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An overview and application to tests of controls

8-1 Define audit sampling. Why do auditors sample instead of examining every transaction?

Audit Sampling is the application of an audit procedure to less than 100 percent of the items within an account or class of transactions for the purpose of evaluating some characteristic of the balance or class. It is not economical for auditors to test 100% of the population; instead they use sampling to gather sufficient audit evidence.

8-2 Distinguish between Type I and Type II errors. What terms are used to describe these errors when the auditor is conducting tests of controls and substantive tests? What costs are potentially incurred by auditors when such decision errors occur?

Type I error is deciding that the population tested is not acceptable when in reality it is. Type II error is deciding that the population tested is acceptable when in reality it is not. When and auditor is evaluating the level of reliance that can be placed on a control in the context of a financial statement audit, this risk is also commonly referred to as the risk of underreliance or the risk of assessing control risk too high. When an auditor is evaluating the level of reliance that can be placed on a control in the context of a financial statement audit, this risk is also commonly referred to as the risk of overreliance or the risk of assessing control risk too low. The risk of incorrect rejection (Type I) can result in the auditor conducting more audit work than necessary in order to reach the correct conclusion. The risk of incorrect acceptance (Type II) can result in the auditor failing to detect a material misstatement in the financial statements. This can lead to litigation against the auditor by parties that rely on the financial statements.

8-3 List audit evidence types that do not involve sampling and provide an example of a situation where an auditor would not use audit sampling.

Audit evidence types that do not involve sampling and an example of a situation where an auditor would not use audit sampling follows:
o Analytical procedures
o Scanning
o Inquiry
o Observation
o Procedures applied to every item in the population
o Classes of transactions or account balances not tested
o Tests of automated information technology controls

• When an account or class of transactions is made up of a few large items, the auditor may test all the items in the account or class of transactions.
• The auditor is aware of certain transactions that look unusual or present greater risk.
• If a relatively small number of large transactions make up a relatively large percentage of an account or class of transactions

8-4 Distinguish between nonstatistical and statistical sampling. What are the advantages and disadvantages of using statistical sampling?

In nonstatistical sampling, the auditor does not use statistical techniques to determine the sample size, select the sample, and /or measure sampling risk when evaluating results. Statistical sampling, on the other hand, uses the laws of probability to compute sample size and evaluate the sample results, thereby permitting the auditor to sue the most efficient sample size and to quantify the sampling risk for the purpose of reaching a statistical conclusion about the population. The major advantages of statistical sampling are that it helps the auditor:
o Design and efficient sample
o Measure the sufficiency of evidence obtained
o Quantify sampling risk
The major disadvantages of statistical sampling include additional costs of:
o Training auditors in the proper use of sampling techniques
o Designing and conducting the sampling application
o Lack of consistent application across audit teams due to the complexity of the underlying concepts

8-5 Define attribute sampling. Why is this sampling technique appropriate for test of controls?

Attribute sampling is a statistical sampling method used to estimate the proportion of a characteristic in a population. In applying this this technique to test of controls, the auditor normally attempts to determine the operating effectiveness to a control in terms of deviations from a prescribed internal control.

8-7 List the four factors that enter into the sample size decision. What is the relationship between sample size and each of these factors?

The four factors that enter into the sample size decision:
Table 8-7 on page 288

8-8 In performin certain audit procedures, the auditor may encounter voided documents, inapplicable documents, or missing documents, or the auditor may stop testing before examining all the items selected for the sample. How should each of these situations be handled within the attribute-sampling application?

Each of these situations should be handled within the attribute-sampling application:

o Voided documents: If the transaction has been properly voided, it does not represent a deviation. The item should be replaced with a new sample item.
o Unused or inapplicable documents: Sometimes a selected item is not appropriate for the definition of the control. In such a case, the item is not a deviation and the auditor would simply replace the item with another purchase transaction.o Missing documents: If the auditor is unable to examine a document or use an alternative procedure to test whether the control was adequately performed, the sample item is a deviation for purposes of evaluating the sample results.
o Stopping the test before completion: If a large number of deviations are detected early in the tests of controls, the auditor should consider stopping the test as soon as it is clear that the results of the test will not support the planned assessed level of control risk.

8-9 The auditor should evaluate the qualitative aspects of deviations found in a sampling application. What are the purposes of evaluating the qualitative aspects of deviations?

The auditor must consider the qualitative aspects of the deviations as well as the number of deviations. Deviations that directly affect the financial statements or appear to be irregularities have greater audit significance. When the sample results do not support the planned control risk, the nature, extent, or timing of substantive tests are ordinarily modified, or, if applicable, tests may be made of other compensating controls.

8-10 How should the results of a nonstatistical test of controls sample be evaluated in terms of considering sampling risk?

In nonstatistical samples, the difference between the auditor's total projected misstatement and tolerable misstatement may be viewed as an allowance for sampling risk.

8-6 How does the timing of controls testing affect the population definition?

The sample population should be restricted to the transactions and time period under the same system of controls that are relevant to the assertions being tested.

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