A.
Stratified Sampling:
Accounts Receivable population
Population Item Recorded Amount Population Item Recorded Amount
(TK.) (TK.)
1 1410 21 4865
2 9130 22 770
3 660 23 2305
4 3355 24 2665
5 5725 25 1000
6 8210 26 6225
7 580 27 3675
8 44110 28 6250
9 825 29 1890
10 1155 30 27705
11 2270 31 935
12 50 32 5595
13 5785 33 930
14 940 34 4045
15 1820 35 9480
16 3380 36 360
17 530 37 1145
18 955 38 6400
19 4490 39 100
20 17140 40 8435
207,295
i) Define the Population: The recorded population of accounts receivable consists of 40
accounts totalling $207,295.
ii) Stratified Sampling For many populations, auditors separate the population into two or
more subpopulations before applying audit sampling. This is called stratified sampling,
Stratum Stratum Criteria No. in Population Dollars in Population
1 > $15,000 3 $ 88,955
2 $5,000–$15,000 10 71,235
3 < $5,000 27 47,105
$207,295
iii) Define the Sampling Unit: the sampling unit will be the customer number.
iv) Determine the Initial Sample Size:
Sample size = (Population Recorded Amount X Confidence Factor)/ Tolerable misstatement
= 19.
Here, the auditor must test all items in stratum 1, which is not audit sampling. They decided to
allocate the sample size of 16 to nine from stratum 2 and seven from stratum 3.
v) Perform the Audit Procedures
Stratum Sample Size Recorded Value Audited Value Client Misstatement
1 3 $ 88,955 $ 91,695 $ (2,740 )
2 9 43,995 43,024 971
3 7 13105 10947 2158
Total 19 $ 146,055 $ 145,666 $ 389
v) Generalize from the Sample to the Population and Decide the Acceptability of the
Population:
Client Misstatement Recorded
÷ Recorded Value Book Value Point Estimate
Stratum of the Sample x for the Stratum = of Misstatement
1 $ (2,740 )/$88,955 $ 88,955 $ (2,740 )
2 $ 971 /$43,995 71,235 1,572
3 $ 2,158 /$13,105 47,105 7757
Total $ 6,589
The point estimate of the misstatement in the population is $6,589, indicating an overstatement.
vi) Decision regarding sampling: In our example, suppose that tolerable misstatement is
$40,000. In that case, the auditor may conclude it is unlikely, given the point estimate of $6,589,
that the true population misstatement exceeds the tolerable amount (calculated sampling error
is $33,411).
Suppose that tolerable misstatement is $15,000 (as it was in the example), only $8,411 greater
than the point estimate. In that case, the auditor will consider other factors. If the larger items
in the population were audited 100 percent (as was done here), any unidentified misstatements
will be restricted to smaller items. If the misstatements tend to be offsetting and are relatively
small in size, the auditor may conclude that the true population misstatement is likely to be less
than the tolerable amount. Also, the larger the sample size, the more confident the auditor can
be that the point estimate is close to the true population value. In this example, when sample
size is considered large, auditors will be more willing to accept that the true population
misstatement is less than tolerable misstatement. However, if one or more of these other
conditions differs, auditors may judge the chance of a misstatement in excess of the tolerable
amount to be high and the recorded population unacceptable.
Analyze the Misstatements It is essential for auditors to evaluate the nature and cause of each
misstatement found in tests of details of balances. For example, suppose that when the auditor
confirmed accounts receivable, all misstatements resulted from the client’s failure to record
returned goods. The auditor will determine why that type of misstatement occurred so often,
the implications of the misstatements on other audit areas, the potential impact on the financial
statements, and its effect on company operations.
The same approach is followed for all misstatements.
3.0 Sampling Phases
3.1 Planning and design: In planning and designing an audit sample, the auditor considers the
relationship of the sample to the relevant specific audit objective or control objective and considers
certain other factors that should influence sample size.
The auditor should design a sample carefully to ensure that it achieves the required audit objective.
The auditor needs to consider:
o the objectives of the audit test
o the population from which to sample
o the possible use of stratification
o the definition of the sampling unit.
i) Audit objectives: The auditor first considers the specific audit objectives and the combination of
audit procedures that is likely to best achieve them (ISA 530.A5). Consideration of the nature of the
audit evidence sought and possible deviation conditions or other characteristics relating to that
evidence assist the auditor in defining what constitutes a deviation or misstatement and what
population to use for sampling.
ii) Population
The population is the entire set of data about which the auditor wishes to draw conclusions and from
which a sample is selected. It is therefore essential for the auditor to ensure that the population
identified is both complete and appropriate to the objective of the sampling procedure.
iii) Stratification
Audit efficiency may be improved if the auditor stratifies a population. This means dividing it into
discrete sub-populations (strata) which have an identifying characteristic.
Example: In testing the accounts receivable master file, the auditor may identify three strata: accounts
greater than $1 million, accounts between $10,000 and $1 million, and accounts less than $10,000.
