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Evidence and Sampling

Mohammad Salahuddin Chowdhury, ACA

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Computer Assisted Audit techniques

With so many accounting systems now held on computer,

the assurance provider may wish to make use of CAATs.

There are two main types of CAAT : Test data

Audit software

Test data

Under this test of control, the assurance provider

supervises the process of running data through the

clientssystem. The stages are

Notes controls in client's system

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Decide upon test data, the options include

Dummy data

Real dataDummy data against a verified copy of the

clientssystem

Run the test data

Compare results with those expected

Conclude on whether controls are operating properly

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Worked example:

To carry out such a test the assurance provider

identifies a control in the clients system. Theassurance provider then predicts the systemsreaction

to the test data. For example:

An invoice which does not cast should be rejected when entered

in the system.

An invoice with an invalid supplier code should be rejected

Dates outside the current year should be rejected.

The assurance provider then runs the test data

through the clientssystem and compares the results

with those expected.

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Audit Software

Audit software makes use of the assurance providers

own specialised software. There are a number of off theshelf packages available, or the assurance provider

could have a tailor made system. Audit software works

on the basis of interrogating the clients system and

extracting and analysing information. It can therefore

carry out a whole range of substantive procedures,

across all sorts of different data.

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Audit Software

Examples of what audit software can do include:

Extracts a sample according to specified criteria Random

Over a certain amount

Below a certain amount

At certain dates

Calculates ratios and select those outside set criteria

Check calculations and casts performed by the system

Prepare reports (actual vs budgeted)

Follow items through a system and flag where they are

posted.

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Audit Software

Examples of what audit software can do include:

Extracts a sample according to specified criteria Random

Over a certain amount

Below a certain amount

At certain dates

Calculates ratios and select those outside set criteria

Check calculations and casts performed by the system

Prepare reports (actual vs budgeted)

Follow items through a system and flag where they are

posted.

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Directional Testing

Broadly speaking, substantive procedures can be said to

fall into two categories:

Tests to discover errors (resulting in over orunderstatement)

Tests to discover omissions (resulting in

understatement)

Tests to discover errors

Tests to discover errors will start with the accounting

records in which the transactions are recorded and check

from the entries to supporting documents or other

evidence. Such tests should detect any overstatement

through causes other than omission.

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Tests to discover errors (Worked example)

If test is designed to ensure that sales are priced

correctly, the test would begin with a sales

invoice selected from the receivables ledgere.

Prices on that invoice would then be checked to

the official price list.

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Tests for omission

Tests for omission must start from outside the accounting

records and then check back to those records.

Understatements through omission will never be revealedby starting with the account itself as there is clearly no

chance of selecting items that have been omitted from the

account.

Example: If the test is designed to discover whether allraw material purchases have been properly processed, the

test would start, say, with goods received notes, to be

checked to the inventory records or payables ledger.

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Tests for omission

Omission is usually more of a problem for certain account

balances, such as liabilities, than others, such as sales, as

a company might be more inclined to understate liabilitiesto create a good position in the financial statements.

However, this is where the auditorsunderstanding of the

entity is important, as the auditor must make judgments

about the situation of the entity at the moment-for

example, a company with a large VAT commitment might

want to understate sales.

Directional testing is particularly appropriate when testing

the financial statement assertions of existence,

completeness, rights and obligations and valuation.

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Tests for omission

An assurance firm may use directional testing to identify

over and understatements.

Directional testing is particularly appropriate when testingthe financial statement assertions of existence,

completeness, rights and obligations and valuation.

Test are therefore designed in the following way.

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Test item Example

Test debit items (expense or assets)

for overstatement by selecting debit

entries recorded in the nominal

ledger and checking value and

existence

If a non-current asset entry in the

nominal ledger of BDT 1000 is

selected, it would be overstated if it

should have been recorded at

anything less than BDT1,000 or if the

company did not own it, or indeed if

it did not exist.

Test credit items (income or

liabilities) for understatement byselecting items from appropriate

sources independent of the nominal

ledger and ensuring that they result

in the correct nominal ledger.

