SELECTING ITEMS FOR

TESTING AND BASIC

AUDIT SAMPLING
CONCEPTS

It requires less effort to do the right things and

succeed, than to do the wrong things and fail.
Introduction
PSA 500, Audit Evidence, states
that:

An effective test provides

appropriate audit evidence to an
extent that, taken with other
audit evidence obtained or to be
obtained, will be sufficient for the
auditor’s purposes.
Introduction

In selecting items for testing, the

auditor is required to determine
the relevance and reliability of
information to be used as audit
evidence; the other aspect of
effectiveness (sufficiency) is an
important consideration in
selecting items to test.
Introduction

The means available to the

auditor for selecting items for
testing are:
a. Selecting all items (100%
examination);
b. Selecting specific items; and
c. Audit sampling.
Selecting All Items
(100% Examination)
 The auditor may decide that it will be
most appropriate to examine the entire
population of items that make up a
class of transactions or account balance
(or a stratum within that population).

 Unlikely in the case of TOC

 More common for test of details

Selecting All Items
(100% Examination)
100% examination may be appropriate
when, for example:
 The population constitutes a small
number of large value items;
 There is a significant risk and other
means do not provide sufficient
appropriate audit evidence; or
 The repetitive nature of a calculation or
other process performed automatically
by an information system makes a
100% examination cost effective.
Selecting Specific Items
The auditor may decide to select
specific items from a population
based on such factors as:
 the auditor’s understanding of
the entity,
 the assessed risks of material
misstatement,
 and the characteristics of the
population being tested.
Selecting Specific Items
The judgmental selection of
specific items is subject to non-
sampling risk.

Specific items selected may

include:
 High value or key items
 All items over a certain amount
 Items to obtain information
Audit Sampling

The application of audit

procedures to less than100% of
items within a population of audit
relevance such that all sampling
units have a chance of selection
in order to provide the auditor
with a reasonable basis on which
to draw conclusions about the
entire population.
Audit Sampling
The objective of the auditor when
using audit sampling is to provide a
reasonable basis for the auditor to
draw conclusions about the
population from which the sample is
selected.

Audit sampling can use either a

statistical or non-statistical approach.
Audit Sampling
Terminologies
Population – The entire set of data from
which a sample is selected and about which
the auditor wishes to draw conclusions.
Sampling unit – The individual items
constituting a population.
Anomaly – A misstatement or deviation that
is demonstrably not representative of
misstatements or deviations in a population.
Stratification – The process of dividing a
population into sub-populations, each of
which is a group of sampling units which
have similar characteristics
Audit Sampling
Terminologies
Statistical sampling – An approach to
sampling that has the following
characteristics:
i. Random selection of the sample items;
and
ii. The use of probability theory to evaluate
sample results, including measurement of
sampling risk.

A sampling approach that does not have

characteristics (i) and (ii) is considered non-
statistical sampling.
Audit Sampling
Terminologies
 Tolerable misstatement – A monetary
amount set by the auditor in respect of
which the auditor seeks to obtain an
appropriate level of assurance that the
monetary amount set by the auditor is
not exceeded by the actual misstatement
in the population.
 Tolerable rate of deviation – A rate of
deviation from prescribed internal control
procedures set by the auditor in respect
of which the auditor seeks to obtain an
appropriate level of assurance that the
rate of deviation set by the auditor is not
Audit Sampling in Relation
to Audit Procedures
RiskAssessment Procedures
- do not normally involve the use of audit
sampling

Testsof Controls
- Audit sampling for TOC is generally
appropriate when application of controls
leaves audit evidence of performance

SubstantiveProcedures
- Audit sampling is commonly used to verify
one or more assertions about a FS amount
Audit Sampling and Audit
Risk
Audit Risk

Risk of
Detection
Material
Risk
Misstatement
Inherent Sampling
Risk Risk
Non-
Control Risk sampling
Risk
Sampling Risk & Non-Sampling
Risk
Sampling Risk
 Uncertainties related to sampling.
 Arises from the possibility that the
auditor’s conclusion based on a sample
may be different from the conclusion if
the entire population were subjected to
the same audit procedure.

