Substantive Test Sampling

CAS 500 – Audit evidence

CAS 315 - Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment
CAS 450 - Evaluation of Misstatements Identified during the Audit
CAS 320 – Materiality in planning and performing an audit
CAS 530 – Audit sampling

Sampling 1
 Substantive Procedures for Auditing
Account Balances

Substantive tests of details auditing is the performance of

procedures to obtain direct evidence about the dollar
amounts and disclosures in the financial statements.

– Substantive procedures include:

Sampling 2
 The Audit Risk Model

Audit Risk = Inherent Risk x Control Risk x Detection Risk

Audit risk

Inherent risk

Control Risk

Detection risk

Sampling 3
 Risk Model Expansion

• Detection risk (DR) is actually a combination of two

risks:
– Analytical procedures risk (APR)

– Risk of incorrect acceptance (RIA)

Sampling 4
 Risk Model Expansion

Expanded risk model:

AR = IR × CR × APR × RIA
– Only risk of incorrect acceptance can be controlled by the auditor.

– Solve the risk model for RIA:

AR
RIA =
IR x CR x APR
– with AR, IR, and APR held constant RIA varies inversely with CR or control
risk.

Sampling 5
 More About Sampling Risk

• In sampling for substantive procedures, the auditor

faces two sampling risks.
– The risk of incorrect acceptance (RIA)
• (effectiveness risk, beta risk)

– The risk of incorrect rejection (RIR)

• (efficiency risk, alpha risk)

Sampling 6
• Which is considered the more important of the two.
– Incorrect acceptance leads to audit failure.

– Incorrect rejection leads to additional audit procedures to

determine actual misstatement.

Sampling 7
 Sampling Steps for an Account Balance Audit

1. Specify the audit objectives.

2. Define the population.
3. Choose an audit sampling method.
4. Determine the sample size.
5. Select the sample.
6. Perform the substantive-purpose procedures.
7. Evaluate the evidence.

Sampling 8
 Plan the Procedures – involves the first
three steps

The first three steps represent the problem-recognition

phase.

So what is being considered in the first three steps?

Remember a key to the audit approach:

Management’s Assertions lead to Audit Objectives lead to Audit Procedures

Sampling 9
 1. Specify the Audit Objectives

Objective is to decide whether the client’s assertions

about existence, rights, and valuation are materially
accurate.

Sampling 10
 2. Define the Population

Definition of population must match objectives.

Examine individually significant items.

Apply stratification to the remaining population.

Sampling 11
 3. Choose an Audit Sampling Method

Auditor will decide whether to use statistical or

judgmental sampling methods.

Steps 4 to 6 represent the evidence-collection phase.

Sample size determination requires consideration of several
factors. It is important to get the sample size correct, and to
avoid over-auditing or under-auditing.

Sampling 12
 4. Determine the Sample Size

The sample size is based on the following:

risk of incorrect acceptance (RIA),
risk of incorrect rejection (RIR),
material misstatement amount,
expected dollar misstatement in the population,
variability within the population, and
size of the population.

Sampling 13
 5. Select the sample

Random or non-random methods, as in sample selection

for test of controls.

Sampling 14
 6. Perform the substantive purpose
procedures.

• Substantive-purpose audit program produces evidence

to support or refute management assertions.

• Remember the assertions.

Sampling 15
 7. Evaluate the Evidence

Evaluate the evidence:

Determine amount of known misstatement.

Determine the likely misstatement.

Project the misstatement found in the sample to the population.

Sampling 16
 7. Evaluate the Evidence

Consider sampling risks:

Auditor uses professional judgment and experience to consider these risks.

Qualitative evaluation:
Follow up on all differences uncovered to determine
1.any misunderstanding of GAAP,
2.simple mistakes,
3.intentional irregularities, or
4.management override of controls.

Sampling 17
 7. Evaluate the Evidence

Evaluate the misstatement:

Known misstatement and likely misstatement are combined
and compared to materiality.
Sample risk gives rise to “possible misstatements.”

