CHAPTER ONE

AUDIT SAMPLING FOR TESTS

OF CONTROLS AND
SUBSTANTIVE TESTS OF
TRANSACTIONS

November 26, 2024 By: Gizachew S. 15-1

 LEARNING OBJECTIVES
1 Explain the concept of representative sampling.
2 Distinguish between statistical and nonstatistical sampling and
between probabilistic sample selection and nonprobabilistic
sample selection.
3 Select samples using probabilistic and nonprobabilistic methods.
4 Define and describe audit sampling for exception rates.
5 Use nonstatistical sampling in tests of controls and substantive tests
of transactions.
6 Define and describe attributes sampling and a sampling
distribution.
6 Use attributes sampling in tests of controls and substantive tests of
transactions.

November 26, 2024 By: Gizachew S. 15-2

 REPRESENTATIVE SAMPLING
 Audit sampling is the selection and evaluation of less than 100 per
cent of the population of audit relevance such that the auditor expects
the items selected to be representative of the population and, thus,
likely to provide a reasonable basis for conclusions about the
population.
 A representative sample is one in which the characteristics in the
sample are approximately the same as those of the population.
• Auditors strive to get a representative sample for testing.
• Auditors never know if a sample is representative or not, but the
auditor can increase the likelihood by using care in designing the
sampling process, sample selection, and evaluation of sample
results.
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  A sample, even a representative sample, has the risk of two types of errors: a
 sampling error and
 nonsampling error.
• The risks of these two types of errors are called
• sampling risk and
• Non sampling risk.
 Sampling risk is the risk that an auditor reaches an incorrect conclusion
because the sample is not representative of the population.

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 REPRESENTATIVE SAMPLING (CONT.)
 Sampling risk can be controlled by the auditor by:
1. Adjusting sampling size
- Increasing sample size reduces sampling risk
2. Using an appropriate method of selecting sample items from the
population.
- using an appropriate sample selection method increases the
likelihood of representativeness
 Non sampling risk is the risk that the auditor reaches an incorrect conclusion
for any reason not related to sampling risk. Common reasons are:
1. Auditor’s failure to recognize exceptions
2. Ineffective audit procedures
November 26, 2024 By: Gizachew S. 15-5
 STATISTICAL VERSUS NONSTATISTICAL SAMPLING
AND PROBABILISTIC SAMPLE SELECTION
Statistical Versus Non-statistical Sampling -
 Audit sampling methods can be divided into two broad categories: statistical
sampling and non-statistical sampling.
 Both methods involve the same three phases when used in audits:
1. Plan the sample
- to make sure that the audit tests are performed in a manner that provides the
desired sampling risk and minimizes the likelihood of non sampling error.
2. Select the sample and perform the tests
 involves deciding how a sample is selected from the population. The auditor
can perform the audit tests only after the sample items are selected.
3. Evaluate the results-
- drawing of conclusions based on the audit tests
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  Assume that an auditor selects a sample of 100 duplicate sales invoices
from a population, tests each to determine whether a shipping document is
attached, and determines that there are three exceptions. Let’s look at those
actions step-by-step:
Action Step
• Decide that a sample size of 100 is needed. 1. Plan the sample

• Decide which 100 items to select from the population. 2. Select the sample and
• Perform the audit procedure for each of the 100 items and perform the tests
determine that three exceptions exist.
• Reach conclusions about the likely exception rate in the 3. Evaluate the results
total population when the sample exception rate equals
percent.
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  Statistical sampling applies mathematical rules so that the auditor can
quantify (measures) sampling risk in planning the sample (step 1) and
evaluating results (step 3).
 Non statistical sampling does not quantify sampling risk, but a
properly designed non statistical sample can provide effective results in
audits.

November 26, 2024 By: Gizachew S. 15-8

STATISTICAL VERSUS NON-STATISTICAL SAMPLING
AND PROBABILISTIC SAMPLE SELECTION(CONT.)
Probabilistic Versus Non-probabilistic Sample Selection

 Probabilistic sample selection – the auditor randomly selects

items such that each item has a known probability of being
included in the sample.
 When statistical sampling is used, a probabilistic sample must
be used.
 Non-probabilistic sample selection – any other method of
selecting a sample.

