9-1

Chapter Nine
Audit Sampling:
An Application to Substantive Tests
of Account Balances

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 9-2

Substantive Tests of Details of Account

Balances
The statistical concepts we discussed in the last
chapter apply to this chapter as well. Three important
determinants of sample size are
1. Desired confidence level.
2. Tolerable misstatement.
3. Estimated misstatement.
Misstatements discovered in the audit sample must
be projected to the population, and there must be an
allowance for sampling risk.

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 9-3

Substantive Tests of Details of Account

Balances
Consider the following information about the inventory
account balance of an audit client:
Book value of inventory account balance $ 3,000,000
Book value of items sampled $ 100,000
Audited value of items sampled 98,000
Total amount of overstatement observed in audit sample $ 2,000

The ratio of misstatement in the sample is 2%

($2,000 $100,000)
Applying the ratio to the entire population produces a best
estimate of misstatement of inventory of $60,000.
($3,000,000 2%)
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 9-4

Substantive Tests of Details of Account

Balances

The results of our audit test depend

upon the tolerable error associated with
the inventory account. If the tolerable
error is $50,000, we cannot conclude
that the account is fairly stated because
our best estimate of the projected error
is greater than the tolerable error.

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 9-5

Monetary-Unit Sampling (MUS)

MUS uses attribute-sampling theory to

express a conclusion in dollar amounts rather
than as a rate of occurrence. It is commonly
used by auditors to test accounts such as
accounts receivable, loans receivable,
investment securities, and inventory.

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 9-6

Monetary-Unit Sampling (MUS)

MUS uses attribute-sampling theory to

estimate the percentage of monetary units in
a population that might be misstated and then
multiplies this percentage by an estimate of
how much the dollars are misstated.

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 9-7

Monetary-Unit Sampling (MUS)

Advantages of MUS
1. When the auditor expects no misstatement, MUS
usually results in a smaller sample size than classical
variables sampling.
2. The calculation of the sample size and evaluation of
the sample results are not based on the variation
between items in the population.
3. When applied using the probability-proportional-to-size
procedure, MUS automatically results in a stratified
sample.
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 9-8

Monetary-Unit Sampling (MUS)

Disadvantages of MUS
1. The selection of zero or negative balances generally
requires special design consideration.
2. The general approach to MUS assumes that the
audited amount of the sample item is not in error by
more than 100%.
3. When more than one or two misstatements are
detected, the sample results calculations may
overstate the allowance for sampling risk.

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 9-9

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
Define the population.
Define the sample unit.
Define a misstatement.
3. Determine the sample size, using the following inputs:
The desired confidence level or risk of incorrect acceptance.
The tolerable misstatement.
The expected population misstatement.
Population size.
Performance
4. Select sample items.
5. Perform the auditing procedures.
Evaluation
6. Understand an alayzye any missstatements observed.
7. Calculate the projected misstatement and the upper limit on misstatement.
8. Draw final conclusions.
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 9-10

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
Define the population.
Define the sample unit.
Define a misstatement.

Sampling may be used for substantive testing to:

1. Test the reasonableness of assertions about a
financial statement amount.
2. Develop an estimate of some amount.

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 9-11

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
Define the population.
Define the sample unit.
Define a misstatement.

For MUS the population is defined as the

monetary value of an account balance,
such as accounts receivable, investment
securities, or inventory.

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 9-12

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
Define the population.
Define the sample unit.
Define a misstatement.

An individual dollar represents the sampling unit.

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 9-13

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Planning
1. Determine the test objectives.
2. Define the population characteristics.
Define the population.
Define the sample unit.
Define a misstatement.

A misstatement is defined as the difference between

monetary amounts in the clients records and
amounts supported by audit evidence.

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 9-14

Steps in MUS Sampling Application

Steps in MUS Sampling Application
3. Determine the sample size, using the following inputs:
The desired confidence level or risk of incorrect acceptance.
The tolerable misstatement.
The expected population misstatement.
Population size.

