Discussion of Bill DeBurger Case by wA7VNT61


									                                         Chapter 17
                                 Audit Sampling for Tests of
                                    Details of Balances

Key objectives:

1.   Understand the differences between sampling for tests of transactions and sampling for tests
     of details of balances.
2.   Apply non-statistical sampling to tests of details of balances.

         Be able to compute sample sizes and project errors using non-statistical sampling.
         Know the actions available to the auditor when projected error exceeds tolerable

1.   Introduction

     Projecting errors to the population was previously discussed
     in Ch. 9. The objective is to estimate the potential amount of
     misstatement in year-end balances.

2.   Evidence Decisions - As usual, we can start with our four
     evidence decisions.

     A.   Which procedures - This issue is easy. The procedure
          for year-end A/R to which sampling applies is
          confirmation (which primarily satisfies the existence and
          accuracy (valuation) objectives).

          Consult the test of details of balances audit program in
          Table 16-5 on p. 541. Do you see any other TODB for
          A/R for which sampling is likely to apply?

          Note that in other areas (particularly inventory),
          sampling often applies to multiple audit procedures.

     B.   Sample size - Based on auditor judgment, considering
          risk model, results of TOT and analytical procedures.

          Auditor judgment is quantified in Monetary Unit
          Sampling (MUS) and other statistical methods, but the
          inputs still involve considerable judgment.

     C.   Which items - Also based on auditor judgment. As
          discussed in Chapter 16, the emphasis is on large
          amounts and old amounts. We will be more specific as
          to how this is accomplished for statistical and
          nonstatistical tests.

     D.   When - As discussed in Ch. 16, confirmations are often
          sent 1-3 months prior to year-end to facilitate timely
          completion of the audit.

     E.   Evaluation of Results

          1.   Identify errors - need to separate true errors from
               valid timing differences (see Prob. 16-31).

          2.   Project errors to population (including
               consideration of sampling risk).

          3.   Evaluate acceptability of population (decision
               options if the population is not acceptable are
               discussed on p. 143-144 of the notes).

Discussion of Bill DeBurger Case

3.   Sample Size and Selection

     A.   Sample size - The key factors affecting sample size are:

           Population size (note that population size generally
            has no effect in transaction sampling).
           Tolerable misstatement (materiality)
           Desired assurance from test (depends on several
            factors, including inherent risk and control risk)

   B.   AICPA formula - The AICPA Audit Sampling Guide
        (1999) provides a simplified formula based on monetary
        unit sampling. Steps in process:

        1.   Select items to be examined 100% (usually all
             accounts greater than tolerable misstatement).

        2.   Compute sample for remaining dollars using this
             formula (the population value excludes the items
             tested 100% in step 1):

   Population amount     X Assurance Factor = Sample
  Tolerable misstatement                        Size

        3. Assurance factor

 Assessment of Inherent                Risk That Other Substantive Procedures Will
    and Control Risk                      Fail to Detect a Material Misstatement
                                             Slightly Below
                              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

        The level of assurance depends upon the effectiveness of
        controls, audit risk, and the results of other tests.

        4.   Allocate sample - the sample is then allocated to
             strata of the accounts receivable population,
             considering the relative materiality of each strata.

4.   Sample Size Example (modification of Prob.17-29)

      Book value                                       1,975,000
      Tolerable misstatement                              50,000
      Assurance factor (moderate risk, no                     2.3
      assurance from other tests)
      Total of accounts in excess of                    875,000
      tolerable misstatement (3 accts)
      Sample size

      1,100,000 X 2.3 = 51                                    51

      (1,100,000 =
       1,975,000 - 875,000)
      Total sample size (51 + 3 accounts                      54
      larger than tol. mistmt.)

          Effect of changes in variables on sample size

                          Effect on
     Change in             Sample        Comment
     Variable               Size
     Population           Increase       Larger population will
     increase                            require more evidence
     Tolerable            Decrease       Greater materiality, less
     misstatement                        evidence
     Assurance            Increase       More assurance from test
     increase                            requires more evidence

Multiple Choice 17-25 (c)

Accounts receivable contains a few unusually large balances. The
auditor should:

1.   Eliminate any large balances from the sample.
2.   Continue to draw samples until no large balances appear in the
3.   Stratify the population so the large balances are reviewed separately.
4.   Increase the sample size to lessen the impact of the large balances.

5.    Error Projection - Errors are projected within strata, then
      combined to compute an overall projected error.

      Example - p. 565 of text

                  (1)            (2)           (3)=(2)/(1)        (4)
                Sample        Errors and         Sample       Population     (5)=(4)X(3)
                Size in        Untested          Error        Book Value      Projected
 Stratum        Dollars        Amts.(a)           Rate        by Stratum        Error
      1             88,955         (2,740)          (.0308)        88,955      (2,740)(b)
      2             43,955             971            .0221        71,235       1,572
      3             13,105           2,158            .1647        47,105       7,757
 Totals           146,055              389                         207,295     6,589

(a) Amounts may be audited by confirmation or alternative procedures. Sample items not
    tested should be treated as errors.
(b) Strata tested 100%; projected error = actual error

      Auditor should consider sampling risk, especially when the
      projected error is close to tolerable misstatement.

