Audit Sampling Peacock

AUDIT SAMPLING &
EVIDENCE
Victor Peacock and Joseph wachira
2010
Definition
 Audit Sampling is 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.
11/02/21 Internal Auditor Training Program 2

Purpose & Requirements of
Sampling
 The use of sampling techniques is appropriate if any
of the following conditions exist:
 The client’s records are so detailed, complex or
voluminous that an audit of all detailed records would
be unreasonable or impractical.
 The client’s records are inadequate or insufficient, so
that a competent audit for the period in question is not
otherwise possible.

Sampling
 The cost of an audit of all detailed
records to the client or to the auditor will
be unreasonable in relation to the benefits
derived, and sampling procedures will
produce a reasonable result.

CASE STUDY:Section 111.0042 of the tax code
of USA states that two ways that clients can
challenge samples:
1) If a client can demonstrate that a transaction
in a sample period is not representative of the
client’s business operations, the transaction
shall be eliminated from the sample and be
separately assessed in the audit.

 2) If the client demonstrates that any sampling
method used by the auditor was not in
accordance with generally recognized
sampling techniques, the audit will be
dismissed as to that portion of the audit
established by projection based upon the
sampling method, and a new audit may be
performed.
Sampling
 Thus, it is imperative that the auditor designs the
sample to reflect as nearly as possible the normal
business operations and follows generally recognized
sampling techniques.
 Also imperative is that sampling should not be
utilized when records are inadequate to reflect
accurately the business operations of the client.

Sampling
 If a client can demonstrate that a transaction in a
sample period is not representative of the client’s
business operations, the transaction shall be
eliminated from the sample and be separately
assessed in the audit.
 Without good internal controls and records, the
auditor should determine the best information
available and base the audit report on that information
(i.e., estimate).

Professional Standards
 The Auditor uses sampling to increase the
overall coverage and efficiency of the audit
program.
 The use of sampling has been authorized by
statute. The sampling procedures used in
the audit of any individual client must be in
accordance with generally recognized
sampling techniques.

Professional Standards
 ISAS and Audit Sampling issued by the American
Institute of Certified Public Accountants (AICPA)
are the primary sources of guidance.
 Generally accepted auditing standards require that
any actions taken or any audit procedure applied as a
result of sampling be based on sufficient competent
evidential matter.

Generally Accepted Auditing
Standards
 General Standards:
 The examination is to be performed by a person or persons
having adequate technical training and proficiency as an
auditor.
 In all matters relating to the assignment, an independence
in mental attitude is to be maintained by the auditor or
auditors.
 Due professional care is to be exercised in the performance
of the examination and the preparation of the report.

Standards
 Standards of Field Work:
 The work is to be adequately planned and
assistants, if any, are to be properly supervised.
 There is to be a proper study and evaluation of the
existing internal control as a basis for reliance
thereon and for determination of the resultant
extent of the tests to which auditing procedures
are to be restricted.

Standards
 Standards of Field Work:
 Sufficient competent evidential matter is to be
obtained through inspection, observation,
inquiries, and confirmations to afford a
reasonable basis for an opinion regarding the
financial statements under examination.

Generally Recognized Sampling
Techniques
 This section provides guidance for planning,
performing, and evaluating audit samples.
 The auditor often is aware of account balances and
transactions that may be more likely to contain
misstatements. He considers this knowledge in
planning his procedures, including audit sampling.

Techniques
 The auditor usually will have no special
knowledge about other account balances and
transactions that, in his judgment, will need to
be tested to fulfill his audit objectives. Audit
sampling is especially useful in these cases.

Techniques
 There are two general approaches to audit
sampling: non-statistical and statistical.
 Both approaches require that the auditor
use professional judgment in planning,
performing, and evaluating a sample

Techniques
 Auditors are to relate the evidential matter
produced by the sample to other evidential
matter when forming a conclusion about the
related account balance or class of
transactions.

Techniques
 The guidance in this section applies equally
to non-statistical and statistical sampling.
 Either approach to audit sampling, when
properly applied, can provide sufficient
evidential matter.

Techniques
 The sufficiency of evidential matter is related
to the design and size of an audit sample,
among other factors.
 The size of a sample necessary to provide
sufficient evidential matter depends on both
the objectives and the efficiency of the sample

Techniques
 For a given objective, the efficiency of the sample
relates to its design; one sample is more efficient
than another if it can achieve the same objectives
with a smaller sample size.
 In general, careful design can produce more
efficient samples.

