Gramling 9e Auditing Solman Audit Sampling

Solutions for Chapter 8
True-False Questions
8.1
8.2
8.3
8.4
8.5
8.6
8.7
8.8
8.9
8.10
8.11
8.12
8.13
8.14
T
F
T
F
F
F
T
F
F
T
T
F
T
T
Multiple-Choice Questions
8.15
8.16
8.17
8.18
8.19
8.20
8.21
8.22
8.23
8.24
8.25
8.26
8.27
8.28
A
C
E
A
E
C
D
A
E
C
B
D
E
A
Review and Short Case Questions

8-29
Samplingisusedintestingbothcontrolsandaccountbalancesandassertionsandinvolves
lookingatlessthan100%ofthetransactionsthatoccurredduringtheperiodunderaudit.
Samplingtechniqueswouldbeappropriatewhenanauditorwantstoperformproceduressuchas
examiningdocuments,reperformingcalculations,orsendingconfirmations.
2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-1
GAS)aresoftwareprogramsdesignedspecificallyforauditors.GAScanbeusedtofacilitateand
automatethetestingof100%ofapopulationwhenappropriateandtohelpfocustheauditors
attentiononspecificriskareasortransactions.GASissoftwaredesignedtoread,process,and
writedata.AuditorscanuseGAStoimportaclientscomputerizeddata;thenthesoftwarecan
beappliedtothedatainavarietyofways.
8-30
Exhibit8.1
ApproachestoGatheringAuditEvidenceaboutAssertions
Financial
UsingSamplingtoGatherEvidence
UsingGAStoGatherEvidence
Statement
Assertion
Existenceor
Takeasampleofrecordedtransactions Sortthefiletoidentifythelargest
occurrence
andforselecteditemsexamine
items,thesmallestitems,thelast
underlyingevidenceorsendout
transactionsduringtheyear(fortesting
confirmations.
cutoff),orthemostfrequentitems
withinthefile;alsousefulinscanning
Completeness Takeasampleofsubsequentcash
forunusualtransactions.
Sortthefilebyvendortoidentifythe
disbursementstosearchforunder
mostcommonlyusedvendors,orthe
recordedliabilities.
leastcommonlyusedvendors;or
comparingthelistofvendorsfromthe
prioryeartothecurrentyear.
Sortafiletoscanforunusual
Rightsor
Oftendoneinconjunctionwith
obligations
existencetesting,includingexamining transactions.
Valuationor
sourcedocuments.
Selectitemsandtracebacktosource
Allocation
documents,suchaspurchase
Footthefileandtestcomputations.
8-2
Presentation
agreementsorinvoices.
Verifyestimatesorotheritemsfor
andDisclosure properdisclosure.
8-31
Samplingunitsrefertotheindividualitemstobetested.Thesamplingunitsmakeupthe
population.Thepopulationisagroupoftransactionsortheitemsthatmakeupanaccount
balanceforwhichtheauditorwantstoestimatesomecharacteristic,suchastheeffectivenessofa
controlprocedureorestimatetheextentofmisstatementinanaccount.
8-32
Theauditorneedstoanswerfourcriticalquestionswhensampling:
1. Whichpopulationandsamplingunitshouldbetestedandwhatcharacteristicsshouldbe
examined(population)?
2. Howmanyitemsshouldbeselectedforaudittesting(samplesize)?
3. Whichitemsshouldbeincludedinthesample(selection)?
4. Whatinferencescanbemadeabouttheoverallpopulationfromthesample(evaluation)?
8-33
Samplingriskistheriskthattheauditorsconclusionbasedonasamplemightbedifferentfrom
theconclusionheorshewouldreachifthetestwereappliedinthesamewaytotheentire
population.Nonsamplingriskistheriskthattheauditorreachesanerroneousconclusionforany
reasonnotrelatedtosamplingrisk.
834
a.
Riskofincorrectacceptanceofinternalcontrolreliability Theriskthattheauditorwill
concludethatthestateofinternalcontrolsiseffectivewheninternalcontrolsareactuallynot
effective(alsoreferredtoastheriskofassessingcontrolrisktoolow).
Riskofincorrectrejectionofinternalcontrolreliability
Theriskthattheauditorwill
concludethatthestateofinternalcontrolsisnoteffectivewheninternalcontrolsareactually
effective(alsoreferredtoastheriskofassessingcontrolrisktoohigh).
8-3
Riskofincorrectacceptanceofbookvalue Theriskthattheauditorwillconcludethatthe
accountbalancedoesnotcontainamaterialmisstatementwhentheaccountbalanceactually
doescontainamaterialmisstatement.
Riskofincorrectrejectionofbookvalue
Theriskthattheauditorwillconcludethatthe
accountbalancecontainsamaterialmisstatementwhentheaccountbalanceactuallydoesnot
containamaterialmisstatement.
b.
Theauditorshouldbemostconcernedabouttheriskofincorrectacceptanceofeitherinternal
controlreliabilityorofbookvaluebecausetheseleadtoauditineffectiveness.Whiletheauditor
willcertainlynotwanttobeinefficient,ineffectivenessisagreaterrisk.
8-35
Exhibit8.4
ComparisonofNonstatisticalandStatisticalSampling
Samplesize
NonstatisticalSampling
StatisticalSampling
Samplesizeisdeterminedbyauditor Auditorjudgmentisquantifiedand
judgment.
Sampleselection
samplesizeisdeterminedby
probabilitytheory.
Selectioninvolvesanymethodthatthe Thesamplemustberandomly
auditorbelievesisrepresentativeof
selectedtogiveeachunitinthe
thepopulation.
populationanequalchancetobe
Judgmentsamplingcanalsobe
includedinthesample.
Thepopulationofinterestcanalso
directedataportionofthepopulation, bedirected,forexamplethe
forexamplealltransactionsduringthe transactionsduringthelast10days
Evaluation
last5daysoftheyear.
oftheyearcanbestatistically
Evaluationisbasedonauditor
selected.
Evaluationisbasedonstatistical
8-4
Costs
judgmentandprojectionsbasedon
inferencethatisusedtoassist
sampleresults.
auditorjudgment.
Lowerselectioncostbecauseonly
Requiresknowledgeof
requiresauditjudgmentto
statisticalsamplingmethods
determineanappropriatesample
and/orspecialcomputer
sizeandevaluatetheresults
samplingsoftwareisrequired
Doesnotprovideanobjectiveway
andofteninvolvestraining
tocontrolandmeasuresampling
costs
risk
Benefits
Requiresauditortodefine
Canbebasedonauditorsprior
acceptableriskinadvance.
Helpstheauditor:
expectationsabouterrorsinthe
Designanefficientsample
account
Measurethesufficiencyof
Maytakelesstimetoplan,select,
theevidence
andevaluatethesample
Evaluatetheresultsby
providinganobjective
measureofsamplingrisk
Gainefficienciesthrough
computerizedselectionand
statisticalevaluation
Defendsampleinferences
becausetheyarebasedon
statisticaltheory
8-5
Helpstheauditorevaluatethe
samplebyprovidinga
quantitativemeasureof:
Themostlikelyand
maximumfailurerateofacontrol
procedurethatisbeingevaluated
foreffectiveness
Themostlikelyand
maximumamountof
misstatementintherecorded
accountbalanceorclassof
transactions
Theriskthattheauditor
maymakeanincorrect
judgmentaboutthestateof
controlsorcorrectnessof
accountbalances
8-6
8-36
Attributessamplingisastatisticalsamplingmethodusedtoestimatetherateofcontrol
procedurefailuresbasedonselectingonesampleandperformingtheappropriateaudit
procedure.Anattributeisacharacteristicofthepopulationofinteresttotheauditor.
Anexampleofanattributeofinteresttoanauditorwouldbeevidencethattheclienthasmatched
vendorinvoicedetailswiththepurchaseorderandreceivingreportbeforepaymentapproval,and
notingthattheymatchbeforeauthorizingapaymentforthegoodsreceived.
Anexampleofacontrolfailurewouldbeiftheappropriateclientemployeefailedtoseekcredit
approvalforanewaccount,eventhoughdoingsoisrequiredbycompanypolicy.
837
Indefiningthepopulation,thefollowingfactorsneedtobeaddressed:
Theperiodtobecoveredbythetest;forexample,theyearwhenevaluatingcontrols
Thesamplingunit;forexample,anitemthatwouldindicatetheoperationofacontrol
Thecompletenessofthepopulation
838
TheAICPAs2012AuditSamplingguideformallydefinesthetolerablerateofdeviationasa
rateofdeviationsetbytheauditorinrespectofwhichtheauditorseekstoobtainanappropriate
levelofassurancethattherateofdeviationsetbytheauditorisnotexceededbytheactualrateof
deviationinthepopulation.Thistermissometimesreferredtoasthetolerablefailurerate.In
morepracticalterms,theauditorstoleraterateofdeviationisthelevelatwhichthecontrols
failuretooperatewouldcausetheauditortoconcludethatthecontrolisnoteffectiveandwould
likelychangetheauditorsplannedassessmentofcontrolriskinperformingtestsofaccount
balances.
839
Sampling risk
Tolerable rate of
deviation
5%
5%
5%
10%
2%
6%
10%
2%
Expected
population
deviation rate
1%
5%
8%
1%
Sample Size
(expected errors)
590 (6)
1,580 (79)
649 (52)
398 (4)
8-7
10%
10%
6%
10%
5%
8%
1,019 (51)
424 (34)
Sampling risk
Tolerable rate of
deviation
Sample Size
10%
5%
5%
5%
10%
10%
20%
20%
20%
10%
10%
15%
Expected
population
deviation rate
0%
0%
0.25%
0%
0.25%
7%
840
a.
b.
c.
d.
e.
f.
11
14
22
29
38
52
g. These assumptions imply that in order to justify these relatively small sample sizes, the auditor
will have to accept a relatively high tolerable rate of deviation, while expecting a relatively low
expected population deviation rate; these assumptions may be unrealistic thus calling into
question very low sample sizes.
841
a. An increase in sampling risk results in a smaller sample because the auditor is willing to accept
more risk of the audit conclusion being in error. As a general sampling rule, the more risk the
auditor is willing to take of being wrong, the smaller will be the sample size.
b. An increase in the tolerable rate of deviation results in a smaller sample because the sample
does not have to be as precise - there is a bigger range between the tolerable failure rate and
expected failure rate. Additionally, this increase likely means the auditor has concluded the
control is less important - also resulting in a smaller sample size.
c. An increase in the expected population deviation rate results in a larger sample results because
the sample has to be more precise - there is a smaller range between the tolerable failure rate and
expected failure rate.
d. Increase in population size normally does not affect the sample size unless the population size
is relatively small; then a larger sample would be required, but not in proportion to the increase
in population size.
842
a.Simplerandomsampling.Selectingarandomsamplebymatchingrandomnumbersgenerated
byacomputerorselectedfromarandomnumbertablewith,forexample,documentnumbers
suchasaninvoiceorapurchaseorder.
8-8
b.Systematicsampling.Selectingarandomsamplebymatchingrandomnumbersgeneratedbya
computerorselectedfromarandomnumbertablewith,forexample,documentnumberssuchas
aninvoiceorapurchaseorder.
c.Systematicrandomsampling.Thissamplingtechniqueinvolvessystematicsamplinginwhich
thefirstitemisselectedrandomlyfromtheinterval.
d.Haphazardsampling.Anonstatisticalsampleselectionmethodthatattemptstoapproximatea
randomselectionbyselectingsamplingunitswithoutanyconsciousbias,orspecialreasonfor
includingoromittingcertainitemsfromthesample.
e.Blocksampling.Asamplingtechniquethatinvolvesselectingasamplethatconsistsof
contiguouspopulationitems,suchasselectingtransactionsbydayorweek.
843
Sampling risk
a.
5%
Sample Size
Number of
Upper Limit of
20
Deviations
0
Deviations
14.0%
The upper limit is
greater than 0, even
though there were
no deviations,
because the sample
size is very low; so
there is a strong
possibility that even
though the auditor
detected no
deviations in the
sample of 20 items,
there exist
deviations that the
auditor failed to
detect.
b.
c.
d.
5%
5%
10%
75
150
20
5
10
0
13.6%
11.1%
10.9%
The upper limit is
greater than 0, even
though there were
no deviations in the
8-9
sample, because the