Sampling 18
 Timing of Substantive Procedures

Account balances can, in part, be audited at an interim

date.
Auditor will extend the interim date audit conclusions to
balance sheet date.
Audit work is performed at interim dates:

Poor controls, or significant business risk may preclude

performing procedures at interim.

Sampling 19
Monetary Unit Sampling - How Does it Work?

Auditors use monetary unit sampling, also called probability-proportional-to-size or dollar-unit sampling, to determine the accuracy of financial
accounts. With monetary unit sampling, each dollar in a transaction is a separate sampling unit. A transaction for $40, for example, contains 40
sampling units. Auditors usually use monetary unit sampling to sample and test accounts receivable.

Here’s an example of how monetary unit sampling works The audit client’s accounts receivable book value is $300,000, and the sample size is
set at 96 records.

Figure the sampling interval by dividing book value by sample size

(300,000/96) = 3125

Arrange the client’s accounts receivable in an ordered list using some sort of ordering sequence.
For example, you can arrange them alphabetically by customer name or numerically by customer number.

Pick a random number between 1 and 3,125.

For this method to work correctly, the random number has to be less than the sampling interval and greater than the smallest
sampling unit. Auditors usually use a random-number-generator computer program to pick the random number. The sampling unit
and sampling interval limits are programmed into the software before the task is run. In this case, say the software selects the
random number 556.

Monetary Unit Sampling Table

Customer Name Customer Balance Cumulative Balance Sampling Item

ABC Electric $435 $435

Best Friend Cat Care $785 $1,220 (1) $556

Brandy’s Grill $1,510 $2,730

Buddy’s Gas Station $5,000 $7,730 (2) $556 + $3,125 = $3,681 Sampling 20
First, pick the records to test: Take the alphabetically ordered list shown in the Customer Name column, which lists every customer
balance by dollar amount, and count each dollar until getting to $556. The random number generator gives the number 556 in Step 3 in the
previous slide. The cumulative dollar amount for ABC Electric is under $556.

That shows that the first sampling item is Best Friend Cat Care, which at a cumulative total of $1,220 is the first customer in the list with a
cumulative balance over $556. Best Friend Cat Care becomes the first customer in the sample.

Secondly, select the next invoice to sample: Add the sampling interval of $3,125 to the random number of $556. This equals $3,681,
which is the next sampled item dollar amount. Brandy’s Grill at $2,730 cumulatively is under $3,681, thus Brandy’s is skipped. Buddy’s
Gas Station has the 3,681st dollar.

To pick the next sampling item: Add the sampling interval of $3,125 to the prior sampling item of $3,681, which equals $6,806, and so
on until the last name in the customer list is reached. This will give the total sample size of 96.

When sampling, misstatements are being looked for. If a selected customers invoice should have been entered for $986, for example, and it
was entered as $896, there is a misstatement. If the total misstatements exceed the tolerable level, there may be a material misstatement.

Sampling 21
Example for Calculation of Sample Size for MUS

This example uses materiality:

Book Value of Population = 596,566

Acceptable risk of incorrect acceptance (RIA) = 10%

Tolerable misstatement /materiality (a) = 40,000

Expected misstatements in the population (b) = 4,000

Ratio of expected to tolerable misstatements - b/a = .10

Confidence factor (R) – next page (c) = 2.77

Tolerable misstatement (P) as % of population (d) = 0.067

Sample size - c/d (n=R/P) = 42 (round up)

We will use 40 for MUS.

Sampling 22
 MUS Confidence Factors (R Values) (RIA in brackets)
Ratio of
Confidence Level (Risk of Incorrect Acceptance)
Expected to
Tolerable
95% 90% 85% 80% 75% 70% 65% 63% 50%
Misstatement
(5%) (10%) (15%) (20%) (25%) (30%) (35%) (37%) (50%)

