CHAPTER ONE

AUDIT SAMPLING
Nature of Audit Sampling
• Sampling refers to the process of selecting a
group of items from a large group of items. The
assumption of sampling is that the sample is the
representative of the population.
• Audit sampling refers to the application of an
audit procedure to less than 100% of the items
within an account balance and class of
transactions for the purpose of evaluating some
characteristic of the balance or class.
 Auditors may encounter two types of risk in evidence
gathering process:
1. Sampling risk:
– the possibility that the sample drawn is not
representative of the population and, as a result, the
auditor will reach an incorrect conclusion.
– Is a function of sample size. The larger the sample
size, the lower the sampling risk and vice versa.
– can be quantified using statistical sampling.
– can be reduced by increasing sample size
– Reducing Sampling Risk – Adjust sample size, Use
appropriate method for selecting sample items.
Note: A 95% confidence level = 5% sampling risk.
– Sampling risk is an inherent part of sampling that
results from testing less than the entire population.
2. Non-sampling risk:
the possibility that the auditor
Con.. uses inappropriate audit
procedures, fail to detect a misstatement when
applying an audit procedure, or misinterpret an
audit result. It can not be quantified using statistical
sampling. The uncertainty related to such risk can
be controlled by:
– Adequate training
– Proper planning
– Effective supervision
– Reducing Non-sampling Risk – Careful design of audit
procedures, proper instruction, supervision, and review.
• Audit sampling is needed for audit test. However,
all audit tests do not involve audit sampling. Which
audit tests do not involve sampling?
• Audit Tests that do not involve sampling
a. Inquiry and Observation
• Are used extensively as a source of evidential matter such
as:
– To understand the components of internal control
– To evaluate many of the inherent risk factors
– To establish the existence of some items
– Reviewing records for the method of accounting and
other information.
– Observing accounting procedures.
– Discussing methods of accounting and reporting with
the client.
– Scanning documents for possible issues.
 Con…
b. Analytical review procedures
»Especially simple analytical procedures such
as simple comparisons and ratio analysis
»Comparing records reports and other
information.
»Re computing or estimating amounts.
»Reviewing trends in reporting.
»Comparing similar businesses.
c. Procedures applied to every item in the
population/One Hundred Percent Examination
. Reviewing all fixed asset purchases, where appropriate.
. Examining all contracts, where there are a small number.
.Reconciling items.
d. Classes of transactions or account balances not
tested/ Zero Percent Examination : Because of an
acceptably low risk of material misstatement or
immateriality
e. Tests of automated information technology controls
 Type I and Type II Errors
1. In relation to tests of controls:
A. Type I Error (alpha)
– The risk that the assessed level of control risk
based on the sample is greater than the true
operating effectiveness of the control (assessed
risk beyond the truth).
– Risk of assessing control risk too high
B. Type II Error (beta)
– The risk that the assessed level of control risk
based on the sample is less than the true operating
effectiveness of the control (assessed risk below
the truth).
– Risk of assessing control risk too low
2. In relation to substantive tests
A. Type I Error (alpha)
–The risk that the sample supports the
conclusion that the recorded account
balance is materially misstated when it
is not materially misstated
–Risk of incorrect rejection
–Relates to the efficiency of the audit
(more audit work than necessary)
 B. Type II Error (beta)
–The risk that the sample supports the
conclusion that the recorded account
balance is not materially misstated
when it is materially misstated
–Risk of incorrect acceptance
–Relates to the effectiveness of the audit
(less audit work than necessary and may
lead to litigation against the auditor)
 Types of Audit Sampling
1. Non-statistical (or Judgmental) sampling
The auditor considers sampling risk when evaluating the
results of an audit sample without using statistical
theory to measure sampling risk
Requires the auditor’s professional judgment to plan,
perform, and evaluate the sample evidence.
Limitation: may not be as effective as statistical
sampling.
 2. Statistical Sampling
– Uses the laws of probability to select and
evaluate the result of audit sample
– Helps the auditor:
• Design an efficient sample
• Measure the sufficiency of evidence obtained
• Quantify sampling risk
– Limitations (drawbacks):Involve additional costs
of:
• Training auditors in the proper use of sampling
techniques
• Designing and conducting the sampling
application
Three major types of statistical sampling plans may be
used:
A. Attribute sampling
"Attribute sampling" is used when the auditor
is only concerned with acceptance or
rejection of a hypothesis.
 It is used to reach a yes or no answer about a
question.
• Is commonly used for tests of controls
 B. Monetary-Unit Sampling (MUS) – percentage of
monetary units/overstatements issues
• Uses attribute sampling theory and techniques to
estimate the birr amount of misstatement for a class
of transactions or an account balance.
• designed to test for overstatements
• Its sampling unit is individual Dollar (Birr)
• is important for auditing accounts receivable, loans
receivables, investment securities, and inventory
• estimates 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.
 Classical Variables Sampling (CVS) – transaction issue
(overstatements + understatements)
"Variables sampling" is used to reach a conclusion
about a population in terms of an amount.
Variables sampling is commonly used to determine
the dollar/birr size of a population or to determine
if the stated dollar /birr size is correct.
• Auditors most commonly use classical variables
sampling to estimate the size of misstatement
• The techniques are effective for both
overstatements and understatements.
• The selection of zero balances generally does not
require special sample design considerations.
 STATISTICAL VS. NONSTATISTICAL SAMPLING
• Audit sampling may be performed using either
statistical or non-statistical techniques
Statistical techniques require
(i) the units in the population to have the same
chance of being selected
(ii) the items for examination to be selected
randomly and
(iii)the conclusion to be drawn using tables or
formulas based on probability theory.
• Non-statistical Sampling (or Judgmental Sampling)
estimates sampling risk by using professional
judgment rather than using by statistical techniques.
 Similarities
• Both sampling approaches require the exercise of auditor
judgment during the planning, implementation and evaluation of
the sampling plan.
• In other words, the use of statistical methods does not eliminate
the need to exercise judgment.
Differences
• Statistical sampling allows the user to measure and control the
sampling risk associated with the procedure.
• Statistical sampling applies the laws of probability to determine
the percent likelihood that the sample does not accurately reflect
the population.
• In non statistical sampling those items that the auditor believes
will provide the most useful information are selected.
Conclusions are judgmental = judgmental sampling
PROBABILISTIC VERSUS NONPROBABILISTIC SAMPLE SELECTION

