1. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-1 Chapter 8 CHAPTER 8 AUDIT SAMPLING: AN OVERVIEW AND APPLICATION TO TESTS OF CONTROLS

2. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-2 SAMPLING DEFINED SAS No. 39 defines audit sampling as the application of an audit procedure to less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class (AU 350.01).

3. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-3 A UDIT PROCEDURES THAT DO NOT INVOLVE AUDIT SAMPLING Inquiry and observation Analytical procedures Procedures applied to every item in the population Classes of transactions or accounts not tested Tests of automated IT controls.

4. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-4 TERMINOLOGY Sampling Risk Precision

5. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-5 TERMINOLOGY Type I and Type II errors Risk of assessing CR too high / Incorrect rejection Risk of assessing CR too low / Incorrect acceptance

6. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-6 TYPES OF AUDIT SAMPLING Nonstatistical Sampling --Judgmental (may not be as effective) Statistical Sampling --Uses probability to select and evaluate sample --Advantages: Design efficient sample Measure sufficiency of evidence Quantify sampling risk --Disadvantage: Cost of designing application and training employees

7. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-7 SAS 39 Requirements Planning for Sample Application Relationship of sample to objective of test Maximum deviation rate that would support planned level of CR Risk of incorrect acceptance

8. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-8 SAS 39 Requirements Sample Selection (representative of population) Random Number Systematic Haphazard

9. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-9 SAS 39 Requirements Performance Evaluation Consider effect of not being able to apply a planned audit procedure to a sample item Project results to entire population Give consideration to sampling risk Consider qualitative aspects of misstatements

10. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-10 TYPES OF AUDIT SAMPLING Types of statistical sampling techniques Attribute sampling Monetary-unit sampling Classical variables sampling

11. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-11 ATTRIBUTE SAMPLING APPLIED TO TESTS OF CONTROLS Attribute Sampling: Estimates the proportion of a population that possesses a specified characteristic. Normally used in tests of controls (determine the operating effectiveness of a control procedure in terms of deviations from the prescribed internal control).

12. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-12 PHASES IN AN ATTRIBUTE SAMPLING APPLICATION Planning Performance Evaluation

13. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-13 PLANNING Determine the tests objective(s). Define the control deviation conditions. Define the population. Define the period covered by the test. Define the sampling unit.

14. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-14 Determine sample size: Determine acceptable risk of assessing CR too low. Determine tolerable deviation rate. Determine expected population deviation rate. Consider effect of population size. PLANNING

15. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-15 Effect of Sample Selection Factors on Sample Size (Table 8-4) FactorRelationship to Sample Size Acceptable risk of assessing CR too lowInverse Tolerable deviation rateInverse Expected population deviation rateDirect Population sizeNo effect

16. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-16 PERFORMANCE Randomly select the sample items. Perform the audit procedures.

17. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-17 SPECIAL SITUATIONS IN PERFORMING THE AUDIT PROCEDURES Voided documents. Unused or inapplicable documents. Inability to examine a sample item. Stopping the test before completion.

18. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-18 EVALUATION Calculating the sample results. Performing error analysis. Drawing final conclusions

19. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 8-19 Nonstatistical Sampling Differences in 3 Steps 1. Determine Sample Size: Use professional judgment, not a statistical formula. Public firms establish guidelines (Below Max – 10 - 15; Moderate – 20 - 35; Low – 30 - 75) 2. Random Selection: Allows use of haphazard samples 3. Calculating Results: Difficult to consider effect of sampling risk