chapter 17 audit sampling for tests of details of balances

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Chapter 17 Audit Sampling for Tests of Details of Balances

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Page 1: Chapter 17 Audit Sampling for Tests of Details of Balances

Chapter 17Audit Sampling for Tests of Details

of Balances

Page 2: Chapter 17 Audit Sampling for Tests of Details of Balances

Presentation Outline

I. The 14 Steps of Audit Sampling for Tests of Details of Balances

II. The 7 Steps of Monetary Unit Sampling

III. Alternative Procedures When a Population is Projected

IV. ARACR and ARIA

Page 3: Chapter 17 Audit Sampling for Tests of Details of Balances

I. The 14 Steps of Audit Sampling for Tests of Details of

Balances

The 14 steps required in audit sampling for tests of details of balances parallel the 14 steps used for sampling for tests of

controls and substantive tests of transactions. Any differences are noted on the following slides.

Page 4: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 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.

Page 5: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 2: Decide whether audit sampling applies

Audit sampling applies whenever the auditor

plans to reach conclusions about a

population based on a sample.

Page 6: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 3: Define Misstatement Conditions

Misstatement conditions are any conditions that represent a monetary

misstatement in a sample item.

Step 3 for Tests of Controls and Substantive Tests ofTransactions would be: Define attributes and exception conditions.

Page 7: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 4: Define the population

In testing for the existence objective, the recorded dollar population is the

population. If the completeness objective is

a concern, the sample should be selected from

a different source.

Page 8: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 5: Define the Sampling Unit

The sampling unit for nonstatistical audit sampling in

tests of details of balances is almost always the item making

up the account balance. Monetary unit sampling (MUS)

is a statistical technique in which the sampling unit is the

individual dollars that make up an account balance.

Page 9: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 6: Specify Tolerable Misstatement

As discussed in Chapter 9, the auditor starts with a preliminary judgment about materiality and

uses that total in deciding tolerable

misstatement for each account.

Step 6 for Tests of Controls and Substantive Tests ofTransactions would be: Specify the tolerable exception rate.

Page 10: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 7: Specify Acceptable Risk of Incorrect

Acceptance (ARIA)

There is an inverse relationship between ARIA and required

sample size. When internal controls

are effective, control risk can be reduced,

permitting the auditor to increase ARIA.

Step 7 for Tests of Controls and Substantive Tests ofTransactions would be: Specify acceptable risk of assessing control

risk too low.

Page 11: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 8: Estimate Misstatements in the Population

This estimate is based on prior experience with the

client, inherent risk, control risk, etc.

Planned sample size increases as the amount

of expected misstatements in the population increases.

Step 8 for Tests of Controls and Substantive Tests ofTransactions would be: Estimate the population exception rate.

Page 12: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 9: Determine the Initial Sample Size

Table 17-3 on page 525 summarizes the primary

factors that influence sample size for nonstatistical

sampling. Figure 17-2 on page 525

presents a table for computing sample size based on the AICPA Audit Sampling

Auditing Guide. MUS uses a statistical formula illustrated on page

538.

Page 13: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 10: Select the Sample

For nonstatistical sampling, auditing

standards permit the auditor to use any of the

selection methods discussed in Chapter 15.

MUS uses PPS sampling that allows the physical

inclusion of an item more than once in the

sample.

Page 14: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 11: Perform the Audit Procedures

Auditor applies the appropriate audit

procedures to each item in the sample to

determine whether it is correct or contains a

misstatement.

Page 15: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of BalancesStep 12: Generalize from the Sample to the

Population

A common approach to is assume that misstatement in

the population are proportional to

misstatements in the sample. (See pages 526-527).

For MUS, the process involves a four-step process.

(See page 533-534). Auditor must consider that

the true population misstatement may be larger

due to sampling error.

Page 16: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of Balances Step 13: Analyze the Misstatements

The reason for the misstatement must be

considered. It could be from an isolated error. However, it could have

arisen from the consistent misapplication of accounting procedure.

Such causes could represent a large effect

on the financial statements.

Step 13 for Tests of Controls and Substantive Tests ofTransactions would be: Analyze the exceptions.

Page 17: Chapter 17 Audit Sampling for Tests of Details of Balances

Audit Sampling for Tests of Details of Balances Step 14: Decide the Acceptability of the

Population

With nonstatistical population the auditor

uses judgment to decide if the potential

misstatement in the population is greater

than tolerable misstatement.

