CANADIAN EDITION
AUDITING
A PRACTICAL APPROACH
Prepared by:
Angela Davis CA, CFE, MSc
Booth University College
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CHAPTER 6
OVERVIEW OF TESTS OF CONTROLS,
SUBSTANTIVE PROCEDURES, AND SAMPLING
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
8.
9.
Understand the difference between tests of controls and substantive tests
Explain the factors that impact the nature, timing, and extent of audit testing
Explain how audit sampling is used in an audit
Understand the difference between sampling and non-sampling risk
Differentiate between statistical and non-statistical sampling
Describe sampling methods and the factors to be considered when choosing
a sample
Determine the factors that influence the sample size when testing controls
Determine the factors that influence the sample size when substantive
testing
Outline how to evaluate the results of tests conducted on a sample.
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Tests of controls and
substantive procedures
• Audit plan contains audit procedures for
1. testing controls, and
2. conducting detailed substantive tests
• Control tests/procedures are designed to see if
controls work effectively to prevent or detect
and correct material misstatements at the
assertion level
• Substantive tests/procedures are tests designed
to detect material misstatements at the assertion
level
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Tests of controls and
substantive procedures
• Audit plan is based on audit strategy
– Audit strategy is developed after gaining an
understanding of the client’s business (inherent
risk) and its internal control structures (control
risk)
– Therefore, relative emphasis on (1) tests of
controls and (2) substantive procedures
depends on client’s audit risk
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Tests of controls and
substantive procedures
Table 6.1
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Tests of controls
• Preliminary assessment of control risk (CR) is
made after gaining an understanding of client
during planning stage
• Tests of controls are performed on controls
identified during gaining understanding phase
– To obtain evidence that controls operated
effectively and consistently throughout period
• Auditor can reduce reliance on substantive
testing only if tests confirm CR not high
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Most important controls
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Tests of controls cont’d
– Control testing procedures include:
• Inspection of documents for evidence of
authorization
• Inspection of documents for evidence that details
included have been checked by appropriate client
personnel
• Observation of client personnel performing various
tasks, such as opening mail and conducting a
inventory count
• Enquiry of client personnel about how they perform
their tasks
• Re-performing control procedures to test their
effectiveness
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Which controls to test
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Substantive testing
• Types of substantive procedures:
– Substantive tests of transactions
– Substantive tests of balances
– Analytical procedures
• When CR is lower, auditor can rely more on
analytical procedures and less on detailed
substantive tests of transactions and balances
• Analytical procedures are more efficient and
place greater reliance on client’s accounting
records
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Substantive testing cont’d
• Examples of substantive procedures:
– Confirmation from client’s bank regarding interest
rates on borrowings (tests accuracy assertion for
interest expense)
– Recalculate interest expense (accuracy
assertion)
– Inspecting documents to verify date of
transactions posted around year-end (cut-off
assertion)
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Substantive testing cont’d
• Examples of substantive procedures cont’d:
– Inspecting suppliers’ invoices to verify amounts
recorded as purchases (completeness assertion)
– Confirmation from debtors for amount owed
(existence assertion)
– Recalculating wages payable (valuation and
allocation assertion)
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Substantive testing cont’d
• Examples of analytical procedures:
– Estimate depreciation expense by multiplying
average depreciation rate by asset balance
(accuracy assertion)
– Compare inventory balances for this year and
last year (existence, completeness and
valuation and allocation assertions)
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Substantive testing cont’d
• Examples of analytical procedures cont’d:
– Estimate movie theatre revenue by multiplying
average ticket price x number of seats in theatre
x average proportion of seats sold per session x
number of sessions per week x weeks per year
(occurrence and accuracy assertions)
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Analytical procedures, detail
transactions, detail balances
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Nature, timing and extent
of audit testing
• Nature, timing and extent of testing varies
depending on audit strategy adopted and type of
testing (CAS 330)
• Nature of audit testing
– The purpose of the test (control or substantive
test; which assertion is being tested), and
– The procedure used (inspection, observation,
enquiry, confirmation, recalculation, reperformance or analytical procedure)
• Auditor tries to gather most persuasive evidence
for assertions most at risk
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Nature, timing and extent
of audit testing cont’d
• Timing of audit testing
– Date that audit evidence relates to, and
– Stage of audit when procedures are performed
– Interim testing usually done for:
• Control testing
• Low risk accounts
– Year-end testing usually done for:
• High risk accounts
• Accounts affected by high deviations in control
tests
• Cut-off assertion
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Nature, timing and extent
of audit testing cont’d
• Extent of audit testing
– Refers to amount of audit evidence gathered
– Increase extent of control testing when control
risk is low
– Reduce extent of substantive testing and
increase extent of reliance on analytical
procedures when control testing confirms lower
CR
– Do little or no control testing when adopting
predominantly substantive strategy (ie control
risk high)
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Audit sampling
• Sampling is required whenever auditor does not
test entire group of transactions or all items in a
balance (CAS 530)
• In many cases, there are too many items to test,
or auditor decides that it is not necessary to test
all items
• Sample of items tested should be representative
of the population
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Sampling and nonsampling risk
• Sampling risk is the risk that the sample chosen
by the auditor is not representative of the
population available for testing, and causes the
auditor to arrive at an inappropriate conclusion.
