Statistics For Managers Using Microsoft® Excel 5th Edition: Confidence Interval Estimation

Statistics for Managers
Using Microsoft® Excel

5th Edition
Chapter 8
Confidence Interval Estimation
Statistics for Managers Using Microsoft Excel, 5e © 2008 Pearson Prentice-Hall, Inc. Chap 8-1
Learning Objectives
In this chapter, you will learn:

 To construct and interpret confidence
interval estimates for the mean and the
proportion
 How to determine the sample size necessary
to develop a confidence interval for the mean
or proportion
 How to use confidence interval estimates in
auditing
Chapter Outline
1. Confidence Intervals for the Population

Mean, μ
 when Population Standard Deviation σ is
Known
 when Population Standard Deviation σ is
Unknown
2. Confidence Intervals for the Population
Proportion, π
3. Determining the Required Sample Size
Point Estimates
 A point estimate is a single number. For the
population mean (and population standard
deviation), a point estimate is the sample mean
(and sample standard deviation).
 A confidence interval provides additional
information about variability
Lower Confidence Upper Confidence

Limit Point Estimate Limit
Width of
confidence interval
Confidence Interval Estimates
 A confidence interval gives a range estimate of
values:
 Takes into consideration variation in sample
statistics from sample to sample
 Based on all the observations from 1 sample
 Gives information about closeness to unknown
population parameters
 Stated in terms of level of confidence
 Ex. 95% confidence, 99% confidence
 Can never be 100% confident
Confidence Interval Estimates
 The general formula for all

confidence intervals is:
Point Estimate ± (Critical Value) (Standard Error)
Confidence Level
 Confidence Level
 Confidence in which the interval will contain the
unknown population parameter
 A percentage (less than 100%)
Confidence Level
 Suppose confidence level = 95%
 Also written (1 - ) = .95
 A relative frequency interpretation:
 In the long run, 95% of all the confidence
intervals that can be constructed will contain
the unknown true parameter
 A specific interval either will contain or will
not contain the true parameter
Confidence Interval for μ
(σ Known)
Assumptions
 Population standard deviation σ is known
 Population is normally distributed
 If population is not normal, use large sample
Confidence interval estimate:
σ
XZ
n
(where Z is the standardized normal distribution critical value
for a probability of α/2 in each tail)
Finding the Critical Value, Z
Consider a 95% confidence interval:
1    .95
α α
 .025  .025
2 2
Z units: Z= -1.96 0 Z= 1.96

Lower Upper
X units: Confidence Point Estimate Confidence
Limit Limit
Finding the Critical Value, Z
Commonly used confidence levels are 90%, 95%,
and 99%
Confidence Confidence
Level Coefficient Z value
80% .80 1.28

90% .90 1.645
95% .95 1.96
98% .98 2.33
99% .99 2.58
99.8% .998 3.08
99.9% .999 3.27
Intervals and Level of
Confidence
Sampling Distribution
of the Mean
/2 1  /2
x
Intervals μx  μ
extend from x1
(1-)x100%
x2
σ of intervals
X Z
n constructed
to contain μ;
σ
X Z ()x100% do
n Confidence Intervals not.
(σ Known) Example
 A sample of 11 circuits from a large normal
population has a mean resistance of 2.20
ohms. We know from past testing that the
population standard deviation is .35 ohms.
 Determine a 95% confidence interval for the

true mean resistance of the population.
(σ Known) Example
σ
X Z
n
 2.20  1.96 (.35/ 11 )
 2.20  .2068
(1.9932 , 2.4068)
 We are 95% confident that the true mean resistance is between
1.9932 and 2.4068 ohms
 Although the true mean may or may not be in this interval, 95% of
intervals formed in this manner will contain the true mean
(σ Unknown)
 If the population standard deviation σ is
unknown, we can substitute the sample
standard deviation, S
 This introduces extra uncertainty, since S is
variable from sample to sample
 So we use the t distribution instead of the
normal distribution
(σ Unknown)
Assumptions
 Population standard deviation is unknown
 Population is normally distributed
 If population is not normal, use large sample
Use Student’s t Distribution
Confidence Interval Estimate: S
X  t n-1
n
(where t is the critical value of the t distribution with n-1
d.f. and an area of α/2 in each tail)
Student’s t Distribution
 The t value depends on degrees of freedom (d.f.)