Relationship Change Effect on

Factor to Sample Size in Factor Sample
Lower Decrease
Desired confidence level Direct
Higher Increase
Lower Increase
Tolerable mistatement Inverse
Higher Decrease
Lower Decrease
Expected mistatement Direct
Higher Increase
Lower Decrease
Population size Direct
Higher Increase

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 9-15

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Performance
4. Select sample items.
5. Perform the auditing procedures.
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement
7. Draw final conclusions.

The auditor selects a sample for MUS by using a

systematic selection approach called probability-
proportionate-to-size selection. The sampling interval
can be determined by dividing the book value of the
population by the sample size. Each individual dollar in
the population has an equal chance of being selected.

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 9-16

Steps in MUS Sampling Application

Assume a clients book value of accounts receivable is $2,500,000, and the
auditor determined a sample size of 93. The sampling interval will be
$26,882 ($2,500,000 93). The random number selected is $3,977 the
auditor would select the following items for testing:
Cumulatvie Sample
Account Balance Dollars Item
1001 Ace Emergency Center $ 2,350 $ 2,350
1002 Admington Hospital 15,495 17,845 $ 3,977 (1) $ 3,977
1003 Jess Base, Inc. 945 18,780 26,882
1004 Good Hospital Corp. 21,893 40,673 30,859 (2) $ 30,859
1005 Jen Mara Corp. 3,968 44,641
1006 Zippy Corp. 32,549 77,190 57,741 (3)
1007 Green River Mfg. 2,246 79,436
1008 Bead Hospital Centers 11,860 91,306 84,623 (4)


1213 Andrew Call Medical - 2,472,032
1214 Lilly Heather, Inc. 26,945 2,498,977 2,477,121 (93)
1215 Janyne Ann Corp. 1,023 $ 2,500,000
Total Accounts Receivable $ 2,500,000

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 9-17

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Performance
4. Select sample items.
5. Perform the auditing procedures.
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement
7. Draw final conclusions.

After the sample items have been selected,

the auditor conducts the planned audit
procedures on the logical units containing
the selected dollar sampling units.

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 9-18

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement
7. Draw final conclusions.

The misstatements detected in the sample

must be projected to the population.
Example Information
Book value $ 2,500,000
Tolerable misstatement $ 125,000
Sample size 93
Desired confidence level 5%
Expected amount of misstatement $ 25,000
Sampling interval $ 26,882

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 9-19

Steps in MUS Sampling Application

Basic Precision
If no misstatements are found in the sample,
the best estimate of the population
misstatement would be zero dollars.
Sample Actual Number of Deviations Found
Size 0 1 2 3
65 4.6 7.1 9.4 11.5
70 4.2 6.6 8.8 10.8
85 4.0 6.2 8.2 10.1
80 3.7 5.8 7.7 9.5
90 3.3 5.2 6.9 8.4
100 3.0 4.7 6.2 7.6
125 2.4 3.8 5.0 6.1

$26,882 3.0 = $80,646 upper misstatement limit

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 9-20

Steps in MUS Sampling Application

Misstatements Detected
In the sample of 93 items the following misstatements
were found:
Tainting
Customer Book Value Audit Value Difference Factory
Good Hospital $ 21,893 $ 18,609 $ 3,284 15%
Marva Medical Supply 6,705 4,023 2,682 40%
Axa Corp. 32,549 30,049 2,500 NA
Learn Heart Centers 15,000 - 15,000 100%

Because the Axa balance of$3,284

$32,549 is greater
$21,893 than the
= 15%
interval of $26,882, no sampling risk is added. Since all
the dollars in the large accounts are audited, there is no
sampling risk associated with large accounts.