Techniques
 Evaluating the competence of evidential matter is
solely a matter of auditing judgment and is not
determined by the design and evaluation of an
audit sample.
 In a strict sense, the sample evaluation relates only
to the likelihood that existing monetary
misstatements or deviations from prescribed
internal control structure policies or procedures
are proportionately included in the sample, not to
the auditor's treatment of such items.

Techniques
 Thus, the choice of non-statistical or statistical
sampling does not directly affect the auditor's
decisions about the auditing procedures to be
applied, the competence of the evidential matter
obtained with respect to individual items in the
sample, or the actions that might be taken in light
of the nature and cause of particular
misstatements.

Techniques
 Some degree of uncertainty is implicit in the
concept of "a reasonable basis for an
opinion" referred to in the third standard of
field work.

Techniques
 The justification for accepting some uncertainty
arises from the relationship between such factors as
the cost and time required to examine all of the data
and the adverse consequences of possible erroneous
decisions based on the conclusions resulting from
examining only a sample of the data...

Techniques
 The uncertainty inherent in applying audit
procedures is referred to as audit risk.
 Audit risk consists of (a) the risk (consisting of
inherent risk and control risk) that the balance
or class and related assertions contain
misstatements...and

Techniques
 (b) the risk (detection risk) that the auditor
will not detect such misstatement...
 Audit risk includes both uncertainties due to
factors other than sampling. These aspects of
audit risk are sampling risk and nonsampling
risk, respectively.

Techniques
 Sampling risk arises from the possibility
that, when, ... restricted to a sample, the
auditor's conclusions may be different from
the conclusions he would reach if the test
were applied in the same way to all items in
the account balance or class of transactions...

Techniques
 Non-sampling risk includes all aspects of audit
risk that are not due to sampling ...
 Non-sampling risk can be reduced to a
negligible level through such factors as
adequate planning and supervision.

Statistical Versus Non-Statistical
Sampling
 According to the AICPA Audit Sampling
2009 edition,
 cost-benefit is the determining factor of using
either a statistical or non-statistical sampling
approach
 ISAS states that either approach is valid and
involves sampling risk.

Sampling
 Statistical sampling requires the use of
statistical formulas to determine sample size
and directly measure sampling risk whereas
non-statistical sampling does not have these
requirements.

Sampling
 Usually, results for statistical sampling are
evaluated in terms of probabilities, which are
defined as precision and confidence levels.

Overview of the Sampling
Process
 Gather information to plan the sample
 Define the population and stratify into various
sub-populations as needed
 Compile base amounts
 Establish correspondence

Process
 Choose the type of sampling unit and
determine the sample size
 Select the sample units
 Perform an initial evaluation
 Perform a preliminary sample (short-test)

Process
 Evaluate the short-test and make a stop-or-go
decision
 Complete the sample examination
 Project the results to the population
 Evaluate the sample results

Process
 Many of the steps listed above are not
mutually exclusive. In fact, the first four are
interdependent. Proper planning and decision-
making in each of the above steps by the
auditor will greatly affect the desired goals.

Gather Information to Plan the Sample
 In order to successfully complete the steps

in the sampling process, relevant
information about the client should be
obtained. The auditor should understand
the normal conditions of the client’s
business and plan the sample accordingly.

 a number of questions regarding accounting,

reporting, and record storage systems.
 The answers to certain questions will affect
sampling in virtually every case.
 Knowledge of these items should improve the
quality of decision-making.

 This first step of gathering information is

extremely important.
 Most information and answers to many of the
questions above will be obtained from the
audit questionnaire, contacting the client, and
performing the entrance conference.

 The more information that can be obtained

upfront by the auditor will generally provide
the design of a more efficient and effective
sample.
 And, remember, without good internal controls
or records, sampling should not be utilized.

Define the Population and Stratify into
Various Sub-Populations as Needed
 Numerous criteria exist to identify appropriate
subpopulations (homogeneous groups) in a
manner that will increase the accuracy of a
sample.

