VIEWS: 90 PAGES: 46 POSTED ON: 7/17/2012 Public Domain
Chapter 17 Audit Sampling for Tests of Details of Balances Accounts Receivable 1 David Tests of Controls What do they measure The operating effectiveness of internal controls 2 The introduction … when all the confirmation replies were received or alternate procedures were completed ….. Bob called Barbara to do some statistical evaluation. 3 Julian Substantive Tests of Balances What do Substantive Tests measure Whether the dollar amounts of account balances are materially misstated 4 Sampling Methods Non statistical sampling Statistical sampling monetary unit sampling variables sampling (mean per unit) 5 Page 411 Test of Details - sampling Objective Define misstatement population sampling unit Specify tolerable misstatement risk of incorrect acceptance Determine sample size Select the sample Perform the procedure Project the sample results to the population 6 Test of Details - sampling Objective evid inv not material overstated Define misstatement cost or quantity incorrect population items in parts inventory sampling unit SKU or part number Specify tolerable misstatement $200,000 risk of incorrect acceptance 5% Determine sample size 387 Select the sample Perform the procedure Project the sample results to the population 7 Fabiola what is the audit risk model ? 8 Audit Risk Model AAR AAR IR CRPDR AR RoMM PDR rearrange PDR RoMM c PDR f (CR ) if PDR high limited Substantiv e Tests CR if PDR low extensive Substantiv e Tests 9 Nicholas M pretend GAAS requires AAR ≤ .05 Controls are effective, we assess CR as 0.03 Which audit approach will we take ? 10 Belen pretend GAAS requires AAR ≤ .05 Controls are effective, we assess CR as 0.03 We will take the Reduced Level of Control Risk Approach What is the required level of Detection Risk ? 11 Erynn pretend GAAS requires AAR ≤ .05 Controls are effective, not great but effective and we assess CR as 0.50 Which audit approach will we take? 12 Melissa O pretend GAAS requires AAR ≤ .05 Controls are effective, not great but effective and we assess CR as 0.50 We will take the RL of CR What is the required level of Detection Risk ? 13 Andrew F is Detection Risk risk of incorrect rejection Type I or risk risk of incorrect acceptance Type II or risk 14 ately 10% of the $1,965,560 balance. Statistical sampling cannot prove t auditing standards do not require balances to be exact. Auditing “obtain reasonable assurance about whether the financial statements are ” Auditing standards require auditors obtain “sufficient, appropriate ments “present fairly, in all material respects.” Auditors are typically , such as inventory, are overstated. If tolerable error is $200,000, we need ce of the parts inventory is greater than $1,765,560. he hypothetical mean $1,036.74 ($1,765,560 / value $1,154.17 ($1,965,560 / 1,703) is This will remain the same regardless of how ha Risk and Beta Risk. The interval is he upper portion of the hypothesis test and the nterval. Together these two elements comprise 15 Andrew K pretend GAAS requires AAR ≤ .05 Controls are ineffective, we assess CR as MAX Which audit approach are we going to take ? 16 Gavin pretend GAAS requires AAR ≤ .05 Controls are ineffective, we assess CR as MAX We are taking the Primarily Substantive Approach What is the required level of Detection Risk ? 17 type II type I 18 19 Test of Details - sampling Project the sample results to the population you must project sample results to the population plus appropriate consideration for sampling risk 20 projected error + allowance for sampling risk must be less than tolerable error 21 Accept cv 22 $1,110.32 C V Accept allowance for sampling risk BV tolerable error $200,000 or $117.44 23 24 Also notice that the critical value will change because it now 1.645 standard deviations to the right of the hypothesized mean. Later, during the audit we will select and audit a random sample of 387 inventory line items. If everything goes exactly as planned and the sample mean of the audited