Non-sampling Risk
 Uncertainties arising from factors
unrelated to sampling
Sampling Risk in Test of
Controls
1. Risk of assessing control risk too high
- risk that a sample deviation rate
supports assessing control risk as high
when, unknown to the auditor, the true
deviation rate in the population supports
assessing control risk as less than high
2. Risk of assessing control risk too low
- risk that a sample deviation rate
supports assessing control risk as less
than high when, unknown to the auditor,
the true deviation rate in the population
supports assessing control risk at high
Sampling Risk in Substantive
Tests
1. Risk of incorrect rejection – risk that a
sample supports the conclusion that a
recorded account balance is materially
misstated, when, unknown to the auditor,
the account is not materially misstated

2. Risk of incorrect acceptance - risk that

a sample supports the conclusion that a
recorded account balance is not materially
misstated, when, unknown to the auditor,
the account is materially misstated
General Approaches to
Audit Sampling
Statistical Sampling
- applies the laws of probability to aid an
auditor in designing an efficient sample, in
measuring the sufficiency of evidence
obtained, and in evaluating the sample
results

Non-statistical Sampling
- rely exclusively on subjective judgment
to determine sample size and evaluate
sample results
Sample Selection Methods
Random-Number Sampling

Systematic Sampling

BlockSelection or Cluster
Sampling*

Haphazard Sampling
Stratification
Dividing the population into
discrete sub-populations which
have an identifying characteristic
Helps improve efficiency and
reduce variability of items
Results of procedures applied can
only be projected to the items
that make up the stratum
Value-Weighted Selection
Selection of specific monetary
units and examining the
particular items within that
monetary unit
Directs the audit effort to larger
value items because they have a
greater chance of selection, and
can result in smaller sample
sizes.
Attributes Sampling
1. Determine the objective(s) of the test.
2. Define the attributes and deviation
conditions.
3. Define the population.
4. Determine the sample selection
method.
5. Determine the sample size.
6. Perform the attributes sampling plan.
7. Evaluate the sample results.
8. Document the process and the results.
Factors Affecting Sample Size for
Tests of Controls
FACTORS EFFECT ON
SAMPLE SIZE
Increase in the auditor’s intended Increase
reliance on accounting and internal
control systems
Increase in tolerable deviation rate Decrease

Increase in expected deviation rate Increase

Increase in the auditor’s required Increase

confidence level
Increase in the number of sampling Negligible
units in the population effect
Other Sampling Applications for
Test of Controls
Sequential Sampling
- used when the auditor expects very few deviations
- no fixed sample size
- After testing a sample, the auditor makes a
decision whether to stop testing or continue with
the sampling plan
Discovery Sampling
- most appropriate when no deviations are expected
- normally used when the auditor suspects fraud
- involves determining a sample size sufficient to
discover at least one deviation to confirm whether
fraud has occured
Variables Sampling
1. Determine the objectives of the
test
2. Define the population
3. Choose an audit sampling
approach
4. Determine the sample size
5. Perform the sampling plan
6. Evaluate the results
7. Comply with documentation
requirements
Factors Affecting Sample Size for
Substantive Test
EFFECT ON
FACTORS SAMPLE
SIZE
Increase in assessment of inherent Increase
risk
Increase in assessment of control Increase
risk
Increase in the use of other Decrease
substantive procedures directed at
the same assertion
Increase in required confidence Increase
level
Increase in tolerable error Decrease
Projecting Errors
Projections for TOC
- No explicit projection is necessary
since the sample error rate is also the
projected rate of error for the whole
population

Projections for Substantive Test

- project the total monetary errors
found in the sample for the population
to obtain a broad view of the scale of
errors
Estimation Techniques
Difference Estimation
- used to measure the estimated total
misstatement amount in the population
when there is both a recorded value
and an audited value for each item in
the sample

