Chapter 8 Confidence Interval Estimation

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc. Chap 8-1

Learning Objectives
In this chapter, you will learn: To construct and interpret confidence interval estimates for the mean and the proportion How to determine the sample size necessary to develop a confidence interval for the mean or proportion How to use confidence interval estimates in auditing

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-2

Chapter Outline
1.

Confidence Intervals for the Population Mean,

when Population Standard Deviation is Known when Population Standard Deviation is Unknown

2. Confidence Intervals for the Population

Proportion, 3. Determining the Required Sample Size

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-3

Point Estimates

A point estimate is a single number. For the

population mean (and population standard deviation), a point estimate is the sample mean (and sample standard deviation). A confidence interval provides additional information about variability

Lower Confidence Limit

Point Estimate

Upper Confidence Limit

Width of Statistics for Managers Using Microsoft Excel, 5e confidence interval

2008 Pearson Prentice-Hall, Inc.

Chap 8-4

Confidence Interval Estimates

A confidence interval gives a range estimate of

values:
Takes into consideration variation in sample

statistics from sample to sample Based on all the observations from 1 sample Gives information about closeness to unknown population parameters Stated in terms of level of confidence

Ex. 95% confidence, 99% confidence Can never be 100% confident

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-5

Confidence Interval Estimates

The general formula for all

confidence intervals is:

Point Estimate (Critical Value) (Standard Error)

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-6

Confidence Level
Confidence Level Confidence in which the interval will contain the unknown population parameter A percentage (less than 100%)

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-7

Confidence Level
Suppose confidence level = 95%
Also written (1 - ) = .95 A relative frequency interpretation: In the long run, 95% of all the confidence intervals that can be constructed will contain the unknown true parameter A specific interval either will contain or will

not contain the true parameter

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-8

Confidence Interval for ( Known)

Assumptions Population standard deviation is known Population is normally distributed If population is not normal, use large sample Confidence interval estimate:

XZ n
(where Z is the standardized normal distribution critical value for a probability of /2 in each tail)
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-9

Finding the Critical Value, Z

Consider a 95% confidence interval: 1 .95

.025 2
Z units: X units: Z= -1.96 0 Z= 1.96

.025 2

Lower Point Estimate Confidence Limit Statistics for Managers Using Microsoft Excel, 5e
2008 Pearson Prentice-Hall, Inc.

Upper Confidence Limit

Chap 8-10

Finding the Critical Value, Z

Commonly used confidence levels are 90%, 95%, and 99%
Confidence Level Confidence Coefficient Z value 1.28 1.645 1.96 2.33 2.58 3.08 3.27
Chap 8-11

80% .80 90% .90 95% .95 98% .98 99% .99 99.8% .998 99.9% for Managers Using Microsoft Excel, 5e .999 Statistics
2008 Pearson Prentice-Hall, Inc.

Intervals and Level of Confidence

Sampling Distribution of the Mean /2

1
x

/2

Intervals extend from

X Z n
to

x
x1

x2

X Z n

(1-)x100% of intervals constructed contain ; ()x100% do not.

Chap 8-12

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Confidence Intervals

Confidence Interval for ( Known) Example

A sample of 11 circuits from a large normal

population has a mean resistance of 2.20 ohms. We know from past testing that the population standard deviation is .35 ohms.
Determine a 95% confidence interval for the

true mean resistance of the population.