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 9-21

Steps in MUS Sampling Application

Compute the Upper Misstatement Limit
We compute the upper misstatement limit by calculating basic
precision and ranking the detected misstatements based on
the size of the tainting factor from the largest to the smallest.
Tainting Sample Projected 95% Upper Upper
Customer Factor Interval Misstatement Limit Misstatement
Basic Precision 1.00 $ 26,882 NA 3.0 $ 80,646
Learn Heart Centers 1.00 26,882 (26,882) 1.7 (4.7 - 3.0) 45,700
Marva Medical 0.40 26,882 (10,753) 1.5 (6.2 - 4.7) 16,130
Good Hospital 0.15 26,882 (4,032) 1.4 (7.6 - 6.2) 5,645
Add misstatments greater
that the sampling interval:
Axa Corp. NA 26,882 NA 2,500
Upper Misstatement Limit $ 150,621

(0.15 $26,882 1.4 = $5,645)

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 9-22

Steps in MUS Sampling Application

Steps in MUS Sampling Application
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement
7. Draw final conclusions.

In our example, the final decision is

whether the accounts receivable balance
is materially misstated or not.

We compare the tolerable misstatement to the upper

misstatement limit. If the upper misstatement limit is less
than or equal to the tolerable misstatement, we conclude
that the balance is not materially misstated.

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 9-23

Steps in MUS Sampling Application

In our example the upper misstatement limit of $150,621
is greater than the tolerable misstatement of $125,000, so
the auditor concludes that the accounts receivable
balance is materially misstated.
When faced with this situation, the auditor may:
1. Increase the sample size.
2. Perform other substantive procedures.
3. Request the client adjust the accounts receivable balance.
4. If the client refuses to adjust the account balance, the
auditor would consider issuing a qualified or adverse
opinion.
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 9-24

Risk When Evaluating Account Balances

True State of Financial Statement Account

Auditor's Decision Based
on Sample Evidence Not Materially Misstated Materially Misstated
Supports the fairness of Risk of incorrect
Correct decision
the account balance acceptance (Type II)
Does not support the
fairness of the account Risk of incorrect Correct Decision
balance rejection (Type I)

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 9-25

Why is Sample Size Not Used in

Evaluating MUS Results?

Most MUS evaluation approaches use the misstatement

factors and increments associated with a sample size of 100,
regardless of the actual sample size used by the auditor.
95% Confidence Level 90% Confidence Level
Number of Misstatement Incremental Misstatement Incremental
Errors Factor Increase Factor Increase
0 3.0 2.3
1 4.7 1.7 3.9 1.6
2 6.2 1.5 5.3 1.4
3 7.6 1.4 6.6 1.3
4 9.0 1.4 7.9 1.3

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 9-26

Effect of Understatement Misstatements

MUS is not particularly effective at detecting

understatements. An understated account is less likely to be
selected than an overstated account.
Book Audit Tainting
Customer Value Value Difference Factor
Wayne County Medical $ 2,000 $ 2,200 $ (200) -10%

The most likely error will be reduced by $2,688

( 0.10 $26,882)

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 9-27

Nonstatistical Sampling for Tests of

Account Balances
The sampling unit for nonstatistical sampling is normally a
customer account, an individual transaction, or a line item
on a transactions. When using nonstatistical sampling, the
following items must be considered:

o Identifying individually significant items.

o Determining the sample size.
o Selecting sample items.
o Calculating the sample results.

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 9-28

Identifying Individually Significant Items

The items to be tested individually are items that may

contain potential misstatements that individually exceed
the tolerable misstatement. These items are tested
100% because the auditor is not willing to accept any
sampling risk.

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 9-29

Determining the Sample Size

Sample Population book value

= Tolerable misstatement Assurance factor
Size

Risk That Other Substantive Procedures Will Fail to

Detect Material Misstatements
Combined Assessment of Slightly Below
Inherent and Control Risk Maximum Maximum Moderate Low
Maximum 3.0 2.7 2.3 2.0
Slightly below maximum 2.7 2.4 2.0 1.6
Moderate 2.3 2.1 1.6 1.2
Low 2.0 1.6 1.2 1.0

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 9-30

Selecting Sample Items

Auditing standards require that the sample items be

selected in such a way that the sample can be expected
to represent the population.

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 9-31

Calculating the Sample Results

One way of projecting the sampling results to the

population is to apply the misstatement ratio in the
sample to the population.