• Two consequences of sampling risk:
– Risk that audit will be ineffective
– Risk that audit will be inefficient
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Sampling and nonsampling risk cont’d
• Tests of control and sampling risk
– If sample contains fewer deviations than
population, auditor over relies on controls
• Concludes internal controls work effectively
• Audit is ineffective because risk of misstatement is
greater than auditor’s assessment
– If sample contains more deviations than
population, auditor under relies on controls
• Concludes internal controls do not work effectively
• Audit is inefficient because auditor does more work
than necessary
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Sampling and nonsampling risk cont’d
Table 6.2
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Sampling and nonsampling risk cont’d
• Substantive tests and sampling risk
– If sample contains fewer misstatements than
population, auditor concludes financial
statements not misstated
• Audit is ineffective because risk of misstatement
greater than auditor’s assessment
– If sample contains more misstatements than
population, auditor concludes financial
statement misstated
• Audit is inefficient because auditor does more
work than necessary
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Sampling and nonsampling risk cont’d
• Non-sampling risk is the risk that the auditor
makes an inappropriate conclusion for a reason
unrelated to sampling issues.
• The auditor could:
– Use inappropriate audit procedures,
– Rely too heavily on unreliable evidence,
– Spend too little time testing high risk accounts
or critical controls
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Reducing sampling risk
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Statistical and nonstatistical sampling
• Statistical sampling involves random selection
and probability theory to evaluate the results,
including sampling risk (CAS 530)
– Allows measurement of sampling risk
– Can be costly to use
• Non-statistical sampling allows auditor to use
judgement to select sample items
– More likely used when account is low risk and
corroborating evidence available
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Sampling methods
• Random selection
– Person selecting sample cannot influence
choice of items
– Each item has equal chance of being selected
– Sample can be stratified before selecting
random sample to increase efficiency
• E.g. stratify (subdivide) population of transactions
into different size ranges, then take different size
samples from each stratum
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Example of stratification
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Sampling methods cont’d
• Systematic selection
– Divide number of items in population by sample
size, giving sampling interval (n). Select starting
point, then take every nth item
– Risk that items are listed in way that every nth
item is related – can randomly order first
• Haphazard selection
– Auditor does not use methodical technique
– Not random sampling because personal bias
could affect choice
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Sampling methods cont’d
• Block selection
– Select items grouped together
– Sequence of items may make this inappropriate
– Non-statistical
• Judgemental selection
– Auditor chooses items based on judgement
– E.g. after a new computer system installed
– Non-statistical
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Factors to consider when
selecting sample
• Consider acceptable detection risk (DR) and
planning materiality (PM)
• Define ‘error’ for test, set ‘tolerable error’ and
confidence level required
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Factors to consider when
selecting sample cont’d
• Define population
• Control testing - draw sample from entire
financial year
• Substantive testing - population from which
sample is drawn must be defined according to
assertion being tested, e.g.
– Existence of inventory – draw sample from inventory
records
– Completeness of inventory – draw sample from
physical inventory items
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Factors that influence
sample size cont’d
• When determining size of sample for control
testing, CAS 530 requires auditor to consider:
1. Larger sample size if auditor intends to rely
more heavily on that control to reduce
substantive testing
2. Smaller sample size if auditor is willing to
tolerate a higher deviation rate for that control
3. Larger sample size if auditor expects the
population to have a higher rate of deviation
for that control
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Factors that influence
sample size cont’d
• Sample size for control testing cont’d
4. Larger sample size if auditor requires greater
confidence that the control is operating
effectively (i.e. lower control risk)
5. Very little change to sample size if population
has more sampling units
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Factors that influence
sample size cont’d
Table 6.4
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Factors that influence
sample size cont’d
• When determining size of sample for substantive
testing, CAS 530 requires auditor to consider:
1. Larger sample size if auditor assesses risk of
material misstatement as greater (higher IR,
CR)
2. Smaller sample size if auditor also using other
substantive procedures for same assertion
3. Larger sample size if auditor requires greater
confidence from results of tests (requires lower
DR)
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Who decides the technique
and the size used
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Factors that influence
sample size cont’d
• Sample size for substantive testing cont’d
4. Smaller sample size if auditor is willing to
accept greater total error (higher tolerable
misstatement)
5. Greater sample size if auditor expects to find
greater misstatement in population
6. Smaller sample size if auditor using
stratification of population
7. Very little change to sample size if population
has more sampling units
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Factors that influence
sample size cont’d
Table 6.5
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Evaluating sample test
results
• Auditor will consider whether results of tests
applied to a sample provide evidence that
– Control tested is effective within entire
population (for control tests), or
– Class of transactions or account balance tested
is fairly stated (for substantive tests)
• If errors are found in sample, calculate for
population
– Deviation rate for control, or
– Misstatement of transactions or account
balance
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Deviations and misstatements
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Evaluating sample test
results cont’d
• If sample is representative of population
– Conclude deviation from controls in sample is at
same rate as deviation from controls in
population
• Is deviation rate tolerable? – more testing required?
– Project monetary errors in sample to population
• First remove unique errors
• Consider if sample stratified
• Projected error = dollar size of error / dollar size of
sample x dollar size of population or stratum
• Is total projected error tolerable? – more testing
required?
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Evaluating sample test
results cont’d
As an auditor what would you conclude if the
tolerable error rate was set at $3,500? What if the
tolerable error rate was $7,500?
Table 6.6
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