• Probabilistic Sample Selection – Selecting a

sample such that each population item has a
known probability of being included in the
sample and the sample is selected by a random
process.
• Non-probabilistic Sample Selection –
Selecting a sample in which the auditor uses
professional judgment rather than probabilistic
methods to select sample items.
1. Non-probabilistic Sample Selection methods include:
A. Directed Sample Selection
Also known as judgment sample selection is based
on the auditor's sound and seasoned judgmental
criteria.
Three basic issues determine which items are
selected:
• Items most likely to contain misstatements-relative
risk
• Items containing selected population
characteristics-representativeness
• Large dollar coverage-value of the item
 B. Block Sample Selection
• Selection of several items in sequence forming
“blocks” of items
• For example, all remittances in the month of
November. Alternatively, remittances 300-350
may be examined in their entirety.
• If block sampling is used, many blocks should
be selected to help minimize sampling risk.
 C. Haphazard Sample Selection
• Selection without regard to size, source, or
distinguishing characteristics (without bias)
• It represents the auditor's best estimate of a
representative sample -- and may, in fact, be
representative.
• Defined probability concepts are not employed.
As a result, such a sample may not be used for
statistical inferences.
• The problem with this method is that it does not
avoid unconscious bias.
 2. Probabilistic Sample Selection methods include:
A. Simple Random Sample Selection
• Every possible combination of elements in the
population has an equal chance of constituting
the sample.
• An auditor can implement simple random
sampling in one of two ways: computer
programs to generate random numbers or uses
random number tables.
 B. Systematic Sample Selection
• 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.
 Example
• Population of sales invoices 652 – 3151
• Desired sample size = 125
• Interval = (3151 – 651) / 125 = 20
• Select a random start between 1 & 20 (ex. 9)
• First item in sample is invoice # 661 (652 + 9)
• Remaining 124 items = 681 (661+20), 701
(681+20), 721 (701+20) etc.
 C. Probability Proportional to Size (PPS) Sample Selection
for emphasis on large dollar / birr items
A sample is taken where the probability of
selecting any individual population item is
proportional to its recorded amount (PPS).
• Evaluated using monetary unit sampling
 Stratified Sample Selection
For emphasis on large dollar items
• The population is divided into sub
populations by size and larger samples are
taken of the larger subpopulations.
• Evaluated using variable sampling
 STRATIFICATION EXAMPLE:
Audit client A sells three types of computer
equipment: laptops, desktops and network
servers. The auditor decides to stratify the
total population of sales by type of computer
equipment, since that tends to create more
homogeneous sub-populations.
There were $2,000,000 total laptop sales during
the period, $3,000,000 total desktop sales and
$5,000,000 server sales
• The auditor should allocate the total sample size as
follows:
100 from laptop sales
100 from desktop sales
100 from network sales
The results were as follows:
5% under-reported laptop sales X $2,000,000 =
$100,000
5% over-reported desktop sales X $3,000,000 =
($150,000)
10% under-reported network sales X $5,000,000 = $500,000
 Application of Audit (attribute)
Sampling to Tests of Control