sample size is very
low; so there is a
strong possibility
that even though the
auditor detected no
deviations in the
sample of 20 items,
there exist
deviations that the
auditor failed to
detect.
e.
f.
10%
10%
75
150
5
10
12.1%
10.1%
Interpretations:
a. Theauditoris95%confidentthatthattheupperlimitoftherealdeviationrateinthe
populationdoesnotexceed14.0%.Statedanotherway,itmeansthatthereisa5%chancethat
therealdeviationrateexceeds14.0%.Becausethetolerabledeviationrateis12%,theauditor
concludesthatthecontrolisnotoperatingeffectively.
b. Theauditoris95%confidentthatthattheupperlimitoftherealdeviationrateinthe
concludesthatthecontrolisnotoperatingeffectively.
c. Theauditoris95%confidentthatthattheupperlimitoftherealdeviationrateinthe
concludesthatthecontrolisoperatingeffectively.
d. Theauditoris90%confidentthatthattheupperlimitoftherealdeviationrateinthe
e. Theauditoris90%confidentthatthattheupperlimitoftherealdeviationrateinthe
concludesthatthecontrolisnotoperatingeffectively.However,givenhowclosetheupperlimit
istothetolerablerate,theauditormightconsiderincreasingthesamplesizeabittobemore
certainaboutthisconclusion.
8-10
f. Theauditoris90%confidentthatthattheupperlimitoftherealdeviationrateinthe
8-44
In any sampling application there exists sampling risk. The upper limit takes sampling risk into
account and is the best indicator of the maximum deviation rate in the population and should be
compared to the tolerable failure rate.
The alternative courses of action are:
A compensating control procedure could be identified and tested. The decision to test the
compensating control procedure will depend on the perceived effectiveness of the control and
the additional cost to test the control procedure.
A larger sample could be taken, but this is not likely to be cost-beneficial unless the
auditor has reason to believe the original sample was not representative.
The assessment of control risk can be set higher than originally planned and the nature,
timing, and/or the extent of the related substantive tests can be modified. If the upper limit
does not exceed the tolerable failure rate by very much, this modification could be very
slight. For example, if the upper limit was 5.4% and the tolerable rate was 5%, very little
modification is needed.
The auditor will analyze the nature of the control deviations and determine the
implications on the type of misstatements, or causes of misstatements, that might occur in the
financial statements and adjust the nature, timing, and/or extent of the planned substantive
testing.
8-45
a.
Control
1
2
3
4
5
6
7
Upper Limit of Control Failures

The upper limit is 3%.
Since the control calls for credit approval to be noted on the customer
orders, there are five deviations (the auditor must conclude there was no
credit approval for the two sales for which no customer order could be
found). The upper limit is 10.3%.
The upper limit is 7.6%.
The upper limit is 6.2%.
There are 6 deviations. The upper limit is 11.5%.
8-11
b. The upper limit of deviation for all controls tested except 1 (sales manager approval
of sales over $10,000) and 5 (proper pricing) exceeded the tolerable deviation rate.
Thus, there are problems with proper credit approval, lack of supporting shipping
documents and customer orders, premature recording of sales, and billing for larger
quantities that customers ordered. These deficiencies in internal controls would
probably result in an adverse opinion on internal controls because they are likely to
cause the auditor to conclude that there is a reasonable possibility that a material
misstatement could exist. Certainly, the pattern of errors suggests pervasive internal
control problems related to revenue and accounts receivable.
Control
2&6
c. Potential Misstatements
The allowance for doubtful accounts
may be understated because of the lack
of proper credit approval.
The lack of customer orders for two

recorded sales could mean that the sales
were not ordered by customers resulting
in artificially inflated sales.
3
The lack of shipping documents could

indicate misplaced documents or that
the sales did not take place. The auditor
should be professionally skeptical and
assume the worst the sales did not take
place.
Sales being recorded prior to shipment

could be an honest mistake due to the
temporary employee. However, this
may result in sales recorded in the
current year that should be recorded
next year.
Billing for more quantities than

customers ordered results in inflated
sales and receivables.
d. Effect on rest of audit

Carefully review the aging of
the year-end receivables.
Increase coverage of
confirmations and subsequent
collections.
Increase the extent of cutoff
testing particularly for sales
recorded just prior to year-end.
Review the extent of subsequent
sales returns to determine if they are
more than normal. This may require
estimating sales returns and
allowances as of year-end to match
with the sales.
Heightened alertness to other
approaches management may use to
manage its earnings, particularly in
the area of accounts based on
estimates
8-46
a. Misstatement. Anerror,eitherintentionalorunintentional,thatexistsinatransactionor
financialstatementaccountbalance.Forsubstantivesamplingpurposes,amisstatement
involvesdifferencesbetweenrecordedvaluesandauditedvalues.
b. Factual misstatement. A misstatement that has been specifically identified and about which
there is no doubt. Alsoreferredtoasaknownmisstatement.
8-12
c. Projected misstatement. Thebestestimateoftheactualamountofdollarmisstatementsinthe

populationbasedonprojectingthesampleresultstothepopulation.Theprojected
misstatementiscalculatedasthesamplingintervalmultipliedbythetaintingpercentage.
Alsoseelikelymisstatementormostlikelymisstatement.
d. Tolerable misstatement. Arateofdeviationsetbytheauditorinrespectofwhichtheauditor
seekstoobtainanappropriatelevelofassurancethattherateofdeviationsetbytheauditoris
notexceededbytheactualrateofdeviationinthepopulation.Alsoreferredtoasthe
tolerablefailurerate.
e. Expected misstatement. Thelevelofmisstatementthattheauditorexpectstodetect,anditis
basedonprojectedmisstatementsinprioryearaudits,resultsofothersubstantivetests,audit
judgment,andknowledgeofchangesinpersonnelandtheaccountingsystem.
8-47
The sampling unit when gathering evidence about misstatements in account balances and
associated assertions is the individual auditable elements that make up individual account
balances. Examples in the context of accounts receivables include the customers balance,
individual unpaid invoices, or a combination of these two.
8-48
Stratification involves the division of a population into two or more sub-groups. Top-stratum
items are those that are large-value items that exceed the sampling interval. All items in the topstratum are audited. In contrast, lower-stratum items are lower-value items that are less than the
sampling interval. These items are sampled.
8-49
When using nonstatistical sampling, the auditor must use judgment in determining the sample
size, selecting the sample, and evaluating the sample results:
a. In determining the sample size, allsignificantitemsshouldbetested.Theauditorshould
selectallitemsoveraspecificdollaramount,andthen,dependingonauditobjectives,select
itemswithothercharacteristics,suchasitemsbilledinthelastweekorbilledtospecific
parties.
b. The sample should be selected toincreasethelikelihoodthatthesampleisrepresentativeof
thepopulation.Theauditormayobtainarepresentativesampleusingarandombased
methodorhaphazardsampling.
c. As is true for statistical sampling, the sample results should be projected to the population
and compared with the tolerable misstatement. The auditor should also consider whether
there is an adequate allowance for sampling risk, the difference between the projected
misstatement and tolerable misstatement.
8-50
8-13
a.
Lower stratum projected misstatement: ($600/$185,000) * $1,500,000 = $4,864.86