November 26, 2024 By: Gizachew S. 15-9

 SAMPLE SELECTION METHODS
 There are a number of techniques/methods that auditors can use to select
a sample.
 Probabilistic sample selection methods:
1. Simple random sample selection
2. Systematic sample selection
3. Probability proportional to size sample selection
 Non-probabilistic sample selection methods:
4. Haphazard sample selection
5. Block sample selection
 Auditors can also use probabilistic methods even when using non-
statistical sampling.
November 26, 2024 By: Gizachew S. 15-10
 SAMPLE SELECTION METHODS (CONT.)
Probabilistic Sample Selection Methods:
For probabilistic samples, the auditor uses no judgment about which sample items are
selected, except in choosing which probabilistic selection method to use
Simple Random Sample Selection :
• In this selection method, every possible combination of population items has an equal
chance of being included in the sample.
• This requires a method to make sure that all items in the population have an equal
chance of selection.
Auditors often generate random numbers by using one of three computer sample
selection techniques (example shown in Figure 15-1) :
1. Electronic spreadsheets, 2. Random number generators, or 3. Generalized audit
software
November 26, 2024 By: Gizachew S. 15-11
  Auditors use simple random sampling to sample populations when there
is no need to emphasize one or more types of population items.
Example,
Auditors want to sample a client’s cash disbursements for the year. They
might
select a simple random sample of 60 items from the cash disbursements
journal,
apply appropriate auditing procedures to the 60 items selected, and
draw conclusions about all recorded cash disbursement transactions.

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November 26, 2024 By: Gizachew S. 15-13
 SAMPLE SELECTION METHODS (CONT.)
Probabilistic Sample Selection Methods (cont.):
• Systematic Sample Selection
• The auditor calculates an interval and then selects items for the sample
based on the size of the interval.
• The interval is determined by dividing the population by the desired
sample size.
• In a population of sales invoices ranging from 652 to 3,151, with a
desired sample size of 125, the interval is 20 [(3,151 – 651)/125].
The auditor first selects a random number between 0 and 19 (the
interval size) to determine the starting point for the sample.
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 If the randomly selected number is 9, the first item in the sample will be
invoice number 661 (652 + 9). The remaining 124 items will be 681 (661 +
20), 701 (681 + 20), and so on through item 3,141.
• Probability Proportional to Size and Stratified Sample Selection
• In many auditing situations, it is advantageous to select samples that
emphasize population items with larger recorded amounts.
 If the auditor takes a sample in which the probability of selecting any
individual population item is proportional to its recorded amount is called
sampling with probability proportional to size (PPS)
 Dividing the population into subpopulations, usually by dollar size, and taking
larger samples from the subpopulations with larger sizes. This is called
stratified sampling, and it is evaluated using non-statistical sampling or
variables statistical sampling.
November 26, 2024 By: Gizachew S. 15-15
 SAMPLE SELECTION METHODS (CONT.)
Non-probabilistic Sample Selection Methods:
• Haphazard Sample Selection
• the selection of items without any conscious bias by the auditor
• the auditor selects population items without regard to their size, source, or other
distinguishing characteristics.
• shortcoming is the difficulty of remaining completely unbiased
• Block Sample Selection
• the auditor selects the first item in a block and then the remainder of the block is
chosen in sequence
• acceptable to use block sampling if a reasonable number of blocks is used
 For example, assume the block sample will be a sequence of 100 sales transactions from
the sales journal for the third week of March. Auditors can select the total sample of 100
by taking 5 blocks of 20 items,S. 10 blocks of 10, 50 blocks of 2, or one block of 100 15-16
By: Gizachew
 SAMPLING FOR EXCEPTION RATES
When testing controls and performing substantive tests of transactions, the auditor
determines whether the controls are operating effectively and whether the rate of
monetary errors is below tolerable limits.
To test this, auditors estimate the percent of items in a population containing a
characteristic or attribute of interest. This percentage is called the occurrence
rate or exception rate.
Auditors are interested in the following types of exceptions in accounting data:
1. Deviations from the client’s established controls
2. Monetary misstatements in populations of transaction data
3. Monetary misstatements in populations of account balance details
When testing controls and performing substantive tests of transactions, the auditor
focuses on the upper limit of the estimated population exception rate, which is the
computed upper exception
November 26, 2024
rate (CUER).
By: Gizachew S. 15-17
Exercise
1. State what is meant by a representative sample and explain its
importance in sampling audit populations.
2. Explain the major difference between statistical and non statistical
sampling. Are both methods acceptable according to auditing
standards?

November 26, 2024 By: Gizachew S. 15-18

 APPLICATION OF NON-STATISTICAL AUDIT SAMPLING

The three phases of sampling are identical for both statistical and
nonstatistical sampling:
1. Plan the Sample
2. Select the Sample and Perform the Audit Procedures
3. Evaluate the Results
There are 14 well-defined steps that fall under the three phases. The
terms used in audit sampling are detailed in Table 15-1.