• Attribute sample is concerned with one-sided

test because the auditor is generally concerned
with the maximum deviation rate in the
population.
Step 1: State the objectives of the audit test.
• The objective is to evaluate the operating
effectiveness of internal control
Step 2: Define the control deviation conditions
• A deviation is a departure from adequate
performance of the internal control
• It is necessary to clearly define the situation in
which deviation occurs.
Eg. Let’s say the objective of the test is to check
whether purchase invoice was approved by the
finance manager before being recorded.
A purchase order which was not approved (no
signature & stamp) by the finance manager is
considered deviation.
Step 3: Define the population & sampling units
Population: all purchase orders received during
the period are considered population.
The auditor should ensure that the sample frame
is complete.
Sampling unit: Sampling unit refers to the
individual members of the population. A
sampling unit may be a document, an entry or a
line item. In the above example, the sampling
unit is individual purchase invoice.
 Step 4: Determine the sample size
Factors to be considered in determining the sample
size:
1. Determining the acceptable risk of assessing control
risk too low
 Its determination is primarily based on the auditor’s
professional judgment
• the auditor should consider the importance of the audit objective
• There is an inverse relationship between the risk of assessing the
control risk too low and sample size
• The smaller the acceptable risk of assessing control risk too low,
the larger the sample size must be.
• Factors to be considered in setting the acceptable risk of
assessing control risk too low:
– Effectiveness concern
– Efficiency concern
2. The tolerable deviation rate
»the maximum deviation from a prescribed
control that the auditor is willing to
accept without altering the planned
assessed level of control risk
»The suggested tolerable deviation rates
for assessed levels of control risk
»The tolerable deviation rate is inversely
related to the sample size
»The lower the tolerable deviation rate,
the larger the sample size
»The concern of the auditor is whether
the true deviation rate exceeds the
tolerable deviation rate
»There is direct relationship between the
planned assessed level of control risk
and tolerable deviation rate
 3. The expected population deviation rate
• is the deviation rate that the auditor expects to exist
in the population
• can be developed based on prior years' results,
paste experience from similar tests on other
engagements, or on a pilot sample
• The larger the expected population deviation rate,
the larger the sample size must be.
• If the auditor believes that the expected population
deviation rate exceeds the tolerable deviation rate,
the statistical test should be omitted and
substantive tests should be used.
 Step 5: Determine sampling method and Select the sample
• Once the sample size is determined, the sample will be
selected using the appropriate techniques
Step 6: Perform the audit procedures/Test the sample
items/
In conducting the planned audit procedures, the following
are not considered deviation
• properly Voided documents
• Unused or inapplicable documents
– If the auditor is unable to examine a sampled item, the
sample item is considered a deviation
– If a large number of deviations are detected early in
the tests of controls, the auditor should consider
stopping the test because the result of the test will not
support the planned assessed level of control risk
 Step 7: Evaluate the Sample Result
1. Calculate the sample results
involves calculating the sample deviation rate and the
computed upper deviation rate
a. Sample deviation rate
– is the number of deviations in the sample divided by
the number of items in the sample
– represents the auditor's best estimate of the
population's deviation rate. However the auditor must
consider allowance for sampling risk
b. Computed upper deviation rate
• is the sum of sample deviation rate and allowance for
sampling risk
• represents the upper limit for population deviation rate
 2. Performing Error Analysis
• involves evaluating the qualitative aspects of the
deviations identified
• Involves two considerations:
–the nature of each deviation and its cause
– Error or fraud?
– Misunderstanding of instructions or carelessness?
–the impact of the deviation on other phases
of the audit
 Step 8: Draw final conclusion
• involves comparing the tolerable deviation rate to the
computed upper deviation rate
• If the computed upper deviation rate is less than or equal
to the tolerable deviation rate, the auditor can conclude that
the controls can be relied on
• If the computed upper deviation rate exceeds the tolerable
deviation rate, the auditor may perform the following:
– Modify sample size
– Modify tolerable deviation rate
– Conclude that the controls are not operating at an
acceptable level.
• The auditor's professional judgment of the results of tests of
control affects the final conclusion.
• Step 9: Document the sampling Procedures
• All steps performed so far should be documented in the
auditor’s working papers
Application of Audit Sampling to Substantive Tests-Monetary Unit Sampling