Plus top-stratum misstatement
1,000.00
Total projected misstatement
$5,864.86
b. Tolerable misstatement has been set at $25,000 so the projected misstatement is significantly
less than tolerable misstatement. No further work needs to be performed.
c. When the total estimated misstatement exceeds the tolerable misstatement, the auditor has
available several possible courses of action. The auditor can:
Ask the client to correct the factual misstatements. If this is done, the total estimated
misstatement can be adjusted for those corrections but not for the projection of
misstatements associated with those items. In some cases, simply correcting the factual
misstatement can bring the total estimated misstatement below the auditors tolerable
misstatement level.
Analyze the detected misstatements for common problem(s). When misstatements are
discovered, the auditor should look beyond the quantitative aspects of the misstatements
to understand the nature and cause of the misstatementsespecially to determine if there
is a systematic pattern to the misstatements. If a systematic pattern is found, the client can
be asked to investigate and make an estimate of the correction needed. The auditor can
review and test this estimate. Further, the auditor can recommend improvements to
prevent such errors in the future. For example, assume several confirmation replies
indicate that merchandise was returned prior to year end but credit was not recorded until
the subsequent year. A careful review of receiving reports related to merchandise returned
prior to year end and of credits recorded in the subsequent year will provide evidence
regarding the extent of the needed correction. The auditor should also consider the
relationship of the misstatements to other phases of the auditproblems in recording
receivables may also reveal problems in the accuracy of recorded sales.
Design an alternative audit strategy. Discovering more misstatements than expected in
the planning stage of the audit suggests that the planning assumptions may have been in
error and internal controls were not as effective as originally assessed. In such cases, the
auditor should plan the rest of the audit accordingly. For public companies, significant
problems with internal control will cause the auditor to consider whether it is necessary to
express an adverse opinion on the effectiveness of the clients internal controls over
financial reporting.
Expand the sample. The auditor can increase the sample size. Although, this approach
may not be very useful if the first sample is representative of the population.
Change the audit objective to estimating the correct value. In cases where material
misstatements are likely, it may be necessary to change from an objective of testing
details to an objective of estimating the correct population value. A lower detection risk
and a smaller tolerable misstatement should be used because the auditor is no longer
testing the balance but estimating the correct population value from the sample. The
8-14
auditor will expect the client to adjust the book value to the estimated value. A larger
sample size will normally be required. Because of the frequency of misstatements
underlying the misstated balance, the auditor should use one of the classical statistical
sampling methods to evaluate the results.
8-51
StrengthsofMUSinclude:
MUSisgenerallyeasiertoapplythanotherstatisticalsamplingapproaches.
MUSautomaticallyselectsasampleinproportiontoanitemsdollaramount,thusproviding
automaticstratificationofthesample.
Iftheauditorexpects(andfinds)nomisstatements,MUSusuallyresultsinahighlyefficient
samplesize.
ExamplesofthecircumstancesinwhichMUSmightbeusedinclude:
Accountsreceivableconfirmations(whencreditbalancesarenotsignificant).
Loansreceivableconfirmations(e.g.,realestatemortgageloans,commercialloans,and
installmentloans).
Inventorypricetestsinwhichtheauditoranticipatesrelativelyfewmisstatementsandthe
populationisnotexpectedtocontainasignificantnumberoflargeunderstatements.
Fixedassetadditionstestswhereexistenceistherelevantassertion.
8-52
TheauditorshouldalsobeawareofdifficultiesinusingMUS:
MUSisnotdesignedtotestfortheunderstatementofapopulation.
IfanauditoridentifiesunderstatementsinaMUSsample,evaluationofthesamplerequires
specialconsiderations.
Selectionofzeroornegativebalancesrequiresspecialdesignconsiderations.
8-53
The sample size of a MUS sample is a function of the following factors: (1) the risk of incorrect
acceptance, (2) the ratio of expected misstatement to tolerable misstatement, and (3) the ratio of
tolerable misstatement to the population.
8-15
8-54
a.
b.
c.
d.
e.
f.
g.
h.
Risk of Incorrect
Ratio of Expected
Ratio of Tolerable
Acceptance
to Tolerable
Misstatement to
5%
10%
15%
20%
25%
30%
35%
50%
Misstatement
0.20
0.20
0.30
0.30
0.40
0.40
0.60
0.60
Population
50%
30%
8%
5%
4%
3%
2%
1%
Sample Size
10
12
43
56
73
80
169
170
8-55
a. $8,500,000 10 = $850,000; no need to round down
b. $8,500,000 12 = 708,333 rounded down to 700,000
c. $8,500,000 43 = $197,674 rounded down to $195,000
d. $8,500,000 56 = $151,786 rounded down to $150,000
e. $8,500,000 73 = $116,438 rounded down to $115,000
f. $8,500,000 80 = $106,250 rounded down to $105,000
g. $8,500,000 169 = $50,296 rounded down to $50,000
h. $8,500,000 170 = $50,000; no need to round down
8-56
a. From Exhibit 8.7, the sample size is 54.
b. The sampling interval = $5,643,200 54 = 104,689
c. $104,689 unless you round the interval down to the next $1,000 or $10,000. If you rounded
down to $100,000, then the largest number for a random start would be $100,000.
d. Using a sampling interval of $100,000, items 4, 6, 10, and 14 would be included in the
sample:
8-16
e.
Item
Book Value
Random Start
25,000
3,900
Book
Value26,000
28,900
100
452,000
25,000
477,000
19,000
496,000
10
10,000
506,000
11
9,000
515,000
12
2,500
517,500
13
65,000
582,500
14
110,000
692,500
15
6,992
699,492
1
2
Item
3
1
4
2
5
4
6
6
f.
the
Cumulative
Amount
Sample Item
- Selection
Amount
The
probability of
selecting each
item is as
follows:
54,900
Probability of Selection
5,000
59,900
3,900
3.9% = 3,900 / 100,000
130,000
189,900
100,000
26,000
26.0% = 26,000 / 100,000
2,000
191,900
130,000
100.0% = 130,000 / 100,000
260,000
451,900
200,300, &
260,000
100.0%
400,000
500,000
600,000
Because
logical units with
recorded
amounts greater
than the
sampling interval
might be selected
more than once,
actual number of
logical units
selected for the
sample might be
less than the
computed sample size.