 Number of observations that are free to vary after
sample mean has been calculated
d.f. = n - 1
Degrees of Freedom
Idea: Number of observations that are free to vary
after sample mean has been calculated
Example: Suppose the mean of 3 numbers is 8.0
 Let X1 = 7 If the mean of these three

 Let X2 = 8 values is 8.0,
 What is X3? then X3 must be 9
(i.e., X3 is not free to vary)
Here, n = 3, so degrees of freedom = n – 1 = 3 – 1 = 2
(2 values can be any numbers, but the third is not free to vary for a
given mean)
Student’s t Distribution
Note: t Z as n increases
Standard
Normal
(t with df = ∞)
t (df = 13)
t-distributions are bell-
shaped and symmetric, but
have ‘fatter’ tails than the t (df = 5)
normal
0 t
Student’s t Table
Upper Tail Area
Let: n = 3
df .25 .10 .05 df = n - 1 = 2
 = .10
1 1.000 3.078 6.314 /2 =.05
2 0.817 1.886 2.920

3 0.765 1.638 2.353 /2 = .05
The body of the table contains t

values, not probabilities 0 2.920 t
(σ Unknown) Example
A random sample of n = 25 has X = 50 and S = 8. Form a 95%
confidence interval for μ
 d.f. = n – 1 = 24, so
 The confidence interval is
S 8
X  t/2, n -1  50  (2.0639)
n 25
(46.698 , 53.302)
Confidence Intervals for the
Population Proportion, π
 An interval estimate for the population
proportion ( π ) can be calculated by adding
an allowance for uncertainty to the sample
proportion ( p )
Recall that the distribution of the sample proportion is
approximately normal if the sample size is large, with
standard deviation
 (1   )
σp 
n
We will estimate this with sample data:
p(1 p)
n
Upper and lower confidence limits for the population proportion
are calculated with the formula
p(1  p)
pZ
n
where
 Z is the standardized normal value for the level of
confidence desired
 p is the sample proportion
 n is the sample size
Population Proportion, Example
A random sample of 100 people shows that 25 have opened
IRA’s this year. Form a 95% confidence interval for the true
proportion of the population who have opened IRA’s.
p  Z p(1  p)/n
 25/100  1.96 .25(.75)/100
 .25  1.96 (.0433)

(0.1651 , 0.3349)
Population Proportion, Example
 We are 95% confident that the true
percentage of left-handers in the population
is between 16.51% and 33.49%. Although
the interval from .1651 to .3349 may or may
not contain the true proportion, 95% of
intervals formed from samples of size 100 in
this manner will contain the true proportion.
Determining Sample Size
 The required sample size can be found to

reach a desired margin of error (e) with a
specified level of confidence (1 - )
 The margin of error is also called sampling
error
 the amount of imprecision in the estimate of the
population parameter
 the amount added and subtracted to the point
estimate to form the confidence interval
 To determine the required sample size for the
mean, you must know:
 The desired level of confidence (1 - ), which
determines the critical Z value
 The acceptable sampling error (margin of
error), e
 The standard deviation, σ
2 2
σ Z σ
eZ Now solve
n
n for n to get
e 2
If  = 45, what sample size is needed to estimate

the mean within ± 5 with 90% confidence?
Z 2 σ 2 (1.645)2 (45)2
n 2
 2
 219.19
e 5
So the required sample size is n = 220
 If unknown, σ can be estimated when using

the required sample size formula
 Use a value for σ that is expected to be at least
as large as the true σ
 Select a pilot sample and estimate σ with the
sample standard deviation, S
To determine the required sample size for the proportion,
you must know:
 The desired level of confidence (1 - ), which
determines the critical Z value
 The acceptable sampling error (margin of error), e
 The true proportion of “successes”, π
 π can be estimated with a pilot sample, if necessary (or
conservatively use π = .50)
 (1   ) Now solve Z  (1   )
2
eZ for n to get n

n e2
How large a sample would be necessary to

estimate the true proportion defective in a large
population within ±3%, with 95% confidence?
 (Assume a pilot sample yields p = .12)
Solution:
For 95% confidence, use Z = 1.96
e = .03
p = .12, so use this to estimate π
Z 2  (1   ) (1.96) 2 (.12)(1  .12)

