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Audit Sampling and Tests of Controls
Audit sampling is applying audit procedures to less than 100% of a population where all units have an opportunity to be selected. The goal is to provide a reasonable basis for drawing conclusions about the entire population.
What is Audit Sampling?
Auditors use sampling because examining every item in a population is often impractical or uneconomical. Sampling allows auditors to form an opinion without checking all items. Sampling theory provides a basis for selecting sample items and understanding sampling risk.
Sampling Risk
Sampling risk is the risk that the auditor's conclusion based on a sample differs from the conclusion if the entire population were examined (ISA [NZ] 530.5). Non-sampling risk is the risk of an incorrect conclusion for reasons unrelated to sampling risk.
According to ISA (NZ) 530.5, there are two types of incorrect conclusions:
First Type: Controls appear more effective than they are, or a material misstatement seems nonexistent when it does exist. This affects audit effectiveness and can lead to an inappropriate audit opinion.
Second Type: Controls appear less effective than they are, or a material misstatement seems to exist when it doesn't. This affects audit efficiency and leads to extra work.
Erroneous Conclusions and Their Effects
Type of erroneous conclusion | In the case of tests of controls, the auditor erroneously concluded that | In the case of tests of details, the auditor erroneously concluded that | Effect of the type of erroneous conclusion on the audit |
|---|---|---|---|
First type | controls are more effective than they actually are | a material misstatement does not exist when in fact it does | affects audit effectiveness and is more likely to lead to an inappropriate audit opinion |
Second type | controls are less effective than they actually are. | a material misstatement exists when in fact it does not. | affects audit efficiency as it would usually lead to additional work to establish that initial conclusions were incorrect. |
Statistical vs. Non-Statistical Sampling
Audit sampling can be statistical or non-statistical. Statistical sampling requires random selection of sample items and mathematical evaluation of results, including quantifying sampling risk. Non-statistical sampling lacks either random selection or probability theory in evaluating results.
Sampling Phases
Both statistical and non-statistical audit sampling involve four phases:
Planning and design.
Selecting the sample.
Testing the sample.
Evaluating the results.
1. Planning and Design
During planning, the auditor considers the test's objective and what constitutes a deviation or misstatement. For example, when testing the pre-numbering of inventory receiving reports as a control, a gap in the numerical sequence would be a deviation.
Population
The auditor ensures the population is complete and appropriate. Completeness means reconciling the accounts receivable master file total with the general ledger balance. Appropriateness involves considering the direction of testing. For example, to test the existence of accounts payable, the population could be the accounts payable listing. To test completeness, it might be subsequent disbursements or unpaid invoices.
Stratification
Stratification improves audit efficiency by dividing a population into subpopulations (strata) based on shared characteristics like dollar value. This focuses audit effort on large-value items with the greatest risk of monetary error. An example of strata for current assets register might be:
Balances greater than 1,000,000
Balances of 100,000 to 1,000,000
Balances less than 100,000
The auditor may choose to test 100% of balances greater than 1,000,000. Results from testing this stratum should be separated from sample testing results of other groups since testing 100% of items is not sampling.
Defining the Sampling Unit
A sampling unit is an individual item within a population (ISA [NZ] 530), like individual transactions. Value-weighted selection (monetary-unit sampling or dollar-unit sampling) is a common technique. Under DUS, sampling units are individual dollars rather than transactions or balances.
Substantive Audit Procedures for Inventory
Key Considerations for Inventory Audits
A key aspect of auditing inventories is addressing the inherent risk related to their valuation. Auditors focus on verifying the existence, ownership, and proper valuation of inventories. Therefore, substantiating the valuation and allocation assertion is crucial.
Assertions, Objectives, and Substantive Procedures for Purchases and Inventory
Financial report assertion | Specific audit objective | Common substantive audit procedures to achieve objectives |
|---|---|---|
Assertions about classes of transactions and events, and related disclosures (purchases) | ||
Occurrence | The transactions giving rise to purchases occurred during the period | • Select transactions from purchases journal and agree to supporting documentation (e.g. goods received note) |
Completeness | All purchases transactions and events that should have been recorded have been recorded | • Test from supporting documentation (purchase invoice, goods received note) to purchases journal or subsidiary ledger |
Accuracy | Purchases amount and other data are recorded appropriately | • Check dollar value of purchases to supporting documentation (purchase invoice), and that other data such as supplier’s name recorded accurately |
Cut-off | Purchases are recorded in the correct period | • Check that last purchases recorded before balance date and first purchases recorded after balance date are recorded in the correct period; consider when received by evidence of goods received note |
Classification | Purchases are recorded in the proper accounts | • Enquire and scan to determine that purchases are recorded correctly in accordance with the chart of accounts |
Presentation | Purchases are appropriately aggregated and clearly described, and related disclosures are relevant and understandable | • Check that purchases and cost of goods sold (COGS) are in accordance with the accounting framework |
Assertions about account balances, and related disclosures (inventory) | ||
Existence | Inventories included in the statement of financial position physically exist and represent items held for sale in the ordinary course of business | • Inspect physical inventory (check from inventory records to physical stock)• Undertake substantive analytical procedures• Confirm stock held at other locations |
Rights and obligations | Inventory in the statement of financial position is owned by the entity and excludes items billed to customers or owned by others | • Enquire about legal ownership of goods being shipped to entity and any goods on consignment, and inspect supporting documentation |
Completeness | Inventory in the statement of financial position includes all inventories on hand at balance date, or in transit or at other locations, that are the property of the entity | • Inspect physical inventory (check from physical stock to inventory records)• Undertake substantive analytical procedures• Enquire about stock held at other locations, and review purchase documents for shipping terms for inventory in transit |
Accuracy, valuation and allocation | Inventory in the statement of financial position is stated at the correct amount with respect to:• cost determined by an acceptable method consistently applied• slow-moving, excess, defective and obsolete items identified are reduced to net realisable value if lower than cost | • Undertake tests of pricing and summarisation• Undertake substantive analytical procedures• Observe physical inventory (look for obsolete or damaged items)• Enquire of management and scan inventory records to identify any obsolete, excess or slow-moving inventory• Check subsequent sales prices and compare with cost |
Classification | Purchases have been recorded in the proper accounts | • Check that purchases are correctly classified |
Presentation | Purchases (and COGS) are clearly described and all related disclosures are understandable | • Read draft financial report to ensure clear description and understandable disclosures |
Classification of Audit Procedures
Audit procedures are classified as tests of controls and substantive procedures.