Stratification reduces the variability of items within each stratum and therefore allows sample size to
be reduced without a proportional increase in sampling risk. Sub-populations need to be carefully
defined such that any sampling unit can belong only to one stratum. The auditor may then test 100
per cent of the accounts greater than $1 million (note: this is not a sampling approach, as it involves
testing 100 per cent of the items in this stratum), 10 per cent of the items for the strata $10 000 to $1
million and 2 per cent of items less than $10,000.
iv) Defining the sampling unit
The sampling unit is commonly each of the transactions (especially for tests of controls where controls,
such as authorisations, are related to transactions) or balances making up the account balance (for
example, if sampling from accounts receivable, each individual debtor is a sampling unit).
3.2 Determining sample size
The auditor’s major consideration in determining the appropriate sample size is whether sampling risk
will be reduced to an acceptably low level (ISA 530.7). Sample size is affected by the degree of sampling
risk that the auditor is willing to accept. Sampling risk is the probability that the auditor has reached
an incorrect conclusion because sampling, rather than 100 per cent examination, was used. While
sampling risk can be reduced to an acceptably low level by using an appropriate sample size and
selection method, it can never be eliminated when sampling is being used. The lower the risk the
auditor will accept, the greater the sample size needs to be.
The sample size can be determined by the application of a statistical formula, through the use of
decision aids available to auditing firms or through professional judgment applied to the
circumstances. When a formula is used, the auditor documents the reasons for selecting the various
values used in the formula. Similarly, when judgment alone is used, the auditor documents the factors
considered and their impact on the sample size determined.
3.2.1 Factors that influence sample size for tests of controls:
i) The extent to which the auditor’s risk assessment takes into account relevant controls (control risk
assessment)
ii) The tolerable rate of deviation
iii) The expected rate of deviation in the population: The higher the expected rate of deviation from a
control, the larger the sample size needs to be, so that the auditor is in a position to make a reasonable
estimate of the actual rate of deviation.
iv) The auditor’s desired level of assurance that the actual deviation rate is not larger than the
tolerable deviation rate
v) The number of sampling units in the population.
4. Selecting the sample
4.1 Random selection: In random selection, each sampling unit making up the account balance or
class of transactions has a chance, often an equal chance, of selection. The concept requires that the
person selecting the sample will not influence or bias the selection either consciously or unconsciously,
so some form of impartial selection process is used to make the sample truly random. Auditors
commonly use computerised random number generators or random number tables to generate
numbers which can be linked to pre-numbered sampling units in the population. If selecting from pre-
numbered transactions the auditor can identify the first and last transaction numbers for the period
under audit, between which the random numbers are generated. If sampling from components of
account balances, such as individual debtors or inventory items, the software can randomly select
from the population of valid debtor numbers or inventory item numbers.
4.2 Systematic selection
Systematic selection involves selecting every nth item in the population, the sample interval being
determined by dividing the number of items in the population by the sample size, and selecting a
random starting point. For example, if the auditor wants a sample of 20 from a population of 20 000
items, the sample interval is every 1000th item. The auditor randomly selects a starting point (falling
between the first item in the population and the sample interval) and selects every 1000th item from
that starting point.
4.3 Haphazard selection
Haphazard selection is permitted by the auditing standards, although it cannot normally be used for
statistical sampling applications because it does not allow the auditor to measure the probability of
selecting the combination of sampling units and it cannot guarantee that the auditor will select
without bias. In this method the auditor selects sampling units without any conscious bias, and in a
manner that can be expected to be representative of the population. This technique may be useful
when selecting a sample from a population which is physically stored in an unsystematic manner. For
example, where all sales invoices are filed in a filing cabinet drawer, the auditor selects invoices from
the drawer irrespective of any distinctive feature of any of the individual documents. Humans are,
however, subject to subconscious biases which may affect the randomness of this approach. These
include an affinity with the number seven, and also a bias to select towards the middle of a sequence
rather than at the extremes.
4.4 Unacceptable sample selection methods
i) Block selection: With this method the auditor selects a block of items from a population. For
example, the auditor might examine all cash disbursement transactions in the first week of June and
the last week of December. The problem with this selection method is that the sampling unit is a
period of time rather than an individual transaction. In the example given, the auditor has selected
two units in a population of 52 units. If the blocks or periods were selected randomly the sample might
be representative, but a valid sample size would normally be impractically large. For example, to have
reasonable assurance the auditor might need to select 30 out of 52 weeks.
ii) Judgmental selection based on sample item characteristics: With this method the auditor selects
large or unusual items from the population or uses some other judgmental criterion for selection, with
the result that there is bias towards high-value or key items. This method is an example of ‘selecting
specific items’, which was discussed earlier in this chapter under Various means of gathering audit
evidence, and is not a sampling technique. Obviously, this method has a conscious bias and the items
selected cannot be considered representative of the population. Because these judgmental selection
methods have traditionally been used extensively in practice as a method of selecting sample items,
it is important to recognise that they are unacceptable today even for non-statistical sampling.