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-13

Confidence Interval for ( Known) Example

X Z n 2.20 1.96 (.35/ 11) 2.20 .2068 (1.9932, 2.4068)
We are 95% confident that the true mean resistance is between

1.9932 and 2.4068 ohms

Although the true mean may or may not be in this interval, 95%

of intervals formed in this manner will contain the true mean

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-14

Confidence Interval for ( Unknown)

If the population standard deviation is

unknown, we can substitute the sample standard deviation, S This introduces extra uncertainty, since S is variable from sample to sample So we use the t distribution instead of the normal distribution

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-15

Confidence Interval for ( Unknown)

Assumptions Population standard deviation is unknown Population is normally distributed If population is not normal, use large sample Use Students t Distribution Confidence Interval Estimate: S

X t n-1

(where t is the critical value of the t distribution with n-1 d.f. and an area of /2 in each tail)
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-16

Students t Distribution
The t value depends on degrees of freedom (d.f.) Number of observations that are free to vary after sample mean has been calculated

d.f. = n - 1

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-17

Degrees ofofFreedom are free to vary Idea: Number observations that

after sample mean has been calculated Example: Suppose the mean of 3 numbers is 8.0

Let X1 = 7 Let X2 = 8 What is X3?

If the mean of these three values is 8.0, then X3 must be 9 (i.e., X3 is not free to vary)

Here, n = 3, so degrees of freedom = n 1 = 3 1 = 2

(2 values can be any numbers, but the third is not free to vary for a given mean) Statistics for Managers Using Microsoft Excel, 5e
2008 Pearson Prentice-Hall, Inc. Chap 8-18

Students t Distribution Note: t Z as n increases

Standard Normal (t with df = ) t (df = 13) t-distributions are bell-shaped and symmetric, but have fatter tails than the normal t (df = 5)

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

t
Chap 8-19

Students t Table
Upper Tail Area df .25 .10

.05

1 1.000 3.078 6.314

Let: n = 3 df = n - 1 = 2 = .10 /2 =.05

2 0.817 1.886 2.920

3 0.765 1.638 2.353
The body of the table contains t values, not probabilities
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

/2 = .05
0
t
Chap 8-20

2.920

Confidence Interval for ( Unknown) Example

A random sample of n = 25 has X = 50 and S = 8. Form a 95% confidence interval for d.f. = n 1 = 24, so The confidence interval is

X t/2, n -1

S 50 (2.0639) n

8 25

(46.698 , 53.302)
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-21

Confidence Intervals for the Population Proportion,

An interval estimate for the population

proportion ( ) can be calculated by adding an allowance for uncertainty to the sample proportion ( p )

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-22

Confidence Intervals for the Population Proportion,

Recall that the distribution of the sample proportion is approximately normal if the sample size is large, with standard deviation

(1 )
n

We will estimate this with sample data:

p(1 p) n
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-23

Confidence Intervals for the Population Proportion,

Upper and lower confidence limits for the population proportion are calculated with the formula

p(1 p) pZ n
where Z is the standardized normal value for the level of confidence desired p is the sample proportion n is the sample size
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-24

Confidence Intervals for the Population Proportion, Example

A random sample of 100 people shows that 25 have opened IRAs this year. Form a 95% confidence interval for the true proportion of the population who have opened IRAs.

p Z p(1 p)/n 25/100 1.96 .25(.75)/1 00

.25 1.96 (.0433) (0.1651 , 0.3349)
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-25

Confidence Intervals for the Population Proportion, Example

We are 95% confident that the true

percentage of left-handers in the population is between 16.51% and 33.49%. Although the interval from .1651 to .3349 may or may not contain the true proportion, 95% of intervals formed from samples of size 100 in this manner will contain the true proportion.

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-26

Determining Sample Size

The required sample size can be found to reach a

desired margin of error (e) with a specified level of confidence (1 - ) The margin of error is also called sampling error
the amount of imprecision in the estimate of the

population parameter the amount added and subtracted to the point estimate to form the confidence interval

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-27

Determining Sample Size

To determine the required sample size for the

mean, you must know:

The desired level of confidence (1 - ), which

determines the critical Z value The acceptable sampling error (margin of error), e The standard deviation,

eZ n

Now solve for n to get

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Z n 2 e
2

Chap 8-28

Determining Sample Size

If = 45, what sample size is needed to estimate the mean within 5 with 90% confidence?