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November 26, 2024 By: Gizachew S. 15-20
 APPLICATION OF NON-STATISTICAL AUDIT SAMPLING (CONT.)

Phase 1 - Plan the Sample:

1. State the objectives of the audit test.
2. Decide whether audit sampling applies.
3. Define attributes and exception conditions.
4. Define the population.
5. Define the sampling unit.
6. Specify the tolerable exception rate.
7. Specify acceptable risk of overreliance.
8. Estimate the population deviation or exception rate.
9. Determine the initial sample size.

November 26, 2024 By: Gizachew S. 15-21

 APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)

Phase 2 - Select the Sample and Perform the Audit Procedures:

10.Select the sample.
11.Perform the audit procedures.
Phase 3 – Evaluate the results:
12.Generalize from the sample to the population.
13. Analyze exceptions.
14. Decide the acceptability of the population.
Attributes for Hillsburg Hardware Co. are defined in Table 15-3.

November 26, 2024 By: Gizachew S. 15-22

APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)
Phase 1 - Plan the Sample:
1. State the Objectives of the Audit Test: The objectives of the test must be
in terms of the transaction cycle being tested. The objectives are usually
defined as follows:
• Test the operating effectiveness of controls
• Determine whether the transactions contain monetary misstatements
• The objectives of these tests in the sales and collection cycle are
usually to test the effectiveness of internal controls over sales and cash
receipts and to determine whether sales and cash receipts transactions
contain monetary misstatements.

November 26, 2024 By: Gizachew S. 15-23

 2. Decide Whether Audit Sampling Applies: Audit sampling applies
whenever the auditor plans to reach conclusions about a population based
on a sample.
 The auditor should examine the audit program and select those audit
procedures where audit sampling applies.
 Audit procedures for Hillsburg Hardware Co. where audit sampling is
appropriate are illustrated in Table 15-2.

November 26, 2024 By: Gizachew S. 15-24

  To illustrate, assume the following partial audit program:
1. Review sales transactions for large and unusual amounts (analytical procedure).
2. Observe whether the duties of the accounts receivable clerk are separate from
handling cash (test of control).
3. Examine a sample of duplicate sales invoices for
a. credit approval by the credit manager (test of control).
b. existence of an attached shipping document (test of control).
c. inclusion of a chart of accounts number (test of control).
4. Select a sample of shipping documents and trace each to related duplicate sales
invoices (test of control).
5. Compare the quantity on each duplicate sales invoice with the quantity on related
shipping documents (substantive test of transactions).

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November 26, 2024 By: Gizachew S. 15-26
APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)
Phase 1 - Plan the Sample (cont.):
3. Define Attributes and Exception Conditions: Auditors must carefully define the
characteristics (attributes) being tested as well as the exception conditions.

• Unless each attribute is carefully defined in advance, the staff person who
performs the audit procedures will have no guidelines to identify exceptions.

• Nine attributes of interest and exception conditions for the Hillsburg audit are shown in
Table 15-3.
4. Define the Population: The items which the auditor wishes to generalize.
• The auditor defines the population consistent with the objectives of the tests.
5. Define the Sampling Unit: The sampling unit is defined based on the population
and the sample selection method. The sampling unit is the physical unit that
corresponds to the random numbers the auditor generates.
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November 26, 2024 By: Gizachew S. 15-28
 APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)
Phase 1 - Plan the Sample (cont.):
6. Specify the Tolerable Exception Rate: The tolerable exception rate (TER) for each attribute
requires the auditor’s professional judgment. The TER can significantly affect the sample
size. Figure 15-2 on page 494 shows the TER on a sampling data sheet.
7. Specify Acceptable Risk of Overreliance: Sampling always has a risk of incorrect
conclusions about the population.
• Auditors are concerned with the risk of overreliance because it impacts the effectiveness of
the audit. Underreliance affects the efficiency of the audit.
• The acceptable risk of overreliance (ARO) measures the risk the auditor is willing to take of
concluding that a control is effective when the true population exception rate is greater than
TER.
Guidelines for establishing TER and ARO are illustrated in Tables 15-4 and 15-5.
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 APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)
 Phase 1 - Plan the Sample (cont.):
8. Estimate the Population Exception Rate: Auditors should make an estimate of the
population exception rate to plan the appropriate sample size. If the estimated
population exception rate (EPER) is low, a relatively small sample will satisfy the
auditor’s tolerable exception rate (TER).
9. Determine the Initial Sample Size: Four factors determine the initial sample size:
population size, TER, ARO, and EPER.
• It is called an initial sample size because the exceptions in the initial sample must be
evaluated before an auditor can decide if the sample is sufficient to achieve the
objectives of the test.
 Factors that affect the sample size are shown in Table 15-6.