8-57
a.
The audit conclusion if no misstatements are found in the sample is that the
auditor is 70 percent confident that accounts receivable are not overstated by more
than $121,000 (the basic precision = 1.21 x $100,000). Because this is less than
the tolerable misstatement of $200,000, you can conclude that the account balance
is not materially overstated.
b.
The audit evaluation of the sample results is as follows:

Confidence
Tainting
Sampling
Conclusion
8-17
Factor*
Percent
Interval
Factualmisstatementin
2,000
topstratum
Basicprecision
100,000=
1.21
Projectedmisstatement:
Firstlargesttainting%
750/15,000= 5%
Secondlargesttainting% 90/9000=
1%
100,000=
6%
Incrementalallowanceforsamplingrisk
TotalEstimatedMisstatement:
*Confidencefactorscomefromthe30%columninExhibit8.9.
121,000
6,000
1,330**
130,330
**Seebelowforthecalculationofthisvalue.
ProjectedMisstatement
IncrementalChangesin
ProjectedMisstatementX
ConfidenceFactor
Factor(Step3)
(Step2)
2.441.21=1.23
3.622.44=1.18
5,000+
1,000
6,000(Step1)
Incrementalallowanceforsamplingrisk:
6,150+
1,180
7,330(Step4)
7,3306,000=1,330(Step5)
c.
These results are acceptable because the total estimated misstatement ($130,330) is
less than tolerable misstatement ($175,000).
d.
When the total estimated misstatement exceeds the tolerable misstatement, the
auditor has available several possible courses of action. The auditor can:
Ask the client to correct the factual misstatements. If this is done, the total estimated
misstatement can be adjusted for those corrections but not for the projection of
misstatements associated with those items. In some cases, simply correcting the
factual misstatement can bring the total estimated misstatement below the auditors
tolerable misstatement level.
8-18
Analyze the detected misstatements for common problem(s). When misstatements are
discovered, the auditor should look beyond the quantitative aspects of the
misstatements to understand the nature and cause of the misstatementsespecially to
determine if there is a systematic pattern to the misstatements. If a systematic pattern
is found, the client can be asked to investigate and make an estimate of the correction
needed. The auditor can review and test this estimate. Further, the auditor can
recommend improvements to prevent such errors in the future. For example, assume
several confirmation replies indicate that merchandise was returned prior to year end
but credit was not recorded until the subsequent year. A careful review of receiving
reports related to merchandise returned prior to year end and of credits recorded in the
subsequent year will provide evidence regarding the extent of the needed correction.
The auditor should also consider the relationship of the misstatements to other phases
of the auditproblems in recording receivables may also reveal problems in the
accuracy of recorded sales.
Design an alternative audit strategy. Discovering more misstatements than expected
in the planning stage of the audit suggests that the planning assumptions may have
been in error and internal controls were not as effective as originally assessed. In such
cases, the auditor should plan the rest of the audit accordingly. For public companies,
significant problems with internal control will cause the auditor to consider whether it
is necessary to express an adverse opinion on the effectiveness of the clients internal
controls over financial reporting.
Expand the sample. The auditor can increase the sample size. Although, this approach
may not be very useful if the first sample is representative of the population.
Change the audit objective to estimating the correct value. In cases where material
misstatements are likely, it may be necessary to change from an objective of testing
details to an objective of estimating the correct population value. A lower detection
risk and a smaller tolerable misstatement should be used because the auditor is no
longer testing the balance but estimating the correct population value from the
sample. The auditor will expect the client to adjust the book value to the estimated
value. A larger sample size will normally be required. Because of the frequency of
misstatements underlying the misstated balance, the auditor should use one of the
classical statistical sampling methods to evaluate the results.
8-58
a. Round the ratio of expected to tolerable misstatement up to 30%, and round the ratio of the
tolerable misstatement to the population book value down to 4%. From Exhibit 8.7, the
sample size is 109. This is found by looking in the 10% row, the 0.30 row, and the 4%
column.
Sampling interval = population size / sample size, so:
Sampling interval = $8,124,999 / 109 = $74,541, which would likely be rounded down to
$70,000.
8-19
b.
The total estimated misstatement is calculated as follows:

Confidence
Tainting
Sampling
Factor*
Percent
Interval
Conclusion
2,000
topstratum
Basicprecision
2.31
70,000=
161,700
70,000=
8,352
4,844**
Projectedmisstatementin
lowerstratum:
11.93%
11.93%
Incrementalallowanceforsamplingrisk
inlowerstratum
176,896
**SeebelowandExhibit8.12forthecalculationofthisvalue.
First largest tainting % = $41,906.45 - $36,906.45 = $5,000 / $41,906.45 = 0.119313
ProjectedMisstatementX
ConfidenceFactor
Factor(Step3)
(Step2)
8,352(Step1)
3.892.31=1.58
13,196(Step4)
13,1968,352=4,844(Step5)
Thestatisticalconclusionisthattheauditoris90%confidentthatthispopulationisnot
overstatedbymorethan$176,896.Becausethetotalestimatedmisstatementislessthanthe
tolerablemisstatement($275,000),theauditorcanconcludethat,atthedesiredlevelofriskof
incorrectacceptance,thepopulationdoesnotcontainamaterialamountofoverstatement.
8-59
a. Round the ratio of the tolerable misstatement to the population book value down to 2%. From
Exhibit 8.7, the sample size is 171. This is found by looking in the 10% row, the 0.20 row, and
the 2% column.
8-20
Sampling interval = population size / sample size, so:

Sampling interval = $8,425,000 / 171 = $49,269, which would likely be rounded down to
$45,000.
b.
Item
1.
Dollar/Percent Misstatement
$0 / 0%
2.
3.
4.
5.
$20,000; 50%; Lower-stratum

