The University of Sydney Business School

ACCT3014 - Auditing and Assurance

Semester 1, 2013 Eric Clubb Lecture Topic Week 11

Substantive Tests:
Audit Sampling Using Analytical Procedures as a Substantive Test Other Substantive tests

Business School Auditing and Assurance

Definition and features

Audit sampling: the application of an audit procedure to less than 100% of the items within a population to obtain audit evidence about particular characteristics of the population.
Audit sampling is important because it provides information on:
- How many items to examine - Which items to select - How sample results are evaluated and extrapolated to the population in order to tell us something about the population (e.g. level of misstatement).

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Non-sampling and sampling risk defined

Sampling risk: the probability that the auditor has reached an incorrect conclusion because audit sampling was used rather than 100% examination (ASA/ISA 530.05). Non-sampling risk: arises from factors, other than sample size, that cause an auditor to reach an incorrect conclusion, such as the possibility that:
The auditor will fail to recognise misstatements included in examined items The auditor applies a procedure that is not effective in achieving a specific objective.

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Various means of gathering audit evidence

100% examination: this is not a sampling method. Selecting specific items: e.g. high value or high risk this is not a sampling method. Items selected will not necessarily be representative of the population. Audit sampling, reviewed in this lecture

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Statistical and non-sampling sampling

Statistical sampling: an approach to sampling that has the following characteristics:
Random sample selection Use of probability theory to evaluate sample results Major advantage is defensibility, thorough quantification of sampling risk Refer ASA/ISA 530.5(g)

Non-statistical sampling: sampling approaches that do not have all the characteristics of statistical sampling.
Major advantage is greater application of audit experience or judgement The basic principles and essential procedures identified in ASA/ISA 530 apply equally to both statistical and non-statistical sampling.

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Basic requirements of all audit samples

Whenever an auditor uses audit sampling (statistical
or non-statistical) the following requirements apply:
- Planning and design: - The auditor considers the relationship of the sample to the relevant specific audit objective or control objective and considers certain other factors that should influence sample size. - Selection: - Sample items are selected in such a way that the sample can be expected to be representative of the population. - The key here is that any item in the population has an equal probability of being selected for audit testing. - Performing the procedure and evaluating results:

- The auditor performs the required audit procedures on the items selected, projects the results of the audit procedures undertaken on the sample to the population and considers sampling risk. 11-6

Planning and designing the sample

Auditor must consider:

- Objectives of the audit test (usually related to an audit assertion) - Population from which to sample - Possible use of stratification - Definition of the sampling unit.

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Defining the audit objective and population

Once the audit objective is specified, such as reliance on controls or misstatement of account balance, the auditor must consider what conditions would constitute an error. The auditor must ensure that the population from which the sample is to be selected is complete and appropriate to the audit objective.

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Stratification
Stratification:
- occurs when the auditor divides the population into a series of subpopulations, each of which has an identifying characteristic, such as dollar value (ASA 530/ISA 530).
- We will use accounts receivable as an example

Can assist with audit efficiency as it allows the auditor to reduce the sample size by reducing variability without increasing the sampling risk. Can direct auditors attention to areas of audit interest, especially risky or material items.

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Determining sample size

Sample size is affected by the degree of sampling risk the auditor is willing to accept. Auditor's major consideration in determining sample size is whether, given expected results from examining sample, sampling risk will be reduced to an acceptably low level (ASA/ISA 530.07).

If errors are found in the sample and the quantity exceeds the auditors expectations, then more of the population will need to be tested.

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Selecting the sample

To draw conclusions about population or stratum, the sample needs to be typical of characteristics of population or stratum. Sample needs to be selected without bias so that all sampling units in the population or stratum have a chance of selection. Common sampling techniques are:
Random selection random number generation Systematic selection Haphazard selection select without conscious bias.

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Random selection: random number generation: an example

RANDOM.ORG - Sequence Generator

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Steps in systematic selection

For example, suppose the sample size is 20 and the number of items in the population is 10 000:
Step 1: Calculate the sample interval:

No. of items in population 10 000 500 Sample size 20

Step 2: Give every item in population chance of selection by choosing a random number (random start) within range of 1 and sampling interval (in this example, 500), e.g. 217. Continue to add sampling interval to random start, and identify items to be sampled, e.g. item nos. 217, 717, 1217. . . 9217, 9717.