MUS computes misstatement bounds

that provide an objective evaluation.

Page 18: Chapter 17 Audit Sampling for Tests of Details of Balances

II. The 7 Steps of Monetary Unit Sampling

Monetary unit sampling (MUS) is a statistical method of sampling that is also called dollar unit sampling, cumulative monetary amount sampling, and sampling with probability proportional to size.

This section discusses the seven steps of MUS and the MUS decision rule.

Note: The computation of the appropriate sample size for MUS is illustrated on page 538.

Page 19: Chapter 17 Audit Sampling for Tests of Details of Balances

Monetary Unit Sampling (MUS)Step 1: Determine misstatements for each sample

item.

CUST.

No.

RECORDED

ITEM

VALUE

AUDITED

ITEM

VALUE

MISSTATEMENT

2073 6,200 6,100 100

5111 12,910 12,000 910

5206 4,322 4,450 (128)

7642 23,000 22,995 5

9816 8,947 2,947 6,000

Page 20: Chapter 17 Audit Sampling for Tests of Details of Balances

Monetary Unit Sampling (MUS)Step 2: Calculate misstatement per dollar unit in

each sample item.

CUST.

No.

RECORDED

ITEM

VALUE

AUDITED

ITEM

VALUE

MISSTATEMENT

MISSTATEMENT / RECORDED ITEM VALUE

2073 6,200 6,100 100 .016

5111 12,910 12,000 910 .07

5206 4,322 4,450 (128) (.03)

7642 23,000 22,995 5 .0002

9816 8,947 2,947 6,000 .671

Page 21: Chapter 17 Audit Sampling for Tests of Details of Balances

Monetary Unit Sampling (MUS) Step 3: Layer misstatements per dollar unit from highest to lowest,

including the percent misstatement assumption for sample items not misstated.

OVER-STATEMENTS

RECORDED

POPULATION

VALUE

MISSTATEMENT

PERCENTAGE

ASSUMPTION

0 1,200,000 1.0 *

1 1,200,000 .671

2 1,200,000 .07

3 1,200,000 .016

4 1,200,000 .0002

UNDER-STATEMENTS

RECORDED

POPULATION

VALUE

MISSTATEMENT

PERCENTAGE

ASSUMPTION

0 1,200,000 1.0 *

1 1,200,000 .03

* See Appropriate Percent of Misstatement Assumption on page 533.

Page 22: Chapter 17 Audit Sampling for Tests of Details of Balances

Monetary Unit Sampling (MUS) Step 4: Determine upper precision limit from attributes sampling table (Table 15-

9 on page 470) and calculate the percent misstatement bound for each misstatement (layer).

OVER-STATEMENTS

RECORDED

POPULATION

VALUE

MISSTATEMENT

PERCENTAGE

ASSUMPTION

UPPER PRECISION

LIMIT PORTION*

0 1,200,000 1.0 .030

1 1,200,000 .671 .017

2 1,200,000 .07 .015

3 1,200,000 .016 .014

4 1,200,000 .0002 .014

UNDER-STATEMENTS

RECORDED

POPULATION

VALUE

MISSTATEMENT

PERCENTAGE

ASSUMPTION

UPPER PRECISION

LIMIT PORTION*

0 1,200,000 1.0 .030

1 1,200,000 .03 .017

* ARIA OF 5%. Sample size of 100.

Page 23: Chapter 17 Audit Sampling for Tests of Details of Balances

Monetary Unit Sampling (MUS) Step 5: Calculate initial upper and lower misstatement bounds for each layer

and total.

OVER-STATEMENTS

RECORDED

POPULATION

VALUE

MISSTATEMENT

PERCENTAGE

ASSUMPTION

UPPER PRECISION

LIMIT PORTION

MISSTATE-MENT

BOUND

0 1,200,000 1.0 .030 36,000

1 1,200,000 .671 .017 13,688

2 1,200,000 .07 .015 1,260

3 1,200,000 .016 .014 269

4 1,200,000 .0002 .014 3

UNDER-STATEMENTS

RECORDED

POPULATION

VALUE

MISSTATEMENT

PERCENTAGE

ASSUMPTION

UPPER PRECISION

LIMIT PORTION

MISSTATE-MENT

BOUND

0 1,200,000 1.0 .030 36,000

1 1,200,000 .03 .017 612

Totals .090 51,220

Totals .047 36,612

Page 24: Chapter 17 Audit Sampling for Tests of Details of Balances

Monetary Unit Sampling (MUS) Step 6: Calculate point estimate for

overstatements and understatements.