 Some examples include the following:
 Type of customer
 Reseller vs. end user
 Cash vs. credit
 Manufacturer
 Contractor
 Farmer

 General ledger accounts
 Expenses vs. assets
 Inventory vs. expense
 Accounting treatment
 Cash vs. accrual
 Taxable vs. non-Taxable
 Capitalized vs. expensed
 Tax accrued vs. tax paid
 Journal entry vs. detailed entry
 Computerized entry vs. manual entry

 While it is important to properly identify
subpopulations, it may or may not be feasible to
sample them separately.
 Consideration must be given to the accounting system
and record storage and whether or not population
bases and source documents can be obtained in an
efficient manner for each subpopulation.

 In deciding how to audit these subpopulations two
main options exist:
 Generate separate error schedules and bases for
each subpopulation.
 Include enough randomly selected units to ensure
that each subpopulation is represented
proportionately in one sample.

 Example 1
An equipment retailer has four revenue
categories: sales, rentals, parts, and repair.
Ideally each category should be audited
separately because it represents a separate
activity. Also, there are pricing and dollar
value differences.

 Example 1
If the client has separate revenue accounts
and separate invoice sequences for each
category or computerized records, the
population may be easily stratified upfront

 Example 1
If the client has one invoice sequence for all
categories and no computerized records, it
may be more efficient to select one sample
and ensure that all categories are represented
proportionately.

Compile Base Amounts
 In addition to considering how to define or stratify

the population, the auditor must determine the most
appropriate population base.
 ALL potential population base information must be
available to allow for projection alternatives.
 Having obtained all available sources of information,
the auditor will have choices from which to select the
most appropriate base.

Establish Correspondence
 Correspondence must be established between

the sampling units and the items to be
examined.
 Correspondence can be naturally formed or
auditor-made. However, auditors are
encouraged to use natural correspondence.

 Natural Correspondence
 Invoice numbers
 Voucher numbers
 Check numbers
 Purchase order numbers
 Batch numbers

 Auditor-made correspondence
 The auditor independently assigns a numbering
sequence to the transactions. For example, the auditor
could manually number the "items of interest" in a
detailed general ledger or number the pages in a
journal.

Choose the Type of Sampling Unit and
Determine the Sample Size
 Audit Division has adopted the following hierarchy
regarding the type and size of sampling units.
 Transaction is the preferred sampling unit because
items will be more widely dispersed throughout the
population, and, consequently, more representative.
 Transaction sampling is recommended when fewer
than 1,000 items must be reviewed.

 A cluster is a group of transactions and is
recommended when 1,000 or more transactions must
be examined.
 Cluster sampling is generally more representative
than time period sampling because the clusters are
more dispersed throughout the population and a
uniform number of units are reviewed.

 Time period sample units should only be considered
after transactions and clusters have been eliminated
as options. When time periods are selected, care
should be taken to ensure that they are adequately
dispersed throughout the audit period.
 All transactions occurring in the time periods selected
must be examined.

 The type of sampling unit selected will determine the
recommended minimum sample size.
 The samples sizes appearing in the chart are merely
starting points. Each audit situation is different and
may require the selection of more items than the
suggested minimum.

Select the Sample Units
 The three methods most frequently used for

sample selection are random, systematic, and
judgment.

Random Selection
 Random selection should be used whenever possible
because it allows each item in the population an equal
chance of being selected.
 This selection technique is the most defensible
because it virtually eliminates personal bias or a
pattern in the population from distorting the sample.

Random Selection
 The auditor should remember that it is possible for a
sample to be randomly selected but not be
representative.
 Representativeness should always take precedence
over randomness due to the statutory requirement that
the sample must reflect as nearly as possible the
normal conditions under which the business was
operated during the audit period.

Systematic Selection
 Systematic selection might be used in
situations where it is not feasible to use
random selection because correspondence
cannot be established in an efficient manner
(e.g., invoices are not in any specific numeric
order).

 For a simple systematic selection, the total
number of transactions in the population
should be known or estimated.
 The interval between individual transactions
must be calculated:
 Transactions in population / Minimum
sample size = Interval

 The starting point should always be randomly selected from
within the interval.
 The number "1" should be entered as the beginning invoice
number.
 The interval size should be entered as the ending invoice
number. One number should be selected. The interval is then
added to the starting point for the second transaction to
examine.
 The interval is successively added until the sample is
complete.