- appropriate when the misstatement in

an account is not affected by the book
value of the item being examined
Estimation Techniques
Ratio Estimation
- similar to difference estimation
except that the point estimate of the
population misstatement is
determined by multiplying the portion
of sample amount misstated by the
total recorded population book value

- the use of ratio estimation is

appropriate when the misstatement in
an account is directly proportional to
Estimation Techniques
Mean-per-unit Estimation
- the auditor is more concerned with
the audited value rather than the
misstatement amount of each item in
the sample
- point estimate of the audited value is
the average audited value of items in
the sample times the population size
- appropriate when individual
populations do not have recorded
values
Comprehensive example
An external auditor sent out positive confirmation
requests to 2,000 customers. Population size is
4,800 accounts, with a total recorded value of
P380,000. Below are the summary results of the
examination of confirmation replies received from
customers:
Book value of samples selected P159,960
Audited value of samples selected 151,360
Difference P 8,600

Average/mean book value (P159,960/2,000) P80

Average/mean audited value (P151,360/2,000) P76
Ratio Estimation
1. Compute for the ratio of sample audited value
to sample book value
Sample Audited Value = P151,960 =
94.62%
Sample Book Value P159,960

2. Compute for the Estimated Audited Value (EAV)

or Estimated Population Audited Value (EPAV)
= Ratio x Population Book Value
= .9462 x P380,000 = P359,556

3. Compute for the projected misstatement

= EPAV – PBV = P359,556 – P380,000
= P20,444 overstated
Difference Estimation
1. Compute for the average difference
between SAV and SBV
= Average/Mean AV – Average/Mean BV
= P76 – P80 = P4 overstated

2. Compute for the projected misstatement

= P4 x P4,800 accounts
= P19,200 overstated
Mean-per-unit estimation
1. Compute for the EPAV
= Ave./mean AV x no. of items in the
population
= P76 x 4,800
= P364,800
Monetary Unit Sampling (MUS)
 Widely
used statistical sampling
method

 Results
in efficient sample size and
concentrates on the monetary value of
the account balances

 Thepopulation for MUS is the number

of pesos in the population being
tested thus each peso in the
population has an equal chance of
being chosen
Monetary Unit Sampling (MUS)
 The design of an MUS sample requires
the auditor to determine:
1. Detection risk
2. Tolerable misstatement and
3. Expected misstatement in the
account balance.
Advantages of MUS
 Itis generally easier to use than classical
variables sampling because the auditor
can calculate sample sizes and evaluate
sample results by hand or with the
assistance of tables. The size of a PPS
sample is not based on any measure of
the estimated variation of audit values.

 PPS sampling automatically results in a

stratified sample because items are
selected in proportion to their dollar
values.
Advantages of MUS
(continued)
 PPS systematic sample selection
automatically identifies any item that is
individually significant if its value
exceeds an upper monetary cutoff.

 Ifthe auditor expects no misstatements,

PPS sampling will usually result in a
smaller sample size than under classical
variables sampling.

A PPS sample can be designed more

easily, and sample selection may begin
Disadvantages of MUS

 Itincludes an assumption that the audit

value of a sampling unit should not be
less than zero or greater than book
value. When understatements or audit
values of less than zero are anticipated,
special design considerations may be
required.

 Ifunderstatements are identified in the

sample, the evaluation of the sample
may require special considerations.
Disadvantages of MUS
(Continued)

