for testing:
Cumulatvie Sample
Account Balance Dollars Item
1001 Ace Emergency Center $ 2,350 $ 2,350
1002 Admington Hospital 15,495 17,845 $ 3,977 (1) $ 3,977
1003 Jess Base, Inc. 945 18,780 26,882
1004 Good Hospital Corp. 21,893 40,673 30,859 (2) $ 30,859
1005 Jen Mara Corp. 3,968 44,641
1006 Zippy Corp. 32,549 77,190 57,741 (3)
1007 Green River Mfg. 2,246 79,436
1008 Bead Hospital Centers 11,860 91,306 84,623 (4)
• • • •
• • • •
1213 Andrew Call Medical - 2,472,032
1214 Lilly Heather, Inc. 26,945 2,498,977 2,477,121 (93)
1215 Janyne Ann Corp. 1,023 $ 2,500,000
Total Accounts Receivable $ 2,500,000

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 LO# 3

Steps in MUS Sampling

Steps in MUS Sampling Application
Performance
4. Select sample items.
5. Perform the auditing procedures.
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement.
7. Draw final conclusions.

After the sample items have been selected,

the auditor conducts the planned audit
procedures on the logical units containing
the selected dollar sampling units.

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 LO# 3

Steps in MUS Sampling

Steps in MUS Sampling Application
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement.
7. Draw final conclusions.

The misstatements detected in the sample

must be projected to the population.
Example Information
Book value $ 2,500,000
Tolerable misstatement $ 125,000
Sample size 93
Desired confidence level 95%
Expected amount of misstatement $ 25,000
Sampling interval $ 26,882

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 LO# 3

Steps in MUS Sampling

Basic Precision using the Tables
If no misstatements are found in the sample,
the best estimate of the population
misstatement would be zero dollars.
Sample Actual Number of Deviations Found
Size 0 1 2 3
65 4.6 7.1 9.4 11.5
70 4.2 6.6 8.8 10.8
85 4.0 6.2 8.2 10.1
80 3.7 5.8 7.7 9.5
90 3.3 5.2 6.9 8.4
100 3.0 4.7 6.2 7.6
125 2.4 3.8 5.0 6.1

$26,882 × 3.0 = $80,646 upper misstatement limit

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 LO# 3

Steps in MUS Sampling

Misstatements Detected
In the sample of 93 items, the following misstatements
were found:
Tainting
Customer Book Value Audit Value Difference Factory
Good Hospital $ 21,893 $ 18,609 $ 3,284 15%
Marva Medical Supply 6,705 4,023 2,682 40%
Axa Corp. 32,549 30,049 2,500 NA
Learn Heart Centers 15,000 - 15,000 100%

Because the Axa balance of$3,284

$32,549 is greater
÷ $21,893 than the
= 15%
interval of $26,882, no sampling risk is added. Since all
the dollars in the large accounts are audited, there is no
sampling risk associated with large accounts.

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 LO# 3

Steps in MUS Sampling

Computed Upper Misstatement Limit using Tables
We compute the upper misstatement limit by calculating basic
precision and ranking the detected misstatements based on
the size of the tainting factor from the largest to the smallest.
Tainting Sample Projected 95% Upper Upper
Customer Factor Interval Misstatement Limit Misstatement
Basic Precision 1.00 $ 26,882 NA 3.0 $ 80,646
Learn Heart Centers 1.00 26,882 (26,882) 1.7 (4.7 - 3.0) 45,700
Marva Medical 0.40 26,882 (10,753) 1.5 (6.2 - 4.7) 16,130
Good Hospital 0.15 26,882 (4,032) 1.4 (7.6 - 6.2) 5,645
Add misstatments greater
that the sampling interval:
Axa Corp. NA 26,882 NA 2,500
Upper Misstatement Limit $ 150,621

(0.15 × $26,882 × 1.4 = $5,645) 9-23

 LO# 3

Steps in MUS Sampling

Steps in MUS Sampling Application
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement
7. Draw final conclusions.

In our example, the final decision is

whether the accounts receivable balance
is materially misstated or not.

We compare the tolerable misstatement to the upper

misstatement limit. If the upper misstatement limit is less
than or equal to the tolerable misstatement, we conclude
that the balance is not materially misstated.