Tests of Controls vs. Substantive Procedures
There are two main audit strategies:
Predominantly Substantive Approach: Internal controls are ineffective or unreliable (high control risk), so the auditor relies on substantive procedures.
Lower Assessed Level of Control Risk Approach: The auditor intends to rely on internal controls due to their assessment of control risk as less than high. Tests of controls are crucial for this approach.
Tests of controls assess the design and implementation of internal control policies and procedures. The auditor gathers evidence about the existence, effectiveness, and continuity of each control they intend to rely on.
If the auditor doesn't intend to rely on controls (planning a predominantly substantive approach) due to control weaknesses or economic reasons, tests of controls are not expected. Instead, the auditor seeks more extensive and persuasive audit evidence from substantive procedures, increasing sample sizes and locations included in the audit scope.
Substantive Procedures
The purpose of substantive procedures is to provide direct evidence about the fairness of financial report assertions. They consist of substantive analytical procedures and substantive tests of details.
Substantive tests of details are the auditor’s key response to risks of material misstatement. These tests are required for relevant assertions related to each material:
Class of transactions
Account balance
Disclosure
Examples of Substantive Tests of Details:
Vouching: Verifying transactions recorded in the books by inspecting source documents. Auditors start with the entries and trace back to the source document.
Tracing: Matching source documents to transactions in the financial statements. Auditors start with the source document and trace forward to the financial statements. This tests completeness.
Confirmations sent to third parties (banks, creditors, debtors, suppliers) to confirm balances.
Reconciling payroll in the general ledger to quarterly payroll tax returns.
Inspecting contracts or agreements to identify terms and verify/recalculate balances or transactions.
Importance of Directional Testing
Vouching tests the existence or occurrence by starting with the books of accounts and tracing back to source documents. Tracing tests completeness by starting with source documents and tracing forward to the financial statements.
Selected Audit Objectives for Purchases, Payables, and Payroll
Assertion category | Audit objectives |
|---|---|
Existence or occurrence | Recorded purchase transactions represent goods and services received during the period under the audit. Recorded payment transactions represent payments made during the period to suppliers and creditors. Recorded payroll expenses relate to employee services received in the reporting period. Recorded accounts payable represent amounts owed by the entity at the end of the reporting period. Accrued payroll liability balances represent amounts owed at the end of the reporting period. |
Completeness | All purchases and payment transactions that occurred during the reporting period and that should have been recorded have been recorded. Recorded payroll expenses include all such expenses incurred during the year. Accounts payable include all amounts owed by the entity to suppliers of goods and services at the end of the reporting period. Accrued payroll liabilities include all amounts owed in respect of payroll and deductions therefrom at the end of the reporting period. |
Rights and obligations | Accounts payable and accrued payroll liabilities are liabilities of the entity at the end of the reporting period. |
Accuracy, valuation and allocation | Purchase transactions, payment transactions and payroll transactions are appropriately recorded in the information system and in the correct accounting period. Accounts payable and accrued payroll liabilities are stated at the appropriate amounts. Related expense balances conform to applicable accounting standards. |
Presentation and disclosure | The details of purchase, payment and payroll transactions support their presentation in the financial statements, including their classification and disclosure. Accounts payable, accrued payroll, liabilities and related expenses are properly identified and classified in the financial statements. Disclosure pertaining to commitments, contingent liabilities and related part creditors are adequate. |
Dual-Purpose Testing
Audit tests can provide evidence for both controls and substantive issues. A dual-purpose test examines an invoice to determine whether it has been approved and to also provide substantive audit evidence of a transaction. Each purpose of the test is considered separately.
Computer-Assisted Audit Techniques (CAATs) in Substantive Testing
CAATs increase audit effectiveness and efficiency and help manage audit risk. CAATs can be used for tests of controls and substantive procedures. Audit software performs functions like calculations, sampling, duplicate transaction identification, data queries, and statistical analysis. Three classifications of CAATs are audit software, test data, and embedded audit facilities (EAFs).
Topic Summary
Substantive procedures detect material misstatements in financial report assertions. Auditors identify risk factors and connect them to assertions, considering the materiality and pervasiveness of potential misstatements. Substantive procedures include substantive analytical procedures and substantive tests of details, which are key responses to risks of material misstatement in classes of transactions, account balances, and disclosures.
NoteStudied by 13 peopleNoteStudied by 14 peopleNoteStudied by 15 peopleNoteStudied by 38 peopleNoteStudied by 83 peopleNoteStudied by 12 people