Quiz 8: Audit Sampling: an Overview and Application to Tests of Controls

Business

Audit Sampling Audit sampling is one of the functions of audit procedures, in which some percentage of items are selected from the whole financial transactions. From these selected items, the auditor provides a reasonable basis of conclusions which represent the whole population. Instead of examining every transaction, the auditor examines few samples from whole transactions because economically it is not possible to test 100% transactions. So, sampling method is used to gather adequate audit evidence.

Type I and Type II Errors Auditors make some errors while taking decisions. These errors are classified into Type I Error and Type II Error. Type I Error is a risk of incorrect rejection and Type II Error is a risk of incorrect acceptance. These errors happen while making a decision on sample evidences. With reference to the test of controls, Type I and Type II errors are as follows: • Risk of incorrect rejection (Type I) : While testing the internal control, the risks involved in the assessed level on the control risk occurs when audit sample is greater than the true operating effectiveness of the internal control. This is referred to as risk of under reliance. • Risk of incorrect acceptance (Type II): While testing the internal control, the risks involved in the assessed level on the control risk occurs when audit sample is lesser than the true operating effectiveness of the internal control. This is referred to as risk of over reliance. With reference to the substantive tests, Type I and Type II errors are as follows: • Risk of incorrect rejection (Type I) : When auditor's selection of sample declares that the recorded account balance is materially misstated when actually it is not materially misstated • Risk of incorrect acceptance (Type II): When auditor's selection of sample declares that the recorded account balance is not materially misstated when actually it is materially misstated Type I Error describes the efficiency of the audit carried. The result of this error makes an auditor perform more audit than what is necessary, in order to reach the correct conclusion. Type II Error describes the effectiveness of the audit carried on. This error is committed when the auditor fails to identify the material misstatement in the financial statements. Auditors can be sued by the parties when Type II error occurs.

Types of Audit Evidence not requiring Sampling The auditor assesses the accuracy of the financial statements and asserts the assurance. The process of auditing consists of several processes which include risk assessment procedures, audit plan, and tests of audit. Of these, audit plan and audit tests contribute to the major portion of evidence. To arrive at the evidence, the auditor has to apply sampling theory to test the controls. In addition to sampling, some other approaches are used by the auditor to gather information to ascertain the management's assertion. The following are the types of audit evidences that do not involve sampling : • Analytical procedures • Scanning • Inquiry • Observation • Tests of automated information system controls Examples of the types of audit evidence that do not require sampling are : • A set of large transactions where procedures are applied to each and every item • An account of small number of large transactions • Transactions that look unusual or believed to have greater risk