6.    Options if projected error exceeds tolerable misstatement
      (Note: for simplicity, we will assume errors are material if
      greater than tolerable misstatement, rather than sum errors in all
      segments and compare with materiality.)

      a.   Adjust the account balance
      b.   Increase the sample size
      c.   Perform expanded tests in specific areas (isolate the
      d.   Request the client to correct the population
      e.   Do not issue an unqualified opinion

7.   Discussion of options for unacceptable results

     Typical response is to adjust for actual errors. The adjustment
     lowers the projected error. Although the projected portion of
     errors is not frequently recorded as an adjustment, it can be
     recorded as an adjustment to an allowance account (such as the
     allowance for doubtful accounts).

     If accounts receivable are still not acceptable, i.e., the adjusted
     projected error (projected error reduced by the adjustment for
     actual errors) is still greater than tolerable misstatement),
     increase sample size in attempt to lower projected error.

     A.   Adjust the account balance - Recording actual errors is not
          a problem. But clients are unlikely to adjust for
          unidentified errors based on error projection.

     B.   Increase sample size - issue is similar to attribute
          sampling. We are likely to increase sample size if
          population is still unacceptable after recording actual
          adjustments for two reasons:

          1. The alternative to more testing is probably qualification.

          2. The potential population is smaller (there are less
             ending accounts receivable balances than sales

     C.   Isolation of errors - great if you can determine that errors
          are all of one type, and caused by a unique problem.
          However, this decision not to project errors should be
          made with caution. Isolation is potentially appropriate in
          problem 17-29. Errors number 3 and 5 are cutoff errors,
          which are unique to year-end; the auditor might expand
          cutoff testing.

     D.   Request the client to correct the population - Also a great
          alternative, if client is capable of identifying errors, and
          they are pervasive. Auditor must then perform tests on
          corrected population.

     E.   Qualify opinion - Usually the last resort. May occur if
          client is unwilling to adjust for errors, or pay for additional

           Simplified example of error adjustment:

         A/R book value                              2,000,000
         A/R tested                                    400,000
         Overstatement errors - actual                  30,000
         Projected error                               150,000
         Tolerable misstatement                        100,000

     After adjusting for actual errors, projected error still exceeds
     tolerable error ([150,000 - 30,000] = 120,000 > 100,000).

     The auditor could:

          Record an additional adjustment of at least $20,000
           (probably to the allowance account)
          Increase testing (will lower projected error only if the error
           rate in the additional sample is less than the error rate in
           the initial sample).

     Any projected errors that are not adjusted are normally placed
     on the schedule of adjustments not made to determine whether
     such errors are material when combined with other errors. This
     is discussed in Chapter 24.

                                              Chapter 17

Discussion Case – Bill DeBurger

Homework Problem

Sampling Problem on next two pages (Collected)

Sample Multiple Choice (text)

17-25 (a), (c)
17-26 (c)

                                          Chapter 17
                                       Sampling Problem


Part A - Compute Sample Size
Use the AICPA sampling formula to select a sample size for testing accounts receivable based on
the information below. The company has two major customers that will be tested as a separate

         Book value of accounts receivable                                     6,000,000
         Tolerable misstatement                                                  100,000
         Individual material accounts (2 accts -                               1,600,000
          amount is combined balance of accounts)
         Assurance factor (Low risk, no assurance from                                2.0
         other tests)

Calculate sample size

Part B - Project Error

Regardless of your answer to part a., assume that a total sample of 100 was selected and allocated
as follows:

                 Account            # of        Sample         Sample         Population
 Stratum        Description       accounts       Size          Amount           Value
     1           > $50,000                2               2   1,600,000          1,600,000
     2        10,000 - 49,999           120              40   1,000,000          3,200,000
     3           < $10,000              700              58     200,000          1,200,000
                                                              2,800,000          6,000,000

Three differences were uncovered as described on the following page.

Continued on next page

                                       Sampling Problem

Errors and untested amounts:

  Stratum      Acct #      Balance      Confirmed      Explanation
          2       2196        40,000          20,000 Duplicate shipment not ordered by customer
          2       1347        35,000          25,000 Customer payment on 12/29, rec’d by client
                                                       on 1/3
          3       3652        10,000           2,000 Sale recorded 12/29 for goods shipped 1/3

Compute the projected error using the format below, which is similar to page 139 of the notes.
Note: The above are individual errors. Compute the error rate for each stratum by dividing the
total error in each stratum by the total sample size for that stratum.

                Sample Size          Strata         Strata       Stratum Book       Projected
  Stratum        in Dollars          Errors       Error Rate         Value           Error

      1        1,600,000

      2        1,000,000

      3         200,000

 Totals        2,800,000                                          6,000,000

Part C - Evaluate the acceptability of the population and possible courses of action.
          (Describe the action(s) you would take for these circumstances, and explain why. Do
          not just list the five possible courses of action.)


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