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November 26, 2024 By: Gizachew S. 15-33
 APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)

Phase 2 - Select the Sample and Perform the Audit Procedures:

10. Select the Sample: Auditors can choose any of the methods presented to
select the initial sample.
• To minimize the possibility of the client altering the sample items, the
auditor should not inform the client too far in advance of the sample
items selected.
11. Perform the Audit Procedures: The auditor performs the audit
procedures by examining each item in the sample to determine whether it
is consistent with the definition of the attribute and by maintaining a record
of all the exceptions found.
An inspection of sample items for attributes worksheet is shown in
Figure 15-3 on page 498.
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 APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)
Phase 3 – Evaluate the Results:
12. Generalize from the Sample to the Population: The sample exception rate
(SER) can be calculated from the actual sample results by dividing the actual
exceptions by the actual sample size. When the SER exceeds the EPER used
in designing the sample, the auditor can conclude that the sample results do
not support the preliminary assessed risk.
 The SER and calculated allowance for sampling risk (TER- SER)
is summarized in Figure 15-4 on page 500.
13. Analyze Exceptions: The exception analysis is illustrated in Figure 15-5
on page 501.

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 APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)

Phase 3 – Evaluate the Results:

14. Decide the Acceptability of the Population: If the sample exception
rate is less than the expected rate, the auditor will conclude that the
sample does not indicate any significant problems. However, when the
SER exceeds the EPER, the auditor will conclude that the results are
unacceptable and must follow one of four courses of action:
1. Revise TER or ARO
2. Expand the Sample Size
3. Revise Assessed Control Risk
4. Communicate with the Audit Committee or Management

November 26, 2024 By: Gizachew S. 15-36

 APPLICATION OF NONSTATISTICAL AUDIT SAMPLING (CONT.)

Documentation and Evidence Planning: The auditor needs to retain

adequate documentation of:
• Procedures performed
• Methods used to select the sample and perform the tests
• Results found in the tests
• Conclusions reached
The conclusions of the tests of controls and substantive tests of transactions will
determine the remainder of the audit evidence that needs to be obtained. This
evidence planning is illustrated in Figure 15-6 on page 504.
The steps in nonstatistical sampling are summarized in Figure 15-7.

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November 26, 2024 By: Gizachew S. 15-38
 STATISTICAL AUDIT SAMPLING

Differences Between Attributes Sampling and Nonstatistical

Sampling
 The statistical sampling method most commonly used for tests of
controls and substantive tests of transactions is attributes sampling.
 Statistical attributes sampling and nonstatistical sampling use the same
14 steps. The differences are:
1. The calculation of the initial sample sizes are developed from
statistical probability distributions
2. The calculation of estimated upper exception rates use statistical
probability distributions.

November 26, 2024 By: Gizachew S. 15-39

 STATISTICAL AUDIT SAMPLING(CONT.)
 Sampling Distribution – Auditors base their inferences on sampling
distributions, which are a frequency distribution of the results of all
possible samples of a specified size that could be obtained from a
population containing some specific characteristics.
 Each population exception rate and sample size has a unique sampling
distribution.
 The sampling distribution for a sample of 50 items from a very large
population and an exception rate of 5 percent is shown in Table 15-
7.
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November 26, 2024 By: Gizachew S. 15-41
 APPLICATION OF ATTRIBUTES SAMPLING
The steps for attributes sampling are the same as those for
nonstatistical sampling with a few exceptions:
7. Specify acceptable risk of overreliance – The concepts are the same,
but the method of quantifying is usually different. Rather than using
high, medium, and low, the auditor will use a specific amount, such
as 5 percent.
9. Determine the initial sample size – The factors that affect the
initial sample size are the same, but in attributes sampling, the
auditor uses tables developed from statistical formulas or audit
software to determine the initial sample size.
This is illustrated in Table 15-8 on page 508.
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APPLICATION OF ATTRIBUTES SAMPLING (CONT.)
 The steps for attributes sampling are the same for nonstatistical sampling with a
few exceptions (cont.):
 10. The only difference in sample selection is that probabilistic methods must be
used for statistical sampling.
 12. For attributes sampling, the auditor calculates the computed upper exception rate
using statistical formulas. This is illustrated in Table 15-9 on page 509 and Figure
15-8 on page 511.
 Need for Professional Judgment – One criticism of statistical sampling is that it reduces
the auditor’s use of professional judgment. However, the auditor does have to exercise
considerable judgment in many statistical sampling decisions.

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