0.00 3.00 2.31 1.90 1.61 1.39 1.21 1.05 1.00 0.70

0.05 3.31 2.52 2.06 1.74 1.49 1.29 1.12 1.06 0.73

0.10 3.68 2.77 2.25 1.89 1.61 1.39 1.20 1.13 0.77

0.15 4.11 3.07 2.47 2.06 1.74 1.49 1.28 1.21 0.82

0.20 4.63 3.41 2.73 2.26 1.90 1.62 1.38 1.30 0.87

0.25 5.24 3.83 3.04 2.49 2.09 1.76 1.50 1.41 0.92

0.30 6.00 4.33 3.41 2.77 2.30 1.93 1.63 1.53 0.99

0.35 6.92 4.95 3.86 3.12 2.57 2.14 1.79 1.67 1.06

0.40 8.09 5.72 4.42 3.54 2.89 2.39 1.99 1.85 1.14

0.45 9.59 6.71 5.13 4.07 3.29 2.70 2.22 2.06 1.25

0.50 11.54 7.99 6.04 4.75 3.80 3.08 2.51 2.32 1.37

0.55 14.18 9.70 7.26 5.64 4.47 3.58 2.89 2.65 1.52

0.60 17.85 12.07 8.93 6.86 5.37 4.25 3.38 3.09 1.70

Sampling 23
Problem DC 10-1, Page 547
When Marge Simpson, PA, audited the Candle Company inventory, a random sample of inventory types
was chosen for physical observation and price testing. The sample size was 80 different types of candles
and candle-making inventory. The entire inventory contained 1,740 types, and the amount in the inventory
control account was $166,000. Simpson had already decided that a misstatement of as much as $6,000 in
the account would not be material. The audit work revealed the following no errors in the sample of 80.
This problem has been changed from the text to show no errors.

Sampling 24
 Assume the sample was chosen using Monetary Unit Sampling, and the sampling risk is 10%.
Simpson also assumes that the Misstatement Assumption for zero misstatements is 50% for both
over and under misstatements.
Is the inventory materially misstated?

Total Population = 166,000.00

Sample Size = 80

ARACR = 10.00%

Upper Misstatement Unit Error Assumption 50.00%

Lower Misstatement Unit Error Assumption 50.00%

Materiality 6,000

This part of the

population is not in
the sample. Thus
zero misstatements
have been found here
because these items Sample
have not been
examined.

There are no
misstatements in this
sample.
The misstatements of the remaining part of the population
are not known. Thus a misstatement assumption has to be
made. E.g. they are 50% misstated. See next slide. Sampling 25
 Overstatements
Number of Upper Recorded Misstatement Bound Portion
Misstatements Precision Value Unit Error 2x3x4
(1) Limit Portion (3) Assumption (4)
(2)
Overstatements
0 0.029 166,000 0.500 $2,407
Upper Precision 0.029
Limit
Initial Misstatement $2,407
Bound

Understatements

Number of Upper Recorded Misstatement Bound Portion

Misstatements Precision Value Unit Error 2x3x4
(1) Limit Portion (3) Assumption (4)
(2)
Understatements
0 0.029 166,000 0.500 $2,407
Upper Precision 0.029
Limit
Initial Misstatement $2,407
Bound

As the Upper Bound and Lower Bound are less than the materiality of $6,000, there is no material misstatement
Sampling 26
 ACTUAL NUMBER OF DEVIATIONS FOUND
Sample size
0 1 2 3 4 5 6 7 8 9 10
5 PERCENT RISK OF OVER RELIANCE (RIA or Beta Risk)