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 LO# 3

Steps in MUS Sampling

In our example, the upper misstatement limit of $150,621
is greater than the tolerable misstatement of $125,000, so
the auditor concludes that the accounts receivable
balance is materially misstated.
When faced with this situation, the auditor may:
1. Increase the sample size.
2. Perform other substantive procedures.
3. Request the client adjust the accounts receivable balance.
4. If the client refuses to adjust the account balance, the
auditor would consider issuing a qualified or adverse
opinion.
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 LO# 3

Risk When Evaluating Account Balances

True State of Financial Statement Account

Auditor's Decision Based
on Sample Evidence Not Materially Misstated Materially Misstated
Supports the fairness of Risk of incorrect
Correct decision
the account balance acceptance (Type II)
Does not support the
fairness of the account Risk of incorrect Correct Decision
balance rejection (Type I)

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 Why is the Sampling Interval Rather than LO# 3

the Sample Size Used in Evaluating MUS

Results?
Due to simplifying assumptions about accounting populations,
the misstatement factors used in most MUS evaluation
approaches are nearly identical to the misstatement factors
associated with a sample size of 100, regardless of the actual
sample size used by the auditor. Always use these factors:
95% Confidence Level 90% Confidence Level
Number of Misstatement Incremental Misstatement Incremental
Errors Factor Increase Factor Increase
0 3.0 2.3
1 4.7 1.7 3.9 1.6
2 6.2 1.5 5.3 1.4
3 7.6 1.4 6.6 1.3
4 9.0 1.4 7.9 1.3

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 LO# 3

Effect of Understatement Misstatements

MUS is not particularly effective at detecting

understatements. An understated account is less likely to be
selected than an overstated account.
Book Audit Tainting
Customer Value Value Difference Factor
Wayne County Medical $ 2,000 $ 2,200 $ (200) -10%

The most likely error will be reduced by $2,688

(– 0.10 × $26,882)

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 LO# 4

Nonstatistical Sampling for Tests of

Account Balances
The sampling unit for nonstatistical sampling is normally a
customer account, an individual transaction, or a line item
on a transactions. When using nonstatistical sampling, the
following items must be considered:
o Identifying individually significant items.
o Determining the sample size.
o Selecting sample items.
o Calculating the sample results.

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 LO# 4

Identifying Individually Significant Items

The items to be tested individually are items that may

contain potential misstatements that individually exceed
the tolerable misstatement. These items are tested
100% because the auditor is not willing to accept any
sampling risk.

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 LO# 4

Determining the Sample Size

Sample Sampling Population book value

= Tolerable – Expected misstatement × Assurance factor
Size

Desired Level of Confidence

Assessment of Risk of Slightly Below
Material Misstatement Maximum Maximum Moderate Low
Maximum 3.0 2.7 2.3 2.0
Slightly below maximum 2.7 2.4 2.0 1.6
Moderate 2.3 2.1 1.6 1.2
Low 2.0 1.6 1.2 1.0

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 LO# 4

Selecting Sample Items

Auditing standards require that the sample items be

selected in such a way that the sample can be
expected to represent the population.

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 LO# 4

Calculating the Sample Results

One way of projecting the sampling results to the
population is to apply the misstatement ratio in the
sample to the population.

Assume the auditor If the population

finds $1,500 in
misstatements in a
sample of $15,000.
The misstatement
ratio is 10%.
total is $200,000,
the projected
misstatement would
be $20,000
($200,000 × 10%)

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 LO# 4

Calculating the Sample Results

A second method is the difference estimation. This
method projects the average misstatement of each item
in the sample to all items in the population.

Assume
misstatements in a
sample of 100 items The projected
total $300 (for misstatement would be
average $30,000 ($3 × 10,000).
misstatement of $3),
and the population
contains 10,000
items.
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 LO# 4

Nonstatistical Sampling Example

The auditor’s of Calabro Wireless Service have
decided to use nonstatistical sampling to examine the
accounts receivable balance. Calabro has a total of
11,800 (15 + 250 + 11,535) accounts with a
balance of $3,717,900. The auditor’s stratify the
accounts as follows:
Number and Size Book
of Accounts Value
15 accounts > $25,000 $ 550,000
250 accounts > $3,000 850,500
11,535 accounts < $3,000 2,317,400
Total $ 3,717,900

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 LO# 4

Nonstatistical Sampling Example

The auditor’s decide . . .
o There is a low assessment for inherent and control risk.
o The tolerable misstatement is $55,000, and the expected
misstatement is $15,000.
o There is a moderate risk that other auditing procedures
will fail to detect material misstatements.
o All customer account balances greater than $25,000 are
to be audited.