 The auditor should make sure that the
systematic selection does not coincide with
some pattern in the population (e.g., payroll
checks are always made on Fridays).
 Multiple random starts can be used to avoid
this.

MP Example- Tax Effect
 Population(M): Expenses R1000,000

Planning materiality R100,000 Eff.tax rate 40%
 Desired level of Assurance intermediate (R= 2)
 MP(No tax effect) R80,000 80% OF PM
 Number of selections: 25 M/J where J = MP/R
 Pretax planning materiality: R166,667 100,000/(1-0.4)
 MP(with tax effect) R133,333 80% of pretax PM
 No. of selections: 15 M/J where J= MP/R

 Example:
 6,400 transactions in the population
500 items is minimum sample size
 = 12.8 ~ 13 as interval
 4 random starts: 13 X 4 = 52 Random
starts selected between 1 and 52: 1, 14, 28,
and 41

Judgment Selection
 Selection by judgment alone should be
avoided. Because the auditor could build in
bias, it is very difficult to defend. However, in
limited situations, this method may be the only
option (e.g., incomplete records).
 The decision to use judgment selection should
be made only with the understanding and
approval of the group supervisor.

Perform an Initial Evaluation
 If possible, the auditor should attempt to

evaluate all of the selected sample invoices in
the short-test BEFORE pulling and examining
source documents

 If sales journals, purchase journals, or some

other type of document is available listing
individual transactions, the auditor should be
able to quickly calculate the sample and
population base averages and the variance.
 The variance is one indicator as to whether the
sample selected is representative of the
population.

 $ Amount of Sample Base

Sample Base Average = -----------------------
 # of Sample Units
 $ Amount of Population Base
 Population Base Average = ----------------------------
 # of Units in Population

Perform a Preliminary Sample
(Short-Test)
 The preliminary sample, commonly referred to
as the short-test, consists of reviewing the first
25% of the invoices selected from the
minimum sample size.
 The items should be reviewed in the order
selected so that items are reviewed throughout
the audit period.

Evaluate the Short-Test and Make a
Stop-Or-Go Decision
 Efficiency dictates that excessive hours not be
spent in an unproductive manner.
 If no errors are found in the short-test, the
sample examination should be abandoned.
 However, before deciding whether to abandon
the sample, the auditor must be reasonably
sure that the short-test results are
representative of the population.
Evaluate the Short-Test and Make a
Stop-Or-Go Decision
 Until the auditor evaluates the short-test by
comparing the results to the population, there
is no way of knowing whether the sample was
representative and, consequently, whether
finding no errors was a valid conclusion.

Transaction Sampling
 Transaction sampling is recommended when
the computed minimum sample size is less
than 1,000 transactions.

Step 1 - Determine the minimum
sample size
 The following calculation determines the
minimum sample size for reviewing the
recommended 250 items of interest:
 250 Items of Interest
 % of items of interest in population
 = Minimum Sample Size

Step 1 - Determine the minimum
sample size
 "250" is not a magic number. It is merely a
starting point. A sample with less than 250
items of interest could be valid also. The main
goal is that the sample is representative of the
population.

(percentage of items of interest in the
population)
 $338,000
 $1,058,000
 = 31.95%
 250
 31.95%
 = 782.47 rounded to 783 for minimum sample size
 783 transactions is the minimum sample size to
examine 250 items of interest.

AUDIT EVIDENCE
 Sources of Evidence
 inspection,
 observation,
 inquiries, and
 confirmations
 Computation
 Analytical procedures
 Audit Automation tools (CAAT)
AUDIT EVIDENCE
 to afford a reasonable basis for an opinion
regarding the financial statements under
examination.

INSPECTION
 Inspection of Assets – assets that are recorded
in the accounting records confirms existence,
valuation and completeness.
 Inspection of documentation- this gives
evidence of ownership, occurrence of
transaction, rights, obligation and
authorization.

observation
 This involves watching a procedure being
performed
 It confirms that procedure took place.
 Auditor must be careful to ensure his presence
does not affect result.

Enquiries
 Seeking information from client staff or
external sources.
 Strength of evidence depends on knowledge
and integrity of source of information.

Confirmation
 Confirmation is the name given to a specific
form of inquiry that is particularly widely
used. It involves obtaining written
confirmation from a third party, typically,
although not exclusively, in relation to an
account balance in which the third party has an
interest.