Select a despatch note and check

that the resultant revenue has beenrecorded in the nominal ledger

revenue account. Sales would be

understated if the nominal ledger did

not reflect the transaction at all or

reflected it at less than full value.

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Audit of Accounting Estimates

The auditor often has to audit estimated figures, such as

those for product warranties, depreciation, inventory or

receivable provisions, where the values included in thefinancial statements are not the result of transactions with

third parties (which are fairly reliable) but result from

judgments made by management. Yet these figures can

have a significant effect on reported profits.

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The audit approach required is set in BSA 540 Audit of

Accounting Estimates. Essentially the auditor has three

methods to use:

Method

Example

Test the process that

management used to

estimate the figure

Management may use a formula to calculate the provision for

doubtful accounts receivable. The auditor can test this by:

Looking at past experience

Checking the calculation Considering if anything this year is likely to have changed

the estimate

Use an independentestimate

If a provision is required in respect of legal action against thecompany, the auditor can use evidence from the companys

legal advisors.

Review subsequent

events

If a settlement is reached after the year end regarding a claim

against the company which requires a provision, the auditor

can use the evidence of the agreement to establish the correct

figure for the financial statements. In this case there is usually

no need to use the other two methods.

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Having done the detailed work on the accounting estimate,

the auditor checks the reasonableness of the figure and

then reaches a conclusion about whether it is fairly stated.

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The Concept of Sampling

Assurance providers do not normally examine all the

information available to them; it would be impracticable to

do so and using sampling will produce valid conclusions

provided it is carried out properly.

BSA 530 Audit Sampling and Other Means of Testing

states that whendesigning audit procedures, the auditor

should determine appropriate means for selecting itemsfor testing so as to gather sufficient appropriate audit

evidence to meet the objectives of the audit procedures.

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Audit Sampling

Audit sampling involves the application of audit

procedures to less than 100% of the items within an

account balance or class of transactions such that all

sampling units have a chance of selection. This will enable

the auditor to obtain and evaluate audit evidence about

some characteristic of the items selected in order to form

or assist in forming a conclusion concerning the

population from which the sample is drawn.

Population

Population is the entire set of data from which a sample is

selected and about which an auditor wishes to draw

conclusions.

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Statistical Sampling

Statistical sampling is any approach to sampling that

involves random selection of a sample, and use of

probability theory to evaluate sample results, includingmeasurement of sampling risk.

Non-statistical Sampling

Non-statistical sampling is a subject approach toinference, in that mathematical techniques are not used

consistently in determining sample size, selecting the

sample, or evaluating sample results.

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The auditor may alternatively select certain items from a

population because of specific characteristics they possess.

The results of items in this way cannot be projected onto the

whole population but may be used in conjunction with other

audit evidence concerning the rest of the population. High Value or Key Items: The auditor may select high

value items or items that are suspicious, unusual or

prone to error.

All Items over a Certain Amount: Selecting items this

way may mean a large proportion of the population canbe verified by testing a few items.

Items to obtain information about the clientsbusiness,

the nature of transactions, or the clientsaccounting and

control systems.

Items to test procedures, to see whether particularprocedures are being performed.

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Design of the Sample

When designing the sample, the BSA requires the auditor

to considerthe objectives of the audit procedures and the

attributes of the population from which the sample will be

drawn, and to consider the sampling and selection

methods.

Assurance provider must consider the specific audit

objectives to be achieved and the audit procedures thatare most likely to achieve them. The assurance providers

also need to consider the nature and characteristics of the

audit evidence sought, possible error conditions and the

rate of expected error. These will help them to define what

constitutes an error and what population to use for

sampling.

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Error

Error means either control deviations, when performing

tests of control, or misstatements, when performing

substantive procedures.

Expected Error

Expected error is the error that the auditor expects to be

present in the population.

The population from which the sample is drawn must beappropriate and complete for the specific audit objectives.

The BSA distinguishes between situations where

overstatement or understatement is being tested.

Assurance providers must define the sampling unit in

order to obtain an efficient and effective sample to achievethe particular audit objectives.