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 LO# 4

Nonstatistical Sampling Example

Sample Sampling population book value

= Tolerable - Estimated misstatement × Assurance factor
Size

$3,717,900 – $550,000

Sample $3,167,900
= × 1.2 = 95 (rounded)
Size $40,000
$55,000 – $15,000
Risk That Other Substantive Procedures Fail to
Detect Material Misstatement
Combined Assessment of Slightly Below
Inherent and Control Risk Maximum Maximum Moderate Low
Maximum 3.0 2.7 2.3 2.0
Slightly below maximum 2.7 2.4 2.0 1.6
Moderate 2.3 2.1 1.6 1.2
Low 2.0 1.6 1.2 1.0
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 LO# 4

Nonstatistical Sampling Example

The auditor sent positive confirmations to each of the 110
(95 + 15) accounts selected. Either the confirmations were
returned or alternative procedures were successfully
used. Four customers indicated that their accounts were
overstated and the auditors determined that the
misstatements were the result of unintentional error by
client personnel. Here are the results of the audit testing:
Amount of
Book Value Audit Value Over-
Stratum Book Value of Sample of Sample Statement
>$25,000 $ 550,000 $ 550,000 $ 549,500 $ 500
>$3,000 850,500 425,000 423,000 2,000
<$3,000 2,317,400 92,000 91,750 250

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 LO# 4

Nonstatistical Sampling Example

As a result of the audit procedures, the following
projected misstatement was prepared:
Amount of Ratio of Misstatement Projected
Stratum Misstatement in Stratum Tested Misstatement
>$25,000 $ 500 Not Applicable--100% Tested $ 500
>$3,000 2,000 $2,000 ÷ 425,000 × $850,500 4,002
<$3,000 250 $250 ÷ 92,000 × $2,317,400 6,298
Total projected misstatement $ 10,800

The total projected misstatement of $10,800 is less than

the expected misstatement of $15,000, so the auditors
may conclude that there is an acceptably low risk that
the true misstatement exceeds the tolerable
misstatement. 9-39
 LO# 4

Why Did Statistical Sampling Fall Out Of

Favor?
1.Firms found that some auditors were
over relying on statistical sampling
techniques to the exclusion of good
judgment.
2.There appears to be poor
linkage between the applied audit
setting and traditional statistical
sampling applications.

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 LO# 5

Classical Variable Sampling

Classical variables sampling uses normal distribution
theory to evaluate the characteristics of a population
based on sample data. Auditors most commonly use
classical variables sampling to estimate the size of
misstatement.

Sampling distributions are formed by plotting the

projected misstatements yielded by an infinite
number of audit samples of the same size taken
from the same underlying population.

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 LO# 5

Classical Variables Sampling

A sampling distribution is useful because it allows us

to estimate the probability of observing any single
sample result.
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 LO# 5

Classical Variables Sampling

In classical variables sampling, the sample mean is

the best estimate of the population mean.
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 LO# 5

Classical Variables Sampling

Advantages
1. When the auditor expects a large number of
differences between book and audited values, this
method will result in smaller sample size than
MUS.
2. The techniques are effective for both
overstatements and understatements.
3. The selection of zero balances generally does not
require special sample design considerations.

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 LO# 5

Classical Variables Sampling

Disadvantages
1. Does not work well when little or not misstatement
is expected in the population.
2. To determine sample size, the auditor must
estimate the standard deviation of the audited
value or differences.
3. If few misstatements are detected in the sample
data, the true variance tends to be
underestimated, and the resulting projection of the
misstatements to the population is likely not to be
reliable.
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Applying Classical Variables Sampling
Defining the Sampling Unit

Determining the Sample Size

Selecting the Sample

Calculating the Sample Results

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 Defining the Sampling Unit
the sampling unit can be a customer account,
an individual transaction, or a line item.

For example,

• in auditing accounts receivable, the auditor can define the

sampling unit to be:
• a customer’s account balance or
• an individual sales invoice included in the account
balance.

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 Determining the Sample Size

the standard deviation of audit differences is set at $31

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the confidence coefficient value (CC)

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 the Sample Size
5,500 customer accounts
BV = $5,500,000.
The tolerable misstatement = $50,000,
the expected misstatement=$20,000.
level of assurance 95 percent (risk of incorrect rejection
of 5 percent)

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9-51
9-52
 The projected mean
misstatement for the population
The mean misstatement must then be projected to the
population

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 calculating an allowance for sampling risk
The allowance for sampling risk is represented by
the confidence bound.
To calculate the confidence bound, the auditor first calculates the
standard deviation of audit differences (SD)

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 the confidence bound

$30,803 is the upper limit and -$1,653 is the lower limit

aolerable misstatement $50,000 (either under- or overstatement),

the auditor can accept the population as fairly stated

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9-56
End of Chapter 9

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