Sum of Unit Misstatement Assumptions

Sample SizeX

Recorded Population

Value=

Point Estimate

Overstatement Point Estimate:

( .671 +.07 +.016 + .0002 )

100X 1,200,000 = 9,086

Understatement Point Estimate:

.03

100X 1,200,000 = 360

Page 25: Chapter 17 Audit Sampling for Tests of Details of Balances

Initial understatement bound 36,612Less overstatement point estimate (9,086)Adjusted understatement bound 27,526

Monetary Unit Sampling (MUS) Step 7: Calculate adjusted upper and lower

misstatement bounds.

Most MUS users believe that the approach is overly conservative when there are offsetting amounts. The

adjustment of bounds for offsetting amounts is made by reducing each bound by the opposite point estimate.

Initial overstatement bound 51,220Less understatement point estimate (360)Adjusted overstatement bound 50,860

Page 26: Chapter 17 Audit Sampling for Tests of Details of Balances

Reject

The MUS Decision Rule

If both the lower misstatement bound (LMB) and upper misstatement bound (UMB) fall between the understatement and overstatement tolerable misstatement amounts, accept the conclusions that the book value is not misstated by a

material amount. Otherwise, conclude that the book value is misstated by a material amount.

Tolerable misstatement

($40,000)

Tolerable misstatement

$40,000

($27,526)

LMB

($50,860)

UMB

Page 27: Chapter 17 Audit Sampling for Tests of Details of Balances

III. Alternatives When a Population is Rejected

A. Take No Action Until Tests of Other Audit Areas are Completed

B. Perform Expanded Audit Tests in Specific Areas

C. Increase the Sample Size

D. Adjust the Account Balance

E. Request the Client to Correct the Population

F. Refuse to Give an Unqualified Opinion

Page 28: Chapter 17 Audit Sampling for Tests of Details of Balances

A. Take No Action Until Tests of Other Audit Areas are Completed

Offsetting misstatements in other parts of the audit may make a

balance acceptable.

Page 29: Chapter 17 Audit Sampling for Tests of Details of Balances

B. Perform Expanded Audit Tests in Specific Areas

After a problem area is corrected, the remaining

misstatements may be within an acceptable

range. May be effective when errors are of a

specific type.

Page 30: Chapter 17 Audit Sampling for Tests of Details of Balances

C. Increase the Sample Size

When the auditor increases sample size, sampling error is

reduced if the rate of misstatements in the expanded sample, their dollar amount,

and their direction are similar to those in the original sample.

This could satisfy the auditor’s tolerable

misstatement requirements. May be helpful when initial

sample is not representative of the population.

Page 31: Chapter 17 Audit Sampling for Tests of Details of Balances

D. 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.

Even when the client adjusts the book value the auditor

must consider whether sampling error to exceed tolerable misstatement.

Appropriate when client balance is misstated.

Page 32: Chapter 17 Audit Sampling for Tests of Details of Balances

E. Request the Client to Correct the Population

When the client’s records are filled with significant

misstatements, the auditor may request the

client to correct the population before an

effective audit process can begin.

Page 33: Chapter 17 Audit Sampling for Tests of Details of Balances

F. Refuse to Give an Unqualified Opinion

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.

The audit process

must have some teeth

in it!

Page 34: Chapter 17 Audit Sampling for Tests of Details of Balances

IV. ARACR and ARIA

A lower control risk requires a lower acceptable risk of

assessing control risk too low (ARACR). This requires a

larger sample size for tests of controls.

If tested controls are effective, the auditor can increase

acceptable risk of incorrect acceptance (ARIA). This

means that the auditor can use smaller sample sizes for tests

of details of balances.

Page 35: Chapter 17 Audit Sampling for Tests of Details of Balances

Summary

Steps of Audit Sampling for Tests of Details of Balances

The Statistical Technique of Monetary Unit Sampling

The Rejection of a PopulationARACR and ARIA