n 2
 2
 450.74
e (.03)
So use n = 451
Applications in Auditing
 Six advantages of statistical sampling in

auditing
 Sample result is objective and defensible
 Based on demonstrable statistical principles
 Provides sample size estimation in advance on
an objective basis
 Provides an estimate of the sampling error
Applications in Auditing
 Can provide more accurate conclusions on the
population
 Examination of the population can be time
consuming and subject to more nonsampling error
 Samples can be combined and evaluated by
different auditors
 Samples are based on scientific approach
 Samples can be treated as if they have been done
by a single auditor
 Objective evaluation of the results is possible
 Based on known sampling error
Population Total Amount
 Point estimate:
Population total  NX
 Confidence interval estimate:
S Nn
NX  N ( t n1 )
n N 1
(This is sampling without replacement, so use the finite population correction
in the confidence interval formula)
 A firm has a population of 1000 accounts and wishes

to estimate the total population value.
 A sample of 80 accounts is selected with average

balance of $87.6 and standard deviation of $22.3.
 Find the 95% confidence interval estimate of the

total balance.
N  1000, n  80, X  87.6, S  22.3
S Nn
N X  N (t n 1 )
n N 1
22.3 1000  80
 (1000)(87.6)  (1000)(1.9905)
80 1000  1
 87,600  4,762.48
The 95% confidence interval for the population total balance

is $82,837.52 to $92,362.48
Confidence Interval for
Total Difference
 Point estimate:
Total Difference  ND
 Where the mean difference, D , is:

n
D i
D i 1
n
where D i  audited value - original value
Confidence Interval for
Total Difference
Confidence interval estimate:
SD Nn
ND  N ( t n1 )
n N 1
where n
 i
(D  D ) 2
SD  i1
n 1
One Sided Confidence
Intervals
Application: find the upper bound for the proportion of items that
do not conform with internal controls
p(1  p) N  n
Upper bound  p  Z
n N 1
where
 Z is the standardized normal value for the level of
confidence desired
 p is the sample proportion of items that do not conform
 n is the sample size
 N is the population size
Ethical Issues
 A confidence interval (reflecting sampling

error) should always be reported along with a
point estimate
 The level of confidence should always be
reported
 The sample size should be reported
 An interpretation of the confidence interval
estimate should also be provided
Chapter Summary
In this chapter, we have
 Introduced the concept of confidence intervals
 Discussed point estimates
 Developed confidence interval estimates
 Created confidence interval estimates for the mean
(σ known)
 Determined confidence interval estimates for the
mean (σ unknown)
 Created confidence interval estimates for the
proportion
Chapter Summary
In this chapter, we have
 Determined required sample size for mean and
proportion settings
 Developed applications of confidence interval
estimation in auditing
 Confidence interval estimation for population total
 Confidence interval estimation for total difference in
the population
 One sided confidence intervals
 Addressed confidence interval estimation and ethical
issues

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Statistics for Managers

Using Microsoft® Excel

In this chapter, you will learn:

1. Confidence Intervals for the Population

Lower Confidence Upper Confidence

 The general formula for all

Point Estimate ± (Critical Value) (Standard Error)

Z units: Z= -1.96 0 Z= 1.96

80% .80 1.28

 Determine a 95% confidence interval for the

 The t value depends on degrees of freedom (d.f.)

 Let X1 = 7 If the mean of these three

2 0.817 1.886 2.920

The body of the table contains t

 .25  1.96 (.0433)

 The required sample size can be found to

If  = 45, what sample size is needed to estimate

So the required sample size is n = 220

 If unknown, σ can be estimated when using

eZ for n to get n

How large a sample would be necessary to

Z 2  (1   ) (1.96) 2 (.12)(1  .12)

 Six advantages of statistical sampling in

 Confidence interval estimate:

 A firm has a population of 1000 accounts and wishes

 A sample of 80 accounts is selected with average

 Find the 95% confidence interval estimate of the

N  1000, n  80, X  87.6, S  22.3

The 95% confidence interval for the population total balance

 Where the mean difference, D , is:

 A confidence interval (reflecting sampling

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