CHAPTER TWO: AUDIT TESTING METHODOLOGY

• Chapter Objectives
• After completing this chapter you will be able to:

 Explain the meaning and types of audit sampling and

sample selection methods
 Applications of Sampling in audit

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 Audit Sampling
• What is Sampling?
• Audit sampling is the application of an audit procedure
(test of control or substantive testing) to less than 100% of
the items within an account balance or class of
transactions for the purpose of drawing a general
conclusion about the account balance or the entire group
of transactions based on the characteristics detected in the
sample.

• Sampling allows an auditor to draw conclusions about the

whole population without incurring more time and cost of
examining every transaction/account
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 Audit Sampling
 When is sampling used?
• Sampling is generally used in field audits when
it is not efficient to review 100% of the
records.

• Sampling may also be used if records are

missing or other circumstances make
reviewing all of the records difficult.

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 Audit Sampling
• Representative Sample
• A representative sample is one in which the
characteristics in the sample of audit interest are
approximately the same as those of the population.

 There are two risks in auditing:

► Non-sampling risk
► Sampling risk

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 Audit Sampling
 Non-Sampling Risk
• Non-sampling risk is the risk that the audit tests do not
detect existing exception/material misstatement in the
sample.
• The two causes are:
► Auditor failure to recognize exceptions due to exhaustion,
boredom, and lack of understanding of what to look for.
►Inappropriate or ineffective audit procedures.
 Careful design of audit procedure, proper instruction,
supervision and review are ways to control non - sampling
risk
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 Audit Sampling
 Sampling Risk
• Sampling risk is the risk that an auditor reaches
an incorrect conclusion because the sample is not
representative of the population.

• It is an inherent part of sampling that results

from testing less than the entire population.

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 Audit Sampling
• Sampling Risk (cont.)
• This can be controlled by:
► Adjusting the sample size. e.g. increasing
sample size.
► Testing the total population enables
sampling risk to be zero.
► Using an appropriate method of selecting
sample items
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 Audit Sampling
Statistical vs. Non-Statistical Sampling
 Statistical Sampling
• Statistical sampling provides a means of mathematically
evaluating the outcome of the sampling plan by applying the
laws of probability to measure the likelihood that sample
results are representative of the population.

 Non-Statistical Sampling
• Is solely based on the auditor’s judgment.
• In non-statistical sampling, the auditor does not quantify
sampling risk.

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 Audit Sampling
 Probabilistic Sample Selection
 In probabilistic sample selection selects a sample in
a way that each population item has a known
probability of being included in the sample and the
sample is randomly selected.

 Common types:
• Simple Random sample Selection – all items of the
population have an equal chance of being selected.
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 Audit Sampling
 Probabilistic Sample Selection (cont.)
• Systematic Sample Selection – auditor determines an
interval and selects items on the basis of the interval.
• Probability Proportional to Size (PPS) – probability of
selecting an item is proportional to its recorded
amount.
• Stratified Sample – divided population in to sub-
populations and use different selection criteria for
each sub-population

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 Audit Sampling
Illustration of PPS -Accounts receivable population
Popu item (physical unit) Recorded amount Cumulative total

1 $357 $357
2 1281 1638
3 60 1698
4 573 2271
5 691 2962
6 143 3105
7 1425 4530
8 278 4808
9 942 5750
10 826 6576
11 404 6980
12 396 7376

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 Audit Sampling
• Probability Proportional to Size (PPS) (cont.)
• In the above table the population size is 7376 (the
cumulative total) and each dollar has equal chance of
being included in the sample.
• If the auditor wants to select four physical units, the
auditor needs four random numbers for instance:
6,586, 1,756, 850, and 6,499 . The physical units are
determined by referring to the cumulative total. These
are item 11 containing (6577 to 6980), 4 (1699 to
2271), 2(358 to 1638), and 10 (5751 to 6576)
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 Audit Sampling

• Stratification Illustrated

• The process of dividing a population into sub-

populations that have similar characteristics.
Strata must be defined so that each sampling
unit can only be in one stratum.

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 Audit Sampling
• Accounts Receivable Stratification
Strat size Composition of Stratum Sample Selection
um

1 22 All accounts over $5,000 100%

examination

2 121 All accounts between $1,000 and Simple random

$5,000 sampling

3 85 All accounts under $1,000 Systematic

selection

4 14 All accounts with credit balances 100%

examination

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 Audit Sampling
 Non-probabilistic sample selection
 In this case, those sample items that the auditor
believes will provide the most useful information are
selected judgmentally.
 Types of Non-probabilistic Sample Selection
► Direct sample selection – auditor selects items based
on judgmental criteria such as likelihood of
misstatement, characteristics such as different time
periods, or large dollar amounts.

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 Audit Sampling
Non-probabilistic Sample Selection (cont.)

► Block sample selection – selection of a number of

items in sequence. Auditor must use several blocks to
obtain a representative sample.

► Haphazard sample selection – selection of items

without any conscious bias on the part of the auditor.
Selecting regardless of size, source, and other
distinguishing characteristics.
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 Audit Sampling
• Applications of Sampling in audit: two types

Attribute Sampling Variables Sampling

(Test of Controls)
The use of sampling for
compliance testing
(qualitative
characteristic)
(Test of Account Balances)
The use of sampling for
substantive test on the
client’s account balances
(quantitative characteristic)

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 Audit Sampling
 Sampling Risk in Attribute Sampling

The Risk of Assessing Control

Risk Too High (Risk of Under – The Risk of Assessing
reliance) Control Risk Too Low
Not relying on the internal (Risk of Over-reliance)
controls Relying on internal
when, in fact, the controls when it is
auditor should rely not appropriate.
on internal control.

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 Audit Sampling
• Sampling Risk in Variable Sampling
Risk of Incorrect
Risk of Incorrect
Rejection
Acceptance
Auditor’s sample
Auditor’s sample indicates
indicates that that the account balance is
the account balance is fairly stated even though
materially misstated the account balance is
even though it is fairly materially misstated.
stated.
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 Audit Sampling
• The effect of sampling risk on audit efficiency and
effectiveness
Sampling risk The effect on The effect on
efficiency effectiveness

The Risk of Assessing Control Risk Too High Negative Positive

The Risk of Assessing Control Risk Too Low Positive Negative

Risk of Incorrect Rejection Negative Positive

Risk of Incorrect acceptance Positive Negative

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 Audit Sampling
• The effect of sampling risk on audit efficiency and effectiveness
(cont.)
• If the auditors incorrectly reject an account balance/under-rely on
controls, their audit lacks efficiency since they will perform
additional audit procedures that eventually reveal that the account
is not materially misstated/the control is effective.

• If auditors incorrectly accepts an account balance/over-rely on

controls, the effectiveness of the audit is compromised.
• Therefore, the risk of incorrect acceptance is of the primary
concern to auditors as failure to detect a material misstatement
may lead to accusation of negligence and to extensive legal liability,

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