20 14.0 21.7 28.3 34.4 40.2 45.6 50.8 55.9 60.7 65.4 69.9
25 11.3 17.7 23.2 28.2 33.0 37.6 42.0 46.3 50.4 54.4 58.4
30 9.6 14.9 19.6 23.9 28.0 31.9 35.8 39.4 43.0 46.6 50.0
35 8.3 12.9 17.0 20.7 24.3 27.8 31.1 34.4 37.5 40.6 43.7
40 7.3 11.4 15.0 18.3 21.5 24.6 27.5 30.4 33.3 36.0 38.8
45 6.5 10.2 13.4 16.4 19.2 22.0 24.7 27.3 29.8 32.4 34.8
50 5.9 9.2 12.1 14.8 17.4 19.9 22.4 24.7 27.1 29.4 31.6
55 5.4 8.4 11.1 13.5 15.9 18.2 20.5 22.6 24.8 26.9 28.9
60 4.9 7.7 10.2 12.5 14.7 16.8 18.8 20.8 22.8 24.8 26.7
65 4.6 7.1 9.4 11.5 13.6 15.5 17.5 19.3 21.2 23.0 24.7
70 4.2 6.6 8.8 10.8 12.7 14.5 16.3 18.0 19.7 21.4 23.1
75 4.0 6.2 8.2 10.1 11.8 13.6 15.2 16.9 18.5 20.1 21.6
80 3.7 5.8 7.7 9.5 11.1 12.7 14.3 15.9 17.4 18.9 20.3
90 3.3 5.2 6.9 8.4 9.9 11.4 12.8 14.2 15.5 16.9 18.2
100 3.0 4.7 6.2 7.6 9.0 10.3 11.5 12.8 14.0 15.2 16.4
125 2.4 3.8 5.0 6.1 7.2 8.3 9.3 10.3 11.3 12.3 13.2
150 2.0 3.2 4.2 5.1 6.0 6.9 7.8 8.6 9.5 10.3 11.1
200 1.5 2.4 3.2 3.9 4.6 5.2 5.9 6.5 7.2 7.8 8.4
300 1.0 1.6 2.1 2.6 3.1 3.5 4.0 4.4 4.8 5.2 5.6
400 0.8 1.2 1.6 2.0 2.3 2.7 3.0 3.3 3.6 3.9 4.3
500 0.6 1.0 1.3 1.6 1.9 2.1 2.4 2.7 2.9 3.2 3.4

Sampling 27
 ACTUAL NUMBER OF DEVIATIONS FOUND
Sample size
0 1 2 3 4 5 6 7 8 9 10
10 PERCENT RISK OF OVER RELIANCE (RIA or Beta Risk)

20 10.9 18.1 24.5 30.5 36.1 41.5 46.8 51.9 56.8 61.6 66.2
25 8.8 14.7 20.0 24.9 29.5 34.0 38.4 42.6 46.8 50.8 54.8
30 7.4 12.4 16.8 21.0 24.9 28.8 32.5 36.2 39.7 43.2 46.7
35 6.4 10.7 14.5 18.2 21.6 24.9 28.2 31.4 34.5 37.6 40.6
40 5.6 9.4 12.8 16.0 19.0 22.0 24.9 27.7 30.5 33.2 35.9
45 5.0 8.4 11.4 14.3 17.0 19.7 22.3 24.8 27.3 29.8 32.2
50 4.6 7.6 10.3 12.9 15.4 17.8 20.2 22.5 24.7 27.0 29.2
55 4.2 6.9 9.4 11.8 14.1 16.3 18.4 20.5 22.6 24.6 26.7
60 3.8 6.4 8.7 10.8 12.9 15.0 16.9 18.9 20.8 22.7 24.6
65 3.5 5.9 8.0 10.0 12.0 13.9 15.7 17.5 19.3 21.0 22.8
70 3.3 5.5 7.5 9.3 11.1 12.9 14.6 16.3 18.0 19.6 21.2
75 3.1 5.1 7.0 8.7 10.4 12.1 13.7 15.2 16.8 18.3 19.8
80 2.9 4.8 6.6 8.2 9.8 11.3 12.8 14.3 15.8 17.2 18.7
90 2.6 4.3 5.9 7.3 8.7 10.1 11.5 12.8 14.1 15.4 16.7
100 2.3 3.9 5.3 6.6 7.9 9.1 10.3 11.5 12.7 13.9 15.0
125 1.9 3.1 4.3 5.3 6.3 7.3 8.3 9.3 10.2 11.2 12.1
150 1.6 2.6 3.6 4.4 5.3 6.1 7.0 7.8 8.6 9.4 10.1
200 1.2 2.0 2.7 3.4 4.0 4.6 5.3 5.9 6.5 7.1 7.6
300 0.8 1.3 1.8 2.3 2.7 3.1 3.5 3.9 4.3 4.7 5.1
400 0.6 1.0 1.4 1.7 2.0 2.4 2.7 3.0 3.3 3.6 3.9
500 0.5 0.8 1.1 1.4 1.6 1.9 2.1 2.4 2.6 2.9 3.1

The Upper and Lower Bounds must be determined. What do these mean?
Obtain the Precision Limits from this table – 10% RIA Sampling 28
Problem DC 10-1, Page 547
When Marge Simpson, PA, audited the Candle Company inventory, a random sample of inventory
types was chosen for physical observation and price testing. The sample size was 80 different types
of candles and candle-making inventory. The entire inventory contained 1,740 types, and the amount
in the inventory control account was $166,000. Simpson had already decided that a misstatement of
as much as $6,000 in the account would not be material. The audit work revealed the following eight
errors in the sample of 80.