5. Performing the audit procedures and evaluating sampling results
The auditor should apply audit procedures that are appropriate for the particular audit objective to
each item selected. If the application of the procedure is not appropriate for a selected item, the
procedure is ordinarily performed on a replacement item (ISA 530.9–10). For example, a cancelled
sales invoice may be selected when testing for evidence of existence of sales, in which case it would
be appropriate for the auditor, once satisfied that the sale had been properly cancelled and did not
constitute an error, to examine a replacement.
The auditor undertakes an evaluation of the sample results to determine whether the preliminary
assessment of the relevant characteristic of the population ought to be accepted or rejected. This will
be determined on the basis of whether the tolerable deviation rate or tolerable misstatement has
been exceeded. Rejection would lead the auditor to conclude that, unless further audit evidence is
obtained:
• the preliminary assessment of control risk cannot be accepted (in the case of tests of controls),
or
• the relevant account balance or class of transactions is materially misstated (in the case of
substantive procedures).
Projecting misstatements from sample to population
B. MONETARY UNIT SAMPLING (MUS)
The Definition of the Sampling Unit Is an Individual Dollar: A critical feature of MUS is
the definition of the sampling unit as an individual dollar in an account balance.
Population Recorded Amount Cumulative
Item Total
(Physical (Dollar Unit)
Unit)
1 Tk. 357 Tk. 357
2 1281 1638
3 60 1698
4 573 2271
5 691 2962
6 143 3105
7 2125 5230
8 278 5508
9 242 5750
10 826 6576
11 404 6980
12 396 7376
4 samples will be selected.
Using systematic selection, the sampling interval is 1,844 (7,376 ÷ 4) and the auditor then
chooses a random start between 1 and 1,844 (the length of the sampling interval). Assume the
auditor randomly selects a start of 822. The sample dollars selected for testing are 822; 2,666
(822 + 1,844); 4,510 (2,666 + 1,844); and 6,354 (4,510 + 1,844).
The population physical unit items that contain these random dollars are determined by
reference to the cumulative total column. Looking again at Table 2, the items selected are items
2 (containing 358 through 1,638), 5 (dollars 2,272 through 2,962), 7 (dollars 3,106 through
5,230), and 10 (dollars 5,751 through 6,576).
Action When a Population Is Rejected
i) Take No Action Until Tests of Other Audit Areas Are Completed: Ultimately, the auditor
must evaluate whether the financial statements taken as a whole are materially misstated. If
offsetting misstatements are found in other parts of the audit, such as in inventory, the auditor
may conclude that the estimated misstatements in accounts receivable are acceptable. Of course,
before the audit is finalized, the auditor must evaluate whether a misstatement in one account
may make the financial statements misleading even if there are offsetting misstatements.
ii) Perform Expanded Audit Tests in Specific Areas: If an analysis of the misstatements
indicates that most of the misstatements are of a specific type, it may be desirable to restrict
the additional audit effort to the problem area. For example, if an analysis of the misstatements
in confirmations indicates that most of the misstatements result from failure to record sales
returns, the auditor can make an extended search of returned goods to make sure that they have
been recorded. However, care must be taken to evaluate the cause of all misstatements in the
sample before a conclusion is reached about the proper emphasis in the expanded tests.
Problems may exist in more than one area.
iii) Increase the Sample Size: When the auditor increases the sample size, sampling error is
reduced if the rate of misstatements in the expanded sample, their dollar amounts, and their
direction are similar to those in the original sample. Therefore, increasing the sample size may
satisfy the auditor’s tolerable misstatement requirements.
iv) Adjust the Account Balance: When the auditor concludes that an account balance is
materially misstated, the client may be willing to adjust the book value based on the sample
results. In the preceding example, assume the client is willing to reduce book value by the
amount of the point estimate ($6,589) to adjust for the estimate of the misstatement.
The auditor’s estimate of the misstatement is now zero, but it is still necessary to consider
sampling error. Again, assuming a tolerable misstatement of $15,000, the auditor must now
assess whether sampling error exceeds $15,000, not the $8,411 originally considered. If the
auditor believes sampling error is $15,000 or less, accounts receivable is acceptable after the
adjustment. If the auditor believes it is more than $15,000, adjusting the account balance is not
a practical option.
v) Request the Client to Correct the Population: In some cases, the client’s records are so
inadequate that a correction of the entire population is required before the audit can be
completed. For example, in accounts receivable, the client may be asked to correct the accounts
receivable records and prepare the accounts receivable listing again if the auditor concludes
that it has significant misstatements. When the client changes the valuation of some items in
the population, the results must be audited again.
vi) Refuse to Give an Unqualified Opinion: If the auditor believes that the recorded amount
in an account is not fairly stated, it is necessary to follow at least one of the preceding
alternatives or to qualify the audit report in an appropriate manner. If the auditor believes that
there is a reasonable chance that the financial statements are materially misstated, it would be
a serious breach of auditing standards to issue an unqualified opinion. For purposes of reporting
on internal control, the material misstatement should be considered a potential indicator of a
material weakness in internal control over financial reporting.