 The selection of zero balances or balances of

a different sign (e.g. credit balances)
requires special consideration.
 PPS evaluation may overstate the ASR when
misstatements are found in the sample. As a
result, the auditor may be more likely to
reject an acceptable book value for the
population.
 As the expected number of misstatements
increases, the appropriate sample size
increases. Thus, a larger sample size may
result than under classical variables
sampling.
Monetary Unit Sampling
(MUS)
Sample size and selection
- fixed-interval approach is used based on
the calculated sampling interval in pesos
TM – (EM x
I = EEF)
where RF
TM = Tolerable misstatement
EM = Expected misstatement
EEF = Error expansion Factor
RF = Reliability Factor
Detection Risk 1% 5% 10% 15% 20% 25% 30% 50%
Reliability factor 4.61 3.00 2.31 1.90 1.61 1.39 1.21 0.70
Error expansion 1.90 1.60 1.50 1.40 1.30 1.25 1.20 1.00
rate
Incremental allowance for sampling
Ranked overstatement error:
1 1.03 0.75 0.58 0.48 0.39 0.31 0.23 0.00
2 0.77 0.55 0.44 0.34 0.28 0.23 0.18 0.00
3 0.64 0.46 0.36 0.30 0.24 0.18 0.15 0.00
4 0.56 0.40 0.31 0.25 0.21 0.17 0.13 0.00
5 0.50 0.36 0.28 0.23 0.18 0.15 0.11 0.00
6 0.46 0.33 0.26 0.21 0.17 0.13 0.11 0.00
7 0.43 0.30 0.24 0.19 0.16 0.13 0.10 0.00
8 0.41 0.29 0.22 0.18 0.14 0.12 0.09 0.00
9 0.38 0.27 0.21 0.17 0.14 0.11 0.08 0.00
10 0.36 0.26 0.20 0.17 0.14 0.10 0.08 0.00
Illustration (MUS)
An auditor is planning to confirm accounts
receivable to test the existence and valuation
assertions. There are 450 customer balances
totaling P807,906. Audit risk has been set at a
low (5%) and detection risk has been
computed to be 15%. Tolerable misstatement is
set at P50,000. No misstatements were found
in the past year. However, to be safe, the
auditor uses an expected misstatement of
P5,000.P50,000 – (P5,000
The sampling x is computed as
interval
I = 1.4)
follows: = P22,632
1.9
Illustration (MUS)
Cumulative Selection
Customer Book Value
Amount Amount
Random start 20,000
1 220 20,220
2,200 22,420 22,000
2 22,000 44,420 44,000
3 880 45,300
4 6,128 51,428
5 2,800 54,228
66,000 &
6 45,023 99,251
88,000
7 10 99,261
8 8,231 107,492
9 16,894 124,386 110,000
10 - -
. - -
. 1,900
450 827,906
Sample Evaluation
Upper Misstatement Limit (UML) – maximum
overstatement that might exist in the population
given the misstatement detected in the sample

Basic Precision – amount of uncertainty associated

with testing only a part of the population
Most Likely Misstatement (MLM) – The best
estimate of the actual amount of misstatement
that exist in the account balance
Incremental Allowance for Sampling Error – an
increase in the upper misstatement estimate
caused by the statistical properties of
misstatements found
 Sample Evaluation
The significance of these 3 factors
depends on whether misstatements
are found in the sample.
No Misstateme
Misstatem nts
ent
Interval x
Basic Precision Interval x RF
RF
+ Most Likely
0 Calculate
Misstatement
+ Incremental Allowance
0 Calculate
for Sampling Error
= Upper Misstatement Basic Sum of the
Limit Precision three
Illustration (MUS)
Using the same sample with a
sampling interval of P22,000
based on a detection risk,
assume the following
misstatements
Book Value Audit Value
were found:
Misstateme Tainting
nt Percent

45,023 44,340 683 NA

2,000 1,940 60 3%
8,300 8,217 83 1%
 UML Calculation
UML Taintin Sampling
g Monetary
Facto Interval Conclusion
r Percent

Basic Precision 1.90 x 22,000 = 41,800

Most likely misstatement
Top stratum 683
Lower
Stratum
First largest tainting 3%
Second largest 1%
tainting
4% x 22,000 = 880
Total most likely 1,563
misstatement
Incremental allowance for sampling error
First largest % 0.48 x 3% =
1.44%
Second largest 0.34 x 1% =
Sample Evaluation
When the upper misstatement limit of is
greater than the tolerable misstatement,
the auditor concludes that the account
balance is materially misstated.
 When faced with this situation, the
auditor may:
1. Increase the sample size.
2. Perform other substantive procedures.
3. Request the client adjust the account
balance.
4. If the client refuses to adjust the account
balance, the auditor would consider
issuing a qualified or adverse opinion.