Book Value Audit value Error %

(a) Amount Misstatement
(b) b/a
$600.00 $622.00 $(22.00) (0.037)
15.50 14.50 1.00 0.065
65.25 31.50 33.75 0.517
83.44 53.45 29.99 0.359
16.78 15.63 1.15 0.069
78.33 12.50 65.83 0.840
13.33 14.22 (0.89) (0.067)
93.87 39.87 54.00 0.575
$966.50 $803.67 $162.83

Sampling 29
 Assume the sample was chosen using Monetary Unit Sampling, and the sampling risk is 10%.
Simpson also assumes that the Misstatement Assumption for zero misstatements is 50% for both
over and under misstatements.
Is the inventory materially misstated?

Total Population = 166,000.00

Sample Size = 80

ARACR = 10.00%

Upper Misstatement Unit Error Assumption 50.00%

Lower Misstatement Unit Error Assumption 50.00%

Materiality 6,000

This part of the

population is not in
the sample. Thus
zero misstatements
have been found here
because these items Sample
have not been
examined.

The misstatements of the sample,

as percentages, are known . See
previous slide 39.
The misstatements of the remaining part of the population
are not known. Thus a misstatement assumption has to be
made. E.g. they are 50% misstated. See next slide. Sampling 30
Overstatements
Number of Upper Recorded Misstatement Bound Portion
Misstatements Precision Value Unit Error 2x3x4
(1) Limit (3) Assumption
Portion (4)
(2)
Overstatements

0 0.029 166,000 0.500 $2,407

1 0.019 166,000 0.840 2649

2 0.018 166,000 0.575 1718

3 0.016 166,000 0.517 1373

4 0.016 166,000 0.359 954

5 0.015 166,000 0.069 172

6 0.015 166,000 0.065 162

Upper Precision 0.128

Limit
Initial $9,435
Misstatement
Bound Sampling 31
 ACTUAL NUMBER OF DEVIATIONS FOUND
Sample size
0 1 2 3 4 5 6 7 8 9 10
10 PERCENT RISK OF OVER RELIANCE (RIA or Beta Risk)

20 10.9 18.1 24.5 30.5 36.1 41.5 46.8 51.9 56.8 61.6 66.2
25 8.8 14.7 20.0 24.9 29.5 34.0 38.4 42.6 46.8 50.8 54.8
30 7.4 12.4 16.8 21.0 24.9 28.8 32.5 36.2 39.7 43.2 46.7
35 6.4 10.7 14.5 18.2 21.6 24.9 28.2 31.4 34.5 37.6 40.6
40 5.6 9.4 12.8 16.0 19.0 22.0 24.9 27.7 30.5 33.2 35.9
45 5.0 8.4 11.4 14.3 17.0 19.7 22.3 24.8 27.3 29.8 32.2
50 4.6 7.6 10.3 12.9 15.4 17.8 20.2 22.5 24.7 27.0 29.2
55 4.2 6.9 9.4 11.8 14.1 16.3 18.4 20.5 22.6 24.6 26.7
60 3.8 6.4 8.7 10.8 12.9 15.0 16.9 18.9 20.8 22.7 24.6
65 3.5 5.9 8.0 10.0 12.0 13.9 15.7 17.5 19.3 21.0 22.8
70 3.3 5.5 7.5 9.3 11.1 12.9 14.6 16.3 18.0 19.6 21.2
75 3.1 5.1 7.0 8.7 10.4 12.1 13.7 15.2 16.8 18.3 19.8
80 2.9 4.8 6.6 8.2 9.8 11.3 12.8 14.3 15.8 17.2 18.7
1.5
90 2.6 1.9
4.3 1.8 5.9 1.6 7.3 1.6 8.7 10.1 1.9 11.5 12.8 14.1 15.4 16.7
100 2.3 3.9 5.3 6.6 7.9 9.1 10.3 11.5 12.7 13.9 15.0
125 1.9 3.1 4.3 5.3 6.3 7.3 8.3 9.3 10.2 11.2 12.1
150 1.6 2.6 3.6 4.4 5.3 6.1 7.0 7.8 8.6 9.4 10.1
200 1.2 2.0 2.7 3.4 4.0 4.6 5.3 5.9 6.5 7.1 7.6
300 0.8 1.3 1.8 2.3 2.7 3.1 3.5 3.9 4.3 4.7 5.1
400 0.6 1.0 1.4 1.7 2.0 2.4 2.7 3.0 3.3 3.6 3.9
500 0.5 0.8 1.1 1.4 1.6 1.9 2.1 2.4 2.6 2.9 3.1

