Question

only used for Class Discussion Exercise Kayla Reed is using mean-per-unit estimation in the audit of Hamilton's inventory balances. Hamilton's inventory is recorded at $240,000 and comprises 1.200 different items. Reed determined a sample size of 120 items and performed the appropriate substantive procedures and based on this sample, determined the following: Average audited value (per item) Standard deviation of audited values $ 204 $ 22 A summary of some additional parameters estimated by Reed follow: Tolerable misstatement Expected misstatement Risk of incorrect acceptance Risk of incorrect rejection $ 17,500 $ 7,500 5% 10% Required: a. What is Reed's estimate of the audited value of Hamilton's inventory? b. What is the adjusted allowance for sampling risk? c. What is Reed's conclusion with respect to Hamilton's inventory balance? Book value

Please answer A, B, C

Thanks!

Answer 1

Ans. a.

Mean estimation per unit method :- The auditor focuses on audited value rather then misstatement amount of each item in the sample.

Reed's Estimate of audited value of Hamilton's inventory :-

Estimated Total Audited Value = Mean audited value * Number of accounts

Mean/ Average audited value per unit = $ 204

Number Of Accounts for inventory = 1,200 (No of items)

So Estimated Total audited value = $ 204 * 1,200 = $ 2,44,800

b.

Adjusted Allowance for Sampling Risk :- An adjusted allowance for sampling risk will be calculated when the estimated standard deviation differs from that obtained in the sample. This method keeps the risk of incorrect acceptance at it's planned level. It can be calculated in all circumstances for evaluation purposes in that it provides the planned allowance for sampling risk in situations in which the estimated and sample's (audited value) standard deviations are equal.

Calculation = A' = TM - N * Ua * SDc / √n

Where,

TM = Tolerable misstatement

Ua = Incorrect Acceptance coefficient

N = Population Size

SDc = Sample Standard Deviation

n = Sample Size

TM = $ 17,500, N = 1,200, Ua = 5%, SDc = $ 22, n= 120

A' = 17,500 - 1200* 5% * 22 / √120

= $ 17,379.50

c.

Acceptance Interval = Estimated total audited value +/- Adjusted allowance for sampling

= $ 2,44,800 + $ 17,379.50 = $ 2,62,179.5

= $2,44,800 - $17,379.5 = $ 2,22,420.5

As book value is $ 2,40,000 which is fall between Acceptance level of reed, so valuation of inventory shown in the books is proper & didn't require any comment in audit report.

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