Step 3:

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Biases from haphazard sampling

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Unacceptable sample selection methods

Block selection: the auditor selects all items of a specified type processed on a particular day, week or month.
- This is not objectively testing the population and is only proving that for the limited time period that data was satisfactory.

Judgmental selection (based on sample item characteristics): the auditor selects large or unusual items from the population or uses some other judgmental criterion for selection.
- This method has a conscious bias and cannot be considered representative.

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Evaluating sample results

To evaluate sample results, the auditor determines the level of misstatement found in sample and directly projects this misstatement to relevant population. For example: sample 20%, find misstatement of $10 000. Therefore projected misstatement = $50 000 ($10 000/20%) Projected misstatement is then compared with tolerable misstatement for the audit procedure to determine if characteristic of interest can be accepted or rejected. This links to the concept of materiality. Auditor should consider both the nature and cause of any misstatement or deviations identified.

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Sampling for tests of controls, attribute sampling

Audit sampling is useful for tests of controls, especially involving inspection of source documentation for specific attributes such as evidence of authorisation (attribute sampling).

Involves examination of documents for particular attributes related to controls (e.g. authorisation).
Results of attribute sampling can be used to support or refute an initial assessment of control risk.

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Analytical Procedures as a Substantive Test

Key opening point:
- The auditor can only use analytical procedures to undertake substantive testing if the auditor has first proved the Internal controls are working effectively: - Why? - If the internal controls are not effective then there is a high probability that the data to be tested is corrupt. If this is the case then the result of the analytical test can lead to an incorrect audit assessment of the key account.

A working example:
- The key accounts - Sales Commission expense, (accuracy assertion), and

- Sales Commission Payable, (valuation assertion)

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Month

Commissionable Non Total Sales Sales : (5% to Commissionable 8%) Sales

100,000 150,000 120,000 90,000 140,000 190,000 250,000 150,000 180,000 200,000 130,000 290,000 350,000 300,000 300,000 290,000 270,000 480,000

July August September October November December

Avg. Rate = 6.5%

Total sales subject to commission = 790,000 X 6.5 % = $51,350 (estimated value of expense account) Value in Expense account = $ 53,373 Audit test proved satisfactory
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Sales Commission Payable

Commissionable sales for June 2014 = 185,000 Avg commission rate = 6.5% Expected Commission Payable = $12,025 Liability in Balance Sheet = $12,736 Test proved to be satisfactory. Note that the audit would need to have satisfied him / herself, that the normal commission payable was for a 1 month period. Other audit tests would be adopted to do this

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Designing other Substantive Tests

Must have identified the Key account. Must have decided as to whether the audit test is a test of a balance or a test of transaction. Must have identified the particular assertion to be examined Must be practical and the data available. Example 1
- Auditor wishes to test that sales at a supermarket checkout occurred (transaction) 1. Select a sample of sales from the population (audit sampling) 2. Agree the total sale value to the cash register log, Is it Cash, EFTPOS, Credit card? 3. Agree sale value to banking reports, and agree control total for register for the day to sales for the day. Note that trying to do a positive confirmation to customer would be impractical !
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Designing other Substantive Tests

Example 2 Test of Balance The key Account is Short Term Investments in listed Public securities, and the assertion is valuation 1. Select a Sample (audit sampling) 2. Note: Name, Total No. of Shares, Cost Value Total, Market Value Total and Balance date (per unit $ market value), a GAS report creates this for you.

3. Agree the unit $ to ASX reports or Web site. 4. Re-perform Calculation of No. X $ 5. Ensure value $ in final balance is the lower of the cost or market value

6. Now use exception report GAS to print out the same details where Market value $ (total )< Cost Value (total)
7. Select a sample of these balances and check that the lower value is the $ used for the balance sheet
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Designing other Substantive Tests

Important to note the auditor will have already designed and completed substantive tests to validate the existence of the shares and the number of shares held at balance date. The auditor will then need to document the audit tests to validate the Rights and Obligations assertion and the presentation / classification assertion. With any audit procedure and regardless of the timing and focus of the audit procedure, there is one golden rule: If it is not documented, then the auditor can not prove the procedure was carried out. Think about the legal liability of auditors.

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