The Upper and Lower Bounds must be determined. What do these mean?
Obtain the Precision Limits from this table – 10% RIA Sampling 32
Understatements
Number of Upper Recorded Misstatement Bound Portion
Misstatements Precision Value Unit Error 2x3x4
(1) Limit (3) Assumption
Portion (4)
(2)
Understatements

0 0.029 166,000 0.500 $2,407

1 0.019 166,000 0.067 211

2 0.018 166,000 0.037 111

Upper Precision 0.066

Limit
Initial $2,729
Misstatement
Bound

Sampling 33
Offsetting Adjustments
Number of Misstatements Misstatement Sample Size Recorded Point Estimate Bounds
Unit Error (b) Population a(c/b)
Assumption (c)
(a)
Initial Overstatement Bound $9,435
Understatement Misstatements
1 0.067 80 166,000 139 (139)
2 0.037 80 166,000 77 (77)
Total 0.104 80 166,000 216 (216)
Adjusted Overstatement Bound 9,219

Initial Understatement Bound 2,729

Overstatement Misstatements
1 0.840 80 166,000 1743 (1743)
2 0.575 80 166,000 1193 (1193)
3 0.517 80 166,000 1073 (1073)
4 0.359 80 166,000 745 (745)
5 0.069 80 166,000 143 (143)
6 0.065 80 166,000 135 (135)
Total 2.425 5032 (5032)
Adjusted Understatement Bound -2303

As the Upper Bound is greater than the materiality of $6,000, there may be a material misstatement

Sampling 34
The Decision Rule

Tolerable Tolerable
misstatement misstatement
($6,000) $6,000

Reject Reject

$2,303 $9,219 Proble

LMB UMB m
Since materiality is $6,000, there may be material misstatement.

Sampling 35
Problem EP 10-5, Page 546 – Point Estimate
Assume the results shown below were obtained from a stratified sample.
Required :
Apply the ratio calculation method (Point Estimate) to each stratum to calculate the projected likely
misstatement (PLM). What is the PLM for the entire sample?
SAMPLE RESULTS

Population Recorded Recorded Misstatement

Stratum Sample PLM
Size Amount Amount Amount

1 6 $100,000 6 $100,000 $(600)

2 80 75,068 23 21,700 (274)

3 168 75,008 22 9,476 (66)

4 342 75,412 22 4,692 (88)

5 910 74,512 23 1,973 23

Total 1,506 $400,000 96 $137,841 $(1,005)

Sampling 36
Problem DC 10-1, Page 547 – The Difference Method
Sample size is 80
Population consists of 1,740 types

Book Value Audit value Error %

(a) Amount Misstatement
(b) b/a
$600.00 $622.00 $(22.00) (0.037)
15.50 14.50 1.00 0.065
65.25 31.50 33.75 0.517
83.44 53.45 29.99 0.359
16.78 15.63 1.15 0.069
78.33 12.50 65.83 0.840
13.33 14.22 (0.89) (0.067)
93.87 39.87 54.00 0.575
$966.50 $803.67 $162.83

Sampling 37