values exceeds $1,108.78, we will accept the hypothesis that the parts inventory balance is not materially overstated. The attached work sheet shows the results of our sample. We found two types of errors in our sample. We observed instances where the actual quantity on hand differed from the quantity in the client’s accounting records. We also observed on instance where the cost per the invoice was different than the cost used to determine the inventory balance. The sum of the extended audited balances for the 387 part lines in the sample came to $441,567.00. The sample mean of $1,141.00 lies in the acceptance region. However, the standard deviation of the sample exceeded the standard deviation used to calculate the original critical value. 25 $1,110.32 C V Accept allowance for sampling risk BV tolerable error $200,000 or $117.44 26 Test of Details - sampling Project the sample results to the population you must project sample results to the population appropriate consideration for sampling risk is the projected error too close to tolerable error How close is too close? 27 Applying what we know about Hypothesis Tests and Confidence Intervals The risk of incorrectly concluding the book value of the inventory is incorrect when it is correct is Alpha risk or a Type I error. This is the risk of incorrect rejection. The risk of incorrectly concluding inventory is fairly presented when the book value is materially overstated is Beta risk or a Type II error. This is the risk of incorrect acceptance. In the previous examples the critical value of the hypothesis test and the lower limit of the interval were arbitrarily set to equal to the midpoint between the hypothetical mean and the book value. This will result in Alpha risk that is twice as large as Beta risk because the hypothesis test is a one-tail test while intervals have two tails. For planning purposes assume that tolerable error for the parts inventory has been set as $200,000, which is approximately 10% of the $1,965,560 balance. Statistical sampling cannot prove that the balance is correct. But auditing standards do not require balances to be exact. Auditing standards require auditors to “obtain reasonable assurance about whether the financial statements are free of material misstatement.” Auditing standards require auditors obtain “sufficient, appropriate evidence” the financial statements “present fairly, in all material respects.” Auditors are typically concerned that asset accounts, such as inventory, are overstated. If tolerable error is $200,000, we need evidence that the actual balance of the parts inventory is greater than $1,765,560. The interval between the hypothetical mean $1,036.74 ($1,765,560 / 1,703) and the average book value $1,154.17 ($1,965,560 / 1,703) is $117.44 ($200,000 / 1,703). This will remain the same regardless of how we allocate risk between Alpha Risk and Beta Risk. The interval is comprised of two elements: the upper portion of the hypothesis test and the lower tail of the confidence interval. Together these two elements comprise the tolerable error. 28 $1,110.32 C V Accept allowance for sampling risk BV tolerable error $200,000 or $117.44 29 n= Mean N= Projection Book value 1,154.18 1703 1,965,560.03 Sample total 441,567.00 387 1,141.00 1703 1,943,123.00 overstatement 13.18 22,437.03 Allowance for Zβ for 0.05 sampling risk 1.645 73.59 1703 125,323.77 error plus allowance 86.77 147,760.80 30 Let’s assume the sample mean was $1,094.09 What if the Sample Mean is less than the Critical Value? Assume the sum of the 387 lines that were audited came to $423,412.83; the standard deviation of the sample was $880.00 and the sample mean was $1,094.09. The sample mean would not lie in the acceptance region. However, the sample mean is larger than the hypothetical mean of $1,036.74. The projected balance would be $1,863,235.27 . The projected discrepancy is $102,324.73 ($1,965,560 - $1,863,235) which is less than tolerable error. The sample does not provide sufficient evidence to state that the parts inventory is not materially overstated with 95% confidence. However, the sample does not provide evidence that the parts inventory is materially overstated. We can modify the equation used to calculate the critical value and determine the level of confidence the sample results do provide. 