$75,000; Top-stratum
$ 5,000; Top-stratum
$ 122; 100 percent; Lowerstratum
Problem
Account balance is correct, just
posted to wrong customer.
Credit memo problem.
Cost overrun.
Cost overrun
Credit memo problem.
8-21
c.
The total estimated misstatement is calculated as follows:

Confidence Tainting
Sampling
Factor*
Interval
Percent
Conclusion
topstratum($75K+$5K)
=
$80,000
2.31
45,000=
103,950
45,000=
67,500
Basicprecision
Projectedmisstatementin
thelowerstratum:
100%
Secondlargesttainting%
50%
150%
Incrementalallowanceforsamplingriskinlower
stratum
36,000**
$287,450
**SeebelowandExhibit8.12forthecalculationofthisvalue.
First largest tainting % = $122 0 = 122 / $122 = 100%

Second largest tainting % = $40,000 - $20,000 = $20,000 / $40,000 = 50%
ProjectedMisstatementXFactor(Step
8-22
ConfidenceFactor
(Step2)
3.892.31=1.58
5.333.89=1.44
45,000+
22,500
67,500(Step1)
3)
71,100+
32,400
103,500(Step4)
103,50067,500=36,000(Step5)
Thestatisticalconclusionisthattheauditoris90%confidentthatthispopulationisnot
overstatedbymorethan$287,450.Becausethetotalestimatedmisstatementismorethanthe
tolerablemisstatement($200,000),theauditorcanconcludethat,atthedesiredlevelofriskof
incorrectacceptance,thepopulationdoescontainamaterialamountofoverstatement.
d.
The auditor would expand audit tests on the account balance. There are two types of
misstatement patterns that should concern the auditor. First, there appears to be a problem with
timely issuance of credit memos. The auditor should find out more about the causes of the credit
memo problems and examine the process of issuing credit memos further. Second, there is a
pattern of cost overruns on large projects. The auditor would want to expand audit work to
examine a number of other large contracts to determine whether cost overruns were applicable to
other contracts, including those that had been closed during the period (sales may be overstated
even if there is a zero accounts receivable balance).
8-60
Whenthetotalestimatedmisstatementexceedsthetolerablemisstatement,theauditorhas
availableseveralpossiblecoursesofaction.Theauditorcan:
Asktheclienttocorrectthefactualmisstatements.Ifthisisdone,thetotalestimated
misstatementcanbeadjustedforthosecorrectionsbutnotfortheprojectionofmisstatements
associatedwiththoseitems.Insomecases,simplycorrectingthefactualmisstatementcan
bringthetotalestimatedmisstatementbelowtheauditorstolerablemisstatementlevel.
Analyzethedetectedmisstatementsforcommonproblem(s).Whenmisstatementsare
discovered,theauditorshouldlookbeyondthequantitativeaspectsofthemisstatementsto
understandthenatureandcauseofthemisstatementsespeciallytodetermineifthereisa
systematicpatterntothemisstatements.Ifasystematicpatternisfound,theclientcanbe
askedtoinvestigateandmakeanestimateofthecorrectionneeded.Theauditorcanreview
andtestthisestimate.Further,theauditorcanrecommendimprovementstopreventsuch
errorsinthefuture.Forexample,assumeseveralconfirmationrepliesindicatethat
merchandisewasreturnedpriortoyearendbutcreditwasnotrecordeduntilthesubsequent
year.Acarefulreviewofreceivingreportsrelatedtomerchandisereturnedpriortoyearend
andofcreditsrecordedinthesubsequentyearwillprovideevidenceregardingtheextentof
theneededcorrection.Theauditorshouldalsoconsidertherelationshipofthemisstatements
tootherphasesoftheauditproblemsinrecordingreceivablesmayalsorevealproblemsin
theaccuracyofrecordedsales.
8-23
Designanalternativeauditstrategy.Discoveringmoremisstatementsthanexpectedinthe
planningstageoftheauditsuggeststhattheplanningassumptionsmayhavebeeninerror
andinternalcontrolswerenotaseffectiveasoriginallyassessed.Insuchcases,theauditor
shouldplantherestoftheauditaccordingly.Forpubliccompanies,significantproblemswith
internalcontrolwillcausetheauditortoconsiderwhetheritisnecessarytoexpressan
adverseopinionontheeffectivenessoftheclientsinternalcontrolsoverfinancialreporting.
Expandthesample.
Theauditorcancalculatetheadditionalsamplesizeneededby
substitutingthemostlikelymisstatementfromthesampleevaluationfortheoriginal
expectedmisstatementinthesampleintervalformulaanddetermineanewintervalandtotal
samplesizebasedonthenewexpectations.Thenumberofadditionalsampleitemscanthen
bedeterminedbysubtractingtheoriginalsamplesizefromthenewsamplesize.Thenew
samplingintervalcanbeusedforselectionofitemsnotalreadyincludedinthesample.
Changetheauditobjectivetoestimatingthecorrectvalue.Incaseswherematerial
misstatementsarelikely,itmaybenecessarytochangefromanobjectiveoftestingdetailsto
anobjectiveofestimatingthecorrectpopulationvalue.Alowerdetectionriskandasmaller
tolerablemisstatementshouldbeusedbecausetheauditorisnolongertestingthebalancebut
estimatingthecorrectpopulationvaluefromthesample.Theauditorwillexpecttheclientto
adjustthebookvaluetotheestimatedvalue.Alargersamplesizewillnormallyberequired.
Becauseofthefrequencyofmisstatementsunderlyingthemisstatedbalance,theauditor
shoulduseoneoftheclassicalstatisticalsamplingmethodstoevaluatetheresults.
8-61
Scenario 1 (a). The implication of the closeness of this amount to the tolerable misstatement is
that the auditor should exercise considerable professional skepticism in concluding that the
account balance is correct in all material respects.
Appropriate Course of Action Considering Option (a). Utilitarian Theory and Rights Theory
imply that the auditor should do what is in the interests of shareholders and debt holders in this
setting, since these stakeholders have a vested financial interest in the accuracy of the financial
information. These individuals have a right to receive financial information that is correct in all
material respects. Turning to the ethical decision making framework, the auditor should consider
the following steps:
1. Identify the ethical issue. By doing no more audit work, the auditor is in danger of
concluding that the account balance is materially correct when, in fact, it may not be. The
auditor should analyze the causes of the misstatements. If they appear to be errors rather
than fraud, no further action might be needed. However, if the misstatements may be the
result of fraud, further action is required. Further, the auditor might want to reconsider
the initial professional judgments made when developing the sampling plan and assess
whether these judgments are reasonable (e.g., should tolerable deviation rate be lower,
should risk of incorrect acceptance be lower).
2. Determine the affected parties. As noted above, the shareholders and debt-holders are the
most significant affected parties.
8-24
3. Develop alternative courses of action. One course of action is to do nothing, i.e., maintain
the status quo and do no more sampling. Another course of action is to do more sampling
and/or to reconsider the initial judgments referred to in 1 above.
4. Determine likely consequences. If the auditor does nothing, the account balance may be
correct, and in that case there is no harm done. If the account balance is materially
overstated, the stock may be over-priced, or debt-holders may be providing funds at
inappropriate interest rates. If the auditor collects a larger sample, it may be that the
account balance is correct, and in that case there is no harm done (except that audit effort
is increased, and this has an associated cost). If the auditor collects a larger sample and
finds that the account balance is decidedly overstated, then the auditor could insist that
the client write the account down to a more reasonable level, and stakeholder rights will
be protected.
5. The Rights Framework would likely eliminate the do nothing course of action because of
the associated downside risk, which applies to many stakeholders. The cost of collecting
additional audit evidence is likely very small in relation to the potential benefits achieved
from calculating an accurate accounts receivable balance.
6. The appropriate course of action is to collect additional audit evidence.
Scenario 1 (b). Utilitarian Theory and Rights Theory imply that the auditor should do what is in
the interests of shareholders and debt-holders in this setting, since these stakeholders have a
vested financial interest in the accuracy of the financial information. These individuals have a
right to receive financial information that is correct in all material respects. Turning to the ethical
decision making framework, the auditor should consider the following steps:
1. Identify the ethical issue. By disregarding the detected overstatements, the upper
misstatement limit calculation is incorrect. The statistical conclusion will be invalid, i.e.,