Z 2 2 (1.645) 2 (45) 2 n 219.19 2 2 e 5

So the required sample size is n = 220
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-29

Determining Sample Size

If unknown, can be estimated when using

the required sample size formula

Use a value for that is expected to be at least

as large as the true Select a pilot sample and estimate with the sample standard deviation, S

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-30

Determining Sample Size

To determine the required sample size for the proportion, you must know: The desired level of confidence (1 - ), which determines the critical Z value The acceptable sampling error (margin of error), e The true proportion of successes,

can be estimated with a pilot sample, if necessary (or conservatively use = .50)

eZ

(1 )
n

Now solve for n to get

Z (1 ) n e2
2
Chap 8-31

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Determining Sample Size

How large a sample would be necessary to

estimate the true proportion defective in a large population within 3%, with 95% confidence? (Assume a pilot sample yields p = .12)

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-32

Determining Sample Size

Solution:
For 95% confidence, use Z = 1.96 e = .03

p = .12, so use this to estimate

Z 2 (1 ) (1.96) 2 (.12)(1 .12) n 450.74 2 2 e (.03)
So use n = 451
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-33

Applications in Auditing
Six advantages of statistical sampling in

auditing
Sample result is objective and defensible

Based on demonstrable statistical principles

Provides sample size estimation in advance on

an objective basis Provides an estimate of the sampling error

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-34

Applications in Auditing
Can provide more accurate conclusions on the

population

Examination of the population can be time consuming and subject to more nonsampling error

Samples can be combined and evaluated by different

auditors

Samples are based on scientific approach Samples can be treated as if they have been done by a single auditor

Objective evaluation of the results is possible Based on known sampling error

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-35

Population Total Amount

Point estimate:

Population total NX
Confidence interval estimate:

S NX N(t n1 ) n

Nn N 1
Chap 8-36

(This is sampling without replacement, so use the finite population correction in the confidence interval formula)
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Population Total Amount

A firm has a population of 1000 accounts and

wishes to estimate the total population value.

A sample of 80 accounts is selected with average

balance of $87.6 and standard deviation of $22.3.

Find the 95% confidence interval estimate of the

total balance.

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-37

Population Total Amount

N 1000, n 80, X 87.6, S 22.3
S N X N (t n 1 ) n Nn N 1 1000 80 1000 1

22.3 (1000)(87. 6) (1000)(1.9 905) 80 87,600 4,762.48

The 95% confidence interval for the population total balance is $82,837.52 to $92,362.48
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-38

Confidence Interval for Total Difference

Point estimate:
Total Difference ND

Where the mean difference,

D, is:

D
i 1

n where D i audited value - original value

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-39

Confidence Interval for Total Difference

Confidence interval estimate:

SD ND N(t n1 ) n
where
SD
n

Nn N 1

(Di D)2
i1

n 1
Chap 8-40

Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

One Sided Confidence Intervals

Application: find the upper bound for the proportion of items that do not conform with internal controls

p(1 p) N n Upper bound p Z n N 1

where Z is the standardized normal value for the level of confidence desired p is the sample proportion of items that do not conform n is the sample size N is the population size
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-41

Ethical Issues
A confidence interval (reflecting sampling

error) should always be reported along with a point estimate The level of confidence should always be reported The sample size should be reported An interpretation of the confidence interval estimate should also be provided
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-42

Chapter Summary
In this chapter, we have
Introduced the concept of confidence intervals Discussed point estimates Developed confidence interval estimates

Created confidence interval estimates for the

mean ( known) Determined confidence interval estimates for the mean ( unknown) Created confidence interval estimates for the proportion
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-43

Chapter Summary
In this chapter, we have Determined required sample size for mean and proportion settings Developed applications of confidence interval estimation in auditing Confidence interval estimation for population total Confidence interval estimation for total difference in the population One sided confidence intervals Addressed confidence interval estimation and ethical issues
Statistics for Managers Using Microsoft Excel, 5e 2008 Pearson Prentice-Hall, Inc.

Chap 8-44