31 $1,110.32 C V Accept allowance for sampling risk BV tolerable error $200,000 or $117.44 32 n= Mean N= Projection Book value 1,154.18 1703 1,965,560.03 Sample total 441,567.00 387 1,094.09 1703 1,863,235.27 overstatement 60.09 102,324.76 Allowance for Zβ for 0.05 sampling risk 1.645 73.59 1703 125,323.77 error plus allowance 133.68 227,648.53 33 Nathan Which assertions relate to Inventory and Accounts Receivable? 34 35 Valuation & allocation 36 Valuation & allocation 37 Page 436-437 V&T what we did College Business Computer Sales Collection cycle performed by: date: Tad 2/28/2006 Sales nature of test Test of details of transactions objective The objective of this procedure is to determine if the sales account is overstated. assertion(s) Existence/Occurrence and Valuation ship sales invoice audited difference invoice customer doc order amount amount 1 6523 4973 10153 Trusco Tank 9,182.00 9,182.00 0.00 1 6526 4975 10155 San Luis Ready Mix 22,546.00 22,546.00 0.00 1 6532 4981 10161 Copeland's Sports Superstoresds 4,188.00 4,188.00 0.00 1 6537 4985 10165 Standard Motor Co. 4,538.00 4,538.00 0.00 1 6542 4990 10170 Airport Auto Center 12,664.00 12,664.00 0.00 1 6545 Flora Design Studio 3,432.00 0.00 (3,432.00) 1 6552 4998 10178 F. McLintocks 18,908.00 18,908.00 0.00 1 6560 5006 10186 Foothill Cyclery 12,446.00 11,572.00 (874.00) 1 6562 5008 10188 Sinsheimer, Schiebelhut & Baggett -PC 11,982.00 11,982.00 0.00 1 6565 5011 10191 Hind Inc. 16,576.00 0.00 (16,576.00) sample average 9,558.00 projected value 430,110.00 38 Page 436-437 Difference Estimation Sales Collection cycle date: 2/28/2011 Sales nature of test Test of details of transactions objective The objective of this procedure is to determine if the sales account is overstated. assertion(s) Existence/Occurrence and Valuation ship sales invoice a udite d diffe re nce invoice customer doc order a mount a mount 1 6523 4973 10153 Trusco Tank 9,182.00 9,182.00 0.00 1 6526 4975 10155 San Luis Ready Mix 22,546.00 22,546.00 0.00 1 6532 4981 10161 Copeland's Sports Superstoresds 4,188.00 4,188.00 0.00 1 6537 4985 10165 Standard Motor Co. 4,538.00 4,538.00 0.00 1 6542 4990 10170 Airport Auto Center 12,664.00 12,664.00 0.00 1 6545 Flora Design Studio 3,432.00 0.00 (3,432.00) 1 6552 4998 10178 F. McLintocks 18,908.00 18,908.00 0.00 1 6560 5006 10186 Foothill Cyclery 12,446.00 11,572.00 (874.00) 1 6562 5008 10188 Sinsheimer, Schiebelhut & Baggett -PC 11,982.00 11,982.00 0.00 1 6565 5011 10191 Hind Inc. 16,576.00 0.00 (16,576.00) sample average -2,088.20 projected value -93,969.00 sample std deviation 5,203.64 39 Page 420-29 MUS Miller Motor Co. year-end physical inventory worksheet retail extended line qty SKU price cost cost 1 5 4470312 Tail lamp bulb 4.42 2.65 13.26 0 13.26 2 40 1118019 Oil filter 7.30 4.38 175.20 13.26 188.46 3 240 1851974 Spark plug 9.76 5.86 1,405.44 188.46 1,593.90 4 43 3873086 Air intake filter 44.28 26.57 1,142.42 1,593.90 2,736.32 5 … … … … … … … … … … … … 984 21 6202037 Shock 112.30 67.38 1,414.98 900,356.90 901,771.88 985 2 3680387 Fuel pump diesel 131.98 79.19 158.38 901,771.88 901,930.26 986 11 6730291 Wheel steel 221.53 132.92 1,462.10 901,930.26 903,392.35 987 19 6037192 Brake pads 224.24 134.54 2,556.34 903,392.35 905,948.69 988 3 5119378 Water pump 293.98 176.39 529.16 905,948.69 906,477.85 989 4 4030026 Alternator 335.04 201.02 804.10 906,477.85 907,281.95 990 … … … … … … … … … … … … 1701 2 2780189 Transmission 4l60e m30 1,857.31 1,578.71 3,157.43 1,955,805.42 1,958,962.84 1702 1 1616045 Engine - 4.3L 2,886.86 2,453.83 2,453.83 1,958,962.84 1,961,416.67 1703 1 1478027 Engine - 6.0L 4,874.53 4,143.35 4,143.35 1,961,416.67 1,965,560.03 40 41 42 43 44 45 46