Assume the auditor If the population

finds $1,500 in total is $200,000,
misstatements in a the projected
sample of $15,000. misstatement would
The misstatement be $20,000
ratio is 10%. ($200,000 10%)

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 9-32

Calculating the Sample Results

A second method is the difference estimation. This

method projects the average misstatement of each item
in the sample to all items in the population.

Assume
misstatements in a The projected
sample of 100 items misstatement would
total $300, and the be $30,000, ($300
population contains 100 = $3 10,000).
10,000 items.

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 9-33

Nonstatistical Sampling Example

The auditors of Calabro Paging Service have decided

to use nonstatistical sampling to examine the accounts
receivable balance. Calabro has 11,800 accounts with
a balance of $3,717,900. The auditors stratify the
accounts as follows:
Number and Size Book
of Accounts Value
15 accounts > $25,000 $ 550,000
250 accounts > $3,000 850,500
11,535 accounts < $3,000 2,317,400
Total $ 3,717,900

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 9-34

Nonstatistical Sampling Example

The auditors decide . . .

o There is a low assessment for inherent and control risk.
o The tolerable misstatement is $40,000, and the expected
misstatement is $15,000.
o There is a moderate risk that other auditing procedures
will fail to detect material misstatements.
o All customer account balances greater than $25,000 are
to be audited.

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 9-35

Nonstatistical Sampling Example

Sample Population book value

= Tolerable misstatement Assurance factor
Size

$3,717,900 $550,000

Sample $3,167,900
= 1.2 = 95 rounded
Size $40,000

Risk That Other Substantive Procedures Fail to

Detect Material Misstatement
Combined Assessment of Slightly Below
Inherent and Control Risk Maximum Maximum Moderate Low
Maximum 3.0 2.7 2.3 2.0
Slightly below maximum 2.7 2.4 2.0 1.6
Moderate 2.3 2.1 1.6 1.2
Low 2.0 1.6 1.2 1.0
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 9-36

Nonstatistical Sampling Example

The auditor sent positive confirmations to each of the 110

(95 + 15) accounts selected. Either the confirmations were
returned or alternative procedures were successfully
used. Four customers indicated that their accounts were
overstated and the auditors determined that the
misstatements were the result of unintentional error by
client personnel. Here are the results of the audit testing:
Amount of
Book Value Audit Value Over-
Stratum Book Value of Sample of Sample Statement
>$25,000 $ 550,000 $ 550,000 $ 549,500 $ 500
>$3,000 850,500 425,000 423,000 2,000
<$3,000 2,317,400 92,000 91,750 250

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 9-37

Nonstatistical Sampling Example

As a result of the audit procedures, the following

projected misstatement was prepared:
Amount of Ratio of Misstatement Projected
Stratum Misstatement in Stratum Tested Misstatement
>$25,000 $ 500 100% $ 500
>$3,000 2,000 $2,000 425,000 $850,500 4,002
<$3,000 250 $250 92,000 $2,317,400 6,298
Total projected misstatement $ 10,800

The total projected misstatement of $10,800 is less than

the expected misstatement of $15,000, so the auditors
may conclude that there is a low risk that the true
misstatement exceeds the tolerable misstatement.
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 9-38

Why Did Statistical Sampling Fall Out Of

Favor?

1.Firms found that some auditors were

over relying on statistical sampling
techniques to the exclusion of good
judgment.
2.There appears to be poor linkage
between the applied audit setting and
traditional statistical sampling
applications.

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 9-39

Classical Variable Sampling

Classical variables sampling uses normal distribution

theory to evaluate the characteristics of a population
based on sample data. Auditors most commonly use
classical variables sampling to estimate the size of
misstatement.

Sampling distributions are formed by plotting the

projected misstatements yielded by an infinite
number of audit samples of the same size taken
from the same underlying population.

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 9-40

Classical Variables Sampling

A sampling distribution is useful because it allows us

to estimate the probability of observing any single
sample result.
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 9-41

Classical Variables Sampling

In classical variables sampling, the sample mean is

the best estimate of the population mean.
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 9-42

Classical Variables Sampling

Advantages
1. When the auditor expects a large number of
differences between book and audited values, this
method will result in smaller sample size than
MUS.
2. The techniques are effective for both
overstatements and understatements.
3. The selection of zero balances generally does not
require special sample design considerations.