the account balance is clearly materially misstated if the auditor goes along with what the
senior proposes.
2. Determine the affected parties. As noted above, the shareholders and debt-holders are the
most significant affected parties.
3. Develop alternative courses of action. One course of action is to do nothing, i.e., maintain
the status quo and do as the senior proposes. Another course of action is to make the
correct calculations and try to convince the senior that the associated result is appropriate.
A third course of action is to bring the matter to the attention of the manager or partner
immediately and involve them in the decision making process. Also, the audit firm
should have a whistleblower hotline to which this could be reported.
4. Determine likely consequences. If the auditor does nothing, the account balance will
clearly be misstated, and stakeholders will be materially misinformed. If the auditor
convinces the senior to revise the calculation, the account balance can be properly
adjusted (assuming that the client agrees). If the senior is not convinced, the auditor faces
the difficult choice of ignoring the issue or notifying his/her superiors, which will likely
alienate the senior. But if the manager and partner agree with the staff auditor, then the
account balance can be properly adjusted. If the staff auditor immediately informs the
manager and partner, the same (hopefully good) outcome can occur, but the senior will
very likely be alienated from the staff auditor.
5. The Rights Framework would clearly eliminate the do nothing course of action because
of the associated downside risk, which applies to many stakeholders. The option of
8-25
immediately informing superiors without first allowing the senior to change his mind will
lead to inevitable alienation in the audit team. The option of trying to convince the senior
may yield a positive outcome, and it allows the senior to save face and change his mind
before the staff auditor goes to his/her superiors.
6. The option of trying to convince the senior (and hoping for a good outcome) seems like
the best option.
Scenario 2. The information in the problem implies that there is a 10% chance that the actual
amount of the overstatement is no greater than $230,000. While this amount is greater than the
original tolerable misstatement amount of $215,000, it is less than the new amount of $250,000.
The implication of the change in the tolerable misstatement amount with regards to whether the
accounts receivable amount requires downward adjustment is that the new amount suggests that
the misstatement is not material, so no adjustment would be required. What is very important is
whether the staff auditor believes the seniors rationale for the change (i.e., that the client is in
good financial health and has relatively strong internal controls). If that is truly the case, then
there is no ethical dilemma. But the staff auditor would likely question why this change, and in
this direction, is being made nowdid the senior obtain new information that made the original
judgments inappropriate?
If that is not the case, then the auditor should follow the ethical decision making framework
outlined in Chapter 4. That decision making might proceed as follows:
1. Identify the ethical issue. By altering the tolerable amount simply so that the
misstatement will not be material, the senior allows a materially misstated amount to
be reported. The additional ethical issue is that of the seniors deceptive and
calculating behavior, which harms the character of the engagement team and the audit
firm.
2. Determine the affected parties. As noted above, the shareholders and debt holders are
the most significant affected parties. In addition, other individuals at the audit firm are
harmed because if this behavior is allowed to occur unchecked, then their right to
working at an ethical and professionally-bound workplace is violated.
3. Develop alternative courses of action. One course of action is to do nothing, i.e.,
maintain the status quo and do as the senior proposes. Another course of action is to
convince the senior that his proposal is inappropriate. A third course of action is to
bring the matter to the attention of the manager or partner immediately and involve
them in the decision making process.
4. Determine likely consequences. If the auditor does nothing, the account balance will
clearly be misstated, and stakeholders will be materially misinformed. If the auditor
convinces the senior not to falsely recalculate materiality, the account balance can be
properly adjusted (assuming that the client agrees). If the senior is not convinced, the
auditor faces the difficult choice of ignoring the issue or notifying his/her superiors,
which will likely alienate the senior. But if the manager and partner agree with the
staff auditor, then the account balance can be properly adjusted. If the staff auditor
immediately informs the manager and partner, the same (hopefully good) outcome
can occur, but the senior will very likely be alienated from the staff auditor.
8-26
5. The Rights Framework would clearly eliminate the do nothing course of action
because of the associated downside risk, which applies to many stakeholders. The
option of immediately informing superiors without first allowing the senior to change
his mind will lead to inevitable alienation in the audit team. The option of trying to
convince the senior may yield a positive outcome, and it allows the senior to save
face and change his mind before the staff auditor goes to his/her superiors.
6. The option of trying to convince the senior (and hoping for a good outcome) seems like
the best option.
Scenario 3. Managements incentive is generally to overstate assets, including accounts
receivable. This trend of overstatements reveals either that management is intentionally
overstating the accounts, or they have not invested in adequate internal controls or accounting
staff to assure the accurate recording of accounts receivable. Therefore, the audit firm should
consider this issue in its client continuance decision, increasing the assessed risk profile of
management, and making sure to employ an appropriate level of professional skepticism during
the conduct of the audit. The ethical implication of this issue is that management may not be as
trustworthy as previously thought. A lack of trust has a pervasive effect on the audit because it
calls into question managements possible motivations to misstate other accounts, or to provide
inaccurate descriptions of facts. Auditors in this situation will carefully consider whether they
want to retain this client in the future. If the audit firm does retain the client, the auditor should
increase their professional skepticism, heighten inherent risk assessments, and conduct a more
substantive audit as a result.
8-62
a. Analyze a file. Use GAS to create a graphical analysis of items making up a population, for
example graphing the dollar value of account balances to see how many are above a certain
amount.
b. Select transactions based on logical identifiers. Use GAS to select transactions that are
greater than a certain dollar amount, or that occur during a certain period in time, such as the
last week of the year and the first week of the next year.
c. Select samples. Use GAS to select a sample using a program such as ACL.
d. Evaluate samples. Use GAS to evaluate a sample using a program such as ACL.
e. Print confirmations. Use GAS to select account balances for confirmation, and print
confirmations for mailing.
f. Analyze overall file validity. Use GAS to read a computer file and compare individual items
with control parameters to determine whether edit controls were overridden.
g. General control totals. Use GAS to count the number of transactions contained in a file and
compare that total to the number of individual records.
h. Perform numerical analyses. Use GAS to study patterns of data, for example according to
Benfords Law.
8-27
8-63
AdvantagesofusingGASaspartoftheauditinclude:
Thesoftwareisindependentofthesystembeingauditedandsimplyneedsareadonly
copyofthefiletoavoidanycorruptionofanorganizationsdata.
Thesoftwareincludesmanyauditspecificroutines,suchassampling.
Thesoftwarecanprovidedocumentationofeachtestperformedinthesoftwarethatcan
beusedasdocumentationintheauditorsworkpapers.
GAScanhelpauditorsbemoreefficientincompletingtheirauditresponsibilitiesrelated
togatheringandevaluatingauditevidence.
Academic Research Case

