Question

An auditor used a nonstatisitcal sampling plan to audit the inventory of a bicycle supply company. The auditor tested the recorded cost of a sample of inventory items by reference to vendors’ invoices. In performing the test, the auditor verified all the items on two pages selected at random from the client’s 400 page inventory listing. The sampling plan resulted in a test of $50,000 of the total book value of $5,000,000, and the auditor found a total of $5,000 in overstatements in the sample. Since the audit senior indicated that a material misstatement in the inventory account was $100,000, the auditor concluded that the recorded inventory value was materially correct.

1. Evaluate the auditors’ sampling plan and the manner in which the results were evaluated.
2. What must the auditor do with the potential material misstatement?
3. Is sampling risk present? What is sampling risk?
4. How would the sampling plan be different if a statistical sample had been used?

Answer 1

1. Evaluate the auditors’ sampling plan and the manner in which the results were evaluated.

Sampling should be done in such a way that the sample can be expected to be representative of the population. Therefore, all items in the population should have an opportunity to be selected. For example, haphazard and random-based selection of items represents two means of obtaining such samples.

As per AS 2315: Audit Sampling, the auditor should project the misstatement results of the sample to the items from which the sample was selected. There are several acceptable ways to project misstatements from a sample. For example, an auditor may have selected a sample of every twentieth item (50 items) from a population containing one thousand items. If he discovered overstatements of $3,000 in that sample, the auditor could project a $60,000 overstatement by dividing the amount of misstatement in the sample by the fraction of total items from the population included in the sample. The auditor should add that projection to the misstatements discovered in any items examined 100 percent. This total projected misstatement should be compared with the tolerable misstatement.

In the given case, auditor selects 1% as sample out of the total book value of $5,000,000. The auditor found a total of $5,000 in overstatements in the sample, meaning the auditor could project a $500,000 overstatement by dividing the amount of misstatement in the sample by the fraction of total items from the population included in the sample. Thereafter, the total projected misstatement $500,000 is compared with the tolerable misstatement $100,000 and appropriate consideration should be given to sampling risk. Hence the manner in which auditors evaluated the sample was incorrect.

2. What must auditor do with the potential material misstatement?

As per AS 2315: Audit Sampling, in addition to the evaluation of the frequency and amounts of monetary misstatements, consideration should be given to the qualitative aspects of the misstatements. These include (a) the nature and cause of misstatements, such as whether they are differences in principle or in application, are errors or are caused by fraud, or are due to misunderstanding of instructions or to carelessness, and (b) the possible relationship of the misstatements to other phases of the audit. The discovery of fraud ordinarily requires a broader consideration of possible implications than does the discovery of an error.

If the sample results suggest that the auditor's planning assumptions were incorrect, he should take appropriate action. For example, if monetary misstatements are discovered in a substantive test of details in amounts or frequency that is greater than is consistent with the assessed levels of inherent and control risk, the auditor should alter his risk assessments. The auditor should also consider whether to modify the other audit tests that were designed based upon the inherent and control risk assessments. For example, a large number of misstatements discovered in confirmation of receivables may indicate the need to reconsider the control risk assessment related to the assertions that impacted the design of substantive tests of sales or cash receipts.

The auditor should relate the evaluation of the sample to other relevant audit evidence when forming a conclusion about the related account balance or class of transactions.

Projected misstatement results for all audit sampling applications and all known misstatements from non sampling applications should be considered in the aggregate along with other relevant audit evidence when the auditor evaluates whether the financial statements taken as a whole may be materially misstated.

3. Is sampling risk present? What is sampling risk?

In the given case, the total projected misstatement $500,000 is more than the tolerable misstatement $100,000. Thus, there is high sampling risk that the actual misstatements in the population exceed the tolerable misstatement.

Sampling risk arises from the possibility that, when a test of controls or a substantive test is 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. That is, a particular sample may contain proportionately more or less monetary misstatements or deviations from prescribed controls than exist in the balance or class as a whole. For a sample of a specific design, sampling risk varies inversely with sample size: the smaller the sample size, the greater the sampling risk.

4. How would the sampling plan be different if a statistical sample had been used?

Statistical sampling is an approach to sampling that involves random selection of the sample items and the use of probability theory to evaluate the sample results, including the measurement of sampling risk. Any other approach is described as being ‘non-statistical’.

Statistical sampling requires that sample items are selected at random so that each sampling unit has a known probability of being selected while with non-statistical sampling, an auditor uses professional judgment to select the items for a sample.

Statistical sampling is quantitative evaluation of sample result while non statistical sampling is qualitative evolution of sample result