Step 1: State the objectives of the audit test

• When auditors sample for tests of details of
balances, the objective is to determine whether
the account balance being audited is fairly
stated.
• Sampling may be used for substantive testing to
test the reasonableness of assertions about a
financial statement amount, and to develop an
estimate of some amount.
 Step 2: Define Misstatement Conditions
– Misstatement conditions are any conditions that
represent a monetary misstatement in a sample item.
– A misstatement is defined as the difference between
monetary amounts in the client’s records and
amounts supported by audit evidence.
– When the client’s amount deviates from amount
supported by audit evidence, misstatement is said to
occur. However, it may not be material in amount.
Step 3: Define the population and the sampling units
– In testing for the existence objective, the recorded
dollar population is the population.
– For MUS the population is defined as the monetary
value of an account balance, such as accounts
receivable, investment securities, or inventory
– For MUS, an individual dollar represents the
sampling unit. However, the auditor tests not
individual birr but rather the account or the
transaction that contains the selected birr. The
account balance or transaction that contains the
selected Birr is called the logical unit.
 Step 4: Determine the sample size
Factors to be considered:
1. Variation within the population
– Population variation and sample size have direct relationship
in classical variables sampling.
– As population variation increases, the sample size should
increase
– Population variation Can be minimized by stratifying the
population
– Population variation does not affect the sample size when
monetary unit sampling is used because the sample selection
method considers indirectly.
2. Acceptable risk of incorrect acceptance (type II error)
• There is an inverse relationship between risk of incorrect
acceptance and the sample size
• The lower the risk for incorrect acceptance, the larger the
sample size must be
 3. Tolerable misstatement
• The tolerable misstatement is the amount of the
preliminary judgment about materiality that is
allocated to an account
• The tolerable misstatement is the maximum
amount by which the account can be misstatement
with the auditor still accepting the account as being
fairly presented
• Tolerable misstatement is inversely related to
sample size.
• The lower the amount of tolerable misstatement,
the larger the sample size must be.
 4. Expected misstatement
• The expected misstatement is the amount of
misstatement that the auditor believes exists in
the population.
• The expected misstatement can be developed
based on the assessment of inherent risk, prior
year's results, a pilot sample, the results of
related substantive tests, or the results of tests of
controls.
• There is a direct relationship between expected
misstatement and sample size.
• The larger the expected misstatement, the larger
the sample size must be
 5. Population size
• Population size is directly related to sample
size
• The larger the population size, the larger the
sample size must be.
Step 5: select the sample items using systematic sampling
method
• For Monetary-Unit Sampling, (by applying
systematic sampling method) probability-
proportional-to-size method is used, which gives
each birr in the population an equal chance of
being selected and divides the population in to
equal groups of birr.
• Each group of birr represents a sampling interval,
which is obtained by dividing the book value of
the population by the sample size.
• Assume a client’s book value of accounts
receivable is Br.5,000,000, and the auditor
determined a sample size of 88. The sampling
interval will be Br. 56,818. The auditor randomly
selects a number between 0 and 56,818, and then
select every 56,818th Birr to identify the balance to
be included in the sample.
Step 6: Perform the audit procedures
• After the sample items have been selected, the
auditor conducts the planned audit procedures on
the logical units containing the selected dollar
sampling units.
 Step 7: Evaluate the sample results
1. Calculate the sample results
• projecting the misstatement detected in the
sample to the population (called misstatement
limit), which represents the mean misstatement
in the population
• calculating an allowance for sampling risk and
add it to the projected misstatement in order to
determine the misstatement limit
2. Perform error analysis
 Step 8: Draw final conclusions
• Tolerable misstatement is compared to the sum of projected
misstatement and allowance for sampling risk (misstatement
limit)
• If the sum of projected misstatement and allowance for
sampling risk is less than or equal to tolerable
misstatement, the auditor can conclude that the account is not
materially misstated for the tested assertion
• The sum of projected misstatement and allowance for sampling
risk is greater than tolerable misstatement, the auditor can
conclude that the account is materially misstated for the tested
assertion. When faced with this situation, the auditor may:
• Increase the sample size.
• Perform other substantive procedures.
• Request the client adjust the accounts balance.
• If the client refuses to adjust the account balance, the auditor
would consider issuing a qualified or adverse opinion.
• Step 9: Document the sampling procedures
End of chapter One