a.
The paper provides data on the sampling practices of auditors in industry, government
and public accounting. Auditors were surveyed to determine if they used statistical or
nonstatistical sampling techniques to determine sample size, to select sample items, and to
evaluate sample outcomes. The following issues were also addressed:
training and education received by auditors concerning sampling methods and debiasing
techniques,
sources auditors relied on for guidance on sampling procedures, and
whether debiasing techniques were used when employing nonstatistical methods to determine
samples for audit testing.
b.
The results of the surveys indicated that 85% of the respondents rely on nonstatistical
methods to plan sample sizes within all three areas of audit practice being surveyed. Haphazard
sampling was the most commonly used method to select samples (74% of respondents).
Respondents also indicated that 15% of their samples were selected using statistical methods.
However, 36% of the samples were evaluated using statistical methods. This indicates that 21%
of auditors nonstatistical samples were being improperly evaluated with statistical methods. The
use of improper statistical evaluation methods to evaluate samples obtained using nonstatistical
methods is more predominant in industry audits.
All respondents indicated reliance on employer guidance when seeking guidance on sampling
methods and most reported reliance on AICPA literature. However, 100 % of those surveyed in
the industry field indicated reliance on IIA standards. However, none of the other audit fields
surveyed indicated any reliance on the IIA standards.
Eighty-seven percent of the respondents indicated minor coverage of statistical sampling
methods as part of their college courses, while 91% indicated minor coverage of nonstatistical
sampling methods in college courses.
Regarding biases related to nonstatistical sample selections most respondents reported any such
issues to be minor during sampling selection. None of the respondents used any procedures to
8-28
mitigate the possibilities of any biases affecting sampling selection; nor did they report any
meaningful instruction on the use of mitigating procedures.
c.
Sampling methods used during sample selection can have a major impact on the outcome
of the audit opinion. The method used to select samples of evidence for auditing can affect the
number and type of items selected for review. The method used to evaluate the sample outcome
can also affect the outcome of the audit. Several well designed studies have documented biases
in nonstatistical sample selections. The auditor needs to be aware that nonstatistical sample
methods can lead to biased selections, unless debiasing techniques are used. The absence of
meaningful debiasing procedures for nonstatistical sample selections and evaluations may create
a legal exposure for the auditor.
The findings allow practicing auditors to benchmark their current sampling processes against the
current norms. Auditors (who rely mostly on nonstatistical methods for sampling selections)
should consider the need for debiasing techniques and restrict the use of statistical evaluations to
applications that rely on statistical selection methods to avoid samples being improperly
evaluated.
University educators should consider devoting additional class time to nonstatistical sampling
methods including the weaknesses of these methods and how to work with them. Standardsetting bodies should consider developing detailed sampling standards specifically tailored for
auditors in industry and government as the current standards are mostly related to public
accounting.
d.
Surveys were mailed to 600 randomly selected offices of auditors working in public
accounting, industry, federal and state government. The surveys requested these offices to have
auditors who had performed sampling techniques within the last 6 months to complete and return
the questionnaires. 223 usable surveys were returned. The selected surveys included auditors
with an average experience of 2.6 years and half held entry level staff positions.
e.
The student (and practice) should be aware that the research for this paper was done in
mid-1997. The research on the use of alternative statistical selection methods was limited to
evaluation methods that distinguished between statistical and non-statistical evaluation of
sampling.
8-29

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Solutions for Chapter 8

Review and Short Case Questions

sample, because the

Upper Limit of Control Failures

The lack of customer orders for two

The lack of shipping documents could

Sales being recorded prior to shipment

Billing for more quantities than

d. Effect on rest of audit

c. Projected misstatement. Thebestestimateoftheactualamountofdollarmisstatementsinthe

Lower stratum projected misstatement: ($600/$185,000) * $1,500,000 = $4,864.86

computed sample size.

The audit evaluation of the sample results is as follows:

The total estimated misstatement is calculated as follows:

Sampling interval = population size / sample size, so:

$20,000; 50%; Lower-stratum

The total estimated misstatement is calculated as follows:

First largest tainting % = $122 0 = 122 / $122 = 100%

Academic Research Case

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