Situations for using confirmations
 Confirmations are best used where there is a
knowledgeable party, independent of the entity
and where alternative reliable evidence is not
readily available.
 The most knowledgeable parties are those in a
commercial relationship with the entity
holding reciprocal information as to entity
balances.

Situations for using confirmations
 These include debtors, creditors, banks, lenders,
borrowers and custodians of entity assets such
as stocks and securities.
 It is in their own interest for such parties to
maintain reliable records of their relationship
with the entity.
 It is also in their interest to respond to an
auditor’s request for confirmation to ensure that
any differences are identified and resolved.

Assertions
 Where confirmations relate to reciprocal
balances (such as debtors, creditors, banks,
borrowers and lenders), they provide
persuasive evidence as to rights and
obligations.
 Confirmations also provide strong evidence of
ownership where the other party is acting as
custodian

Assertions
 However, because of human nature,
confirmations may not provide such
persuasive evidence of accuracy where the
entity’s balance is in error in the other party’s
favour, e.g. an understatement of debtors or an
overstatement of creditors.
 Neither do confirmations provide reliable
evidence of the valuation of assets

Form of request
 As a general rule, the request must be
presented in such a form that facilitates a
response by the other party.
 This can be achieved by using a standard form
with space for the response and enclosing a
return addressed envelope.

Form of request
 However, there is sometimes a conflict
between facilitating a response and the
reliability of that response.
 More likely is a general reluctance to confirm
through misunderstanding the purpose of the
request.

Form of request
 Debtors may misinterpret the confirmation as a
demand for payment. Other parties may fear
that confirmation might be binding if they
should subsequently discover an error in their
own records.
 It is usually customary to draft the wording of
the confirmation to allay such fears when
dealing with parties not accustomed to
receiving such requests.

Computation
 Checking arithmetic of client’s records.
 Adding up ledgers.
 Re-computing individual items in a control
account.

Analytical Procedures
 This consist of comparing items, for example,
current year financial information with prior
year financial information, and
 analyzing predictable relationships e.g. the
relationship between receivables and credit
sales.

PRELIMINARY ANALYTICAL
PROCEDURES
Purpose;
 Identify indications of specific risk
 Understand the financial statements
 Understand the client’s business
 Assess planning materiality
 Evaluate going concern

PRELIMINARY ANALYTICAL
REVIEW: STEPS
 Obtain financial and non-financial information
 Compare the information
 Analyze the information

DOCUMENTATION
 Ratios and trends calculated
 Summary of analysis of results of procedures:
 Identification of unexpected results
 Key discussions with management
 Explanations for unexpected differences
 Specific risks identified

CAAT
 CAAT is all those auditing procedures and
techniques which make use of the computer or
the computer programs or the computer data as
a means of obtaining audit evidence.

USES OF CAAT
 To ascertain the correctness of program
processing procedures
 To ascertain the existence and
effectiveness of program control
 To examine transactions and balances on
computer files and select exceptional
items for further audit testing.e.g to
review the stock files and select slow
moving stock items for further audit
examination.
 To stratify transactions and balances on
computer files for audit purposes.
USES OF CAAT
 For example to age debtors balances or
stratify debtors balances into various
brackets e.g balance below R5000,
above R10000.00
 To select transactions and balances on a
random basis from the computer files for
audit purposes.

USES OF CAAT
 To match the content of two computer
files in order to identify unmatched
items for audit purposes. E.g. to compare
the contents of Goods delivery note file
with invoice file so as to identify goods
delivered but not yet invoiced.
 To copy the content of computer files for
audit testing

USES OF CAAT cont..
 To copy the content of a computer file
for audit purpose. E.g. to download the
clients file for testing in a different
computer installation.
 To print/display on screen transactions
and balances of computer files for audit
purposes.
 To sort the content of the clients file into
an order appropriate for audit purpose.
 To perform calculation including
analytical review on transactions and
balances contained in the clients files.

Audit Sampling Peacock

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AUDIT SAMPLING &

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 In order to successfully complete the steps

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 a number of questions regarding accounting,

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 This first step of gathering information is

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 The more information that can be obtained

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 In addition to considering how to define or stratify

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 Correspondence must be established between

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 The three methods most frequently used for

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