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Sampling Units

Sampling units are the individual items constituting a

population.

Example: Sampling Units

Cheques listed on the deposit slip

Credit entries on bank statements

Sales invoices

Receivables balances

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The BSA requires that the auditor shouldselect items for

the sample with the expectation that all sampling units in

the population have a chance of selection.This requires

that all items in the population have an opportunity to be

selected.

In obtaining evidence, the auditor should use professional

judgment to assess audit risk and design audit procedures

to ensure this risk is reduced to an acceptably low level. In

determining the sample size, the auditor should considerwhether sampling risk is reduced to an acceptably low

level.

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Sampling Risk

Sampling risk arises from the possibility that the auditors

conclusion, based on a sample of a certain size, may be

different from the conclusion that would be reached if the

entire population were subjected to the same audit

procedures.

Non-sampling Risk

Non-sampling risk arises from factors that cause theauditor to reach an erroneous conclusion for any reason

not related to the size of the sample. For example, most

audit evidence is persuasive rather than conclusive, the

auditor might use inappropriate procedures, or the auditor

might misinterpret evidence and fail to recognize an error.

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Tolerable Error

Tolerable error is the maximum error in the population that

the auditor would be willing to accept.

Tolerable error is considered during the planning stage

and for substantive procedures, is related to the auditors

judgment about materiality. The smaller the tolerable error,

the greater the sample size will need to be.

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a) In tests of control, the tolerable error is the maximum rate

of deviation from a prescribed control procedure that

assurance providers are willing to accept in the

population ands still concludes that the preliminary

assessment of control risk is valid.

b) In substantive procedures, the tolerable error is the

maximum monetary error in an account balance or class

of transactions that assurance providers are willing to

accept so that, when the results of all audit procedures areconsidered, they are able to conclude, with reasonable

assurance, that the financial statements are not materially

misstated.

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The size and frequency of errors is important when

assessing the sample size; for the same overall error,

larger and fewer errors will mean a bigger sample size

than for smaller and more frequent errors. If the expected

error rate is high then sampling may not be appropriate.When considering expected error, the assurance providers

should consider:

Errors identified in previous audits

Changes in the entitys procedures

Evidence available from other procedures

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Selecting the Sample

There are a number of selection methods available.

a) Random Selection

Random selection ensures that all items in thepopulation have an equal chance of selection, e.g. by

use of random number tables or computerized

generator.

b) Systematic Selection

Systematic selection involves selecting items using aconstant interval between selections, the first interval

having a random start. When using systematic

selection assurance providers must ensure that the

population is not structured in such a manner that the

sampling interval corresponds with a particularpattern in the population.

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c) Haphazard Selection

Haphazard selection may be an alternative to random

selection provided assurance providers are satisfied

that the sample is representative of the entire

population. This method requires care to guardagainst making a selection that is biased, for

example towards items that are easily located, as they

may not be representative. It should not be used if

assurance providers are carrying out statistical

sampling.

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d) Sequence or Block Selection

Sequence sampling may be used to check whether

certain items have particular characteristics. For

example, an auditor may use a sample of 50

consecutive cheques to check whether chequesare signed by authorized signatories rather than picking

50 single cheques throughout the year. Sequence

sampling may, however, produce samples that are

not representative of the population as a whole,

particularly if errors only occurred during a certainpart of the period, and hence the errors found cannot

be projected onto the rest of the population.

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e) Monetary Unit Sampling (MUS)

This is a selection method that ensures that every CU

1 in a population has an equal chance of being

selected for testing. The advantages of this selection

method are that it is easy when computers are used,and that every material item will automatically be

sampled. Disadvantages include the fact that if

computers are not used, it can be time consuming to

pick the sample, and that MUS does not cope well with

errors of understatement or negative balances.

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Drawing Conclusion from Sampling

When the assurance providers have tested a sample

of items, they must then draw conclusions from that

sample. The purpose of sampling the items was to

enable them to project the conclusion they draw from

the sample to the whole population.

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Any Questions ?

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