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 9-43

Classical Variables Sampling

Disadvantages
1. To determine sample size, the auditor must
estimate the standard deviation of the audited
value or differences.
2. If few misstatements are detected in the sample
data, the true variance tends to be
underestimated, and the resulting projection of the
misstatements to the population is likely not to be
reliable.

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 9-44

Applying Classical Variables Sampling

Defining the Sampling Unit

The sampling unit can be a customer account,
an individual transaction, or a line item. In
auditing accounts receivable, the auditor can
define the sampling unit to be a customers
account balance or an individual sales invoice
included in the account balance.

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 9-45

Applying Classical Variables Sampling

Determining the Sample Size

2
Sample Population size ZIA SD
=
Size Tolerable misstatement Estimated misstatement

where
ZIA = One-tailed Z value for the specified
level of the risk of incorrect acceptance.
SD = Estimated standard deviation.

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 9-46

Applying Classical Variables Sampling

The risk of incorrect acceptance is the risk that the

auditor will mistakenly accept a population as fairly
stated when the true population misstatement is greater
than tolerable misstatement.
Risk of Incorrect
Acceptance Z Value
2.5% 1.96
5.0% 1.65
10.0% 1.28
15.0% 1.04
20.0% 0.84

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 9-47

Applying Classical Variables Sampling

The year-end balance for accounts receivable contains 5,500

accounts with a book value of $5,500,000. The tolerable
misstatement for accounts receivable is set at $50,000. The
expected misstatement has been judged to be $20,000. The
risk of incorrect acceptance is 2.5%. Based on work
completed last year, the auditor estimates the standard
deviation at $31. Lets calculate sample size.

2
Sample 5,500 1.96 $31
= = 125
Size $50,000 $20,000

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 9-48

Applying Classical Variables Sampling

Calculating the Sample Results

The sample selection usually relies on random-
selection techniques. Upon completion, 30 of the
customer accounts selected contained misstatements
that totaled $330.20. Our first calculation is the mean
misstatement in an individual account which is
calculated as follows:
Mean
misstatement Total audit difference
=
per sampling Sample size
item
= $330.20 = $2.65
125
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 9-49

Applying Classical Variables Sampling

The mean misstatement must be

projected to the population.

Projected
population = Population size Mean misstatement
misstatement
(in sampling units) per sampling item

= 5,500 $2.65 = $14,575

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 9-50

Applying Classical Variables Sampling

Point estimate of accounts receivable balance . . .

Accounts receivable Book Projected population

=
point estimate value misstatement

= $5,500,000 $14,575 = $5,485,425

The sum of the audited differences squared is

equal to $36,018.32. We will use this value to
calculate the standard deviation.

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 9-51

Applying Classical Variables Sampling

The formula for the standard deviation is . . .

Total audit Sample Mean difference

SD = differences squared Size per sampling item2

Sample size 1

= $36,018.32 (125 2.652) = $16.83

124

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 9-52

Applying Classical Variables Sampling

Confidence Population SD
bound
= size ZIA
Sample size

16.83
= 5,500 1.96 125 = $16,228

Confidence Population Confidence

interval
=
point estimate bound

= $5,485,425 $16,228
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 9-53

Applying Classical Variables Sampling

Book
value
$5,500,000

Lower Point Upper

bound estimate bound
$5,469,198 $5,485,425 $5,501,652

Confidence interval

If the precision interval includes the book value, the

evidence supports the conclusion that the account is not
materially misstated.

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 9-54

Applying Classical Variables

Sampling
Book
value
$5,508,000

Lower Point Upper

bound estimate bound
$5,469,198 $5,485,425 $5,501,652

Confidence interval

When the evidence indicates that the account may be materially

misstated the auditor might consider (1) increasing sample size, (2)
performing additional substantive procedures, (3) adjusting the
account, or (4) issue a qualified or adverse opinion.

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 9-55

End of Chapter 9

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