Chapter 4 Audit Evidence and Sampling

1.       Objectives

1.1       Explain the nature of audit evidence.
1.2       Describe the four audit evidence decisions that the auditor must make to prepare an audit programme.
1.3       Determine the factors affecting the persuasiveness of audit evidence.
1.4       Describe the methods for obtaining audit evidence.
1.5       Explain the concept of representative sampling.
1.6       Distinguish between statistical and non-statistical sampling.
1.7       Select representative samples.

2.       Audit Evidence (審計證據)

2.2       Audit evidence comprises source documents, accounting records and corroborating (確證) information from both internal and external sources. Audit evidence is accumulated from an appropriate mix of tests of control and substantive tests.
2.3       Every auditor has to determine the appropriate type and amount of audit evidence to accumulate to be satisfied that the client’s financial statements are fairly presented. This judgement is important because cost of examining and evaluating all available evidence is too high. The auditor’s decisions on evidence accumulation involve the following aspects.
(a)        Audit procedure
In deciding which audit procedures are to be used, it is common to put them down in sufficiently specific terms to be used as instructions during the audit.
(b)        Sample size
Once the audit procedure is selected, it is possible to vary the sample size from one to all the items in the population being tested. The sample size for any given procedure is likely to vary from different audit assignments.
(c)        Items to be selected
After the sample size has been determined for an audit procedure, it is still necessary to decide which items in the population are to be tested.
(d)        Timing
An audit of financial statements usually covers a period such as a year, and an audit is usually not completed until several weeks or months after the end of the period. The timing of audit procedures can therefore vary from early in the accounting period to long after it has ended.

3.       Quality of Audit Evidence

(A)       Characteristics of quality audit evidence

3.1       HKSA 500 states that the auditor should obtain “sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion”.

3.3       The auditor’s judgement as to what is sufficient appropriate audit evidence is influenced by a number of factors.
(a)        Experience from previous audit including knowledge of business;
(b)        The degree of audit risk which results from the assessment of inherent risk and control risk;
(c)        The persuasiveness (証據的說服力) of the evidence which depends on the source and reliability of the available information;
(d)        Materiality of the item involved; and
(e)        Results of audit procedures.
3.4       Reliability of evidence

(B)       Factors affecting the persuasiveness of audit evidence

3.7       The factors are as follows:
(a)        Competence of evidence
Competence or reliability of evidence refers to the degree to which evidence can be considered believable.
(b)        Relevance to the audit objective
Audit evidence must be relevant to the audit objective that the auditor is testing before it can be reliable. Relevance should be considered in terms of specific audit objectives.
(c)        Timeliness
For example, evidence obtained from physical inventory count is usually more reliable for balance sheet value when it is obtained as close to the balance sheet date as possible.
(d)        Sufficiency of evidence – it is measured primarily by:
(i)         adequate sample size
(ii)        appropriate sampling method – samples containing large value items, high likelihood of misstatements, and representative to the population are usually considered to be sufficient.

4.       Accumulating Audit Evidence

(A)       Use of assertions (認定) in obtaining audit evidence

4.1       HKSA 500 “Audit Evidence” states that the auditor should use assertions “in sufficient detail to form a basis for the assessment of risks of material misstatement and the design and performance of further audit procedures”.
4.2       Financial statement assertions contained:

(B)       Method of accumulating audit evidence

4.3       HKSA 500 states that the methods of collecting audit evidence include the followings:

5.       Audit Sampling

5.2       This HKSA is based on the premise (前提) that auditors do not normally examine all the information available to them; it would be impractical to do so and using audit sampling will produce valid conclusions.
5.3       The auditor may select certain items from a population because of specific characteristics they possess. The results of items selected 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.
(a)        High value or key items. The auditor may select high value items or items that are suspicious, unusual or prone (傾向于) to error.
(b)        All items over a certain amount. Selecting items this way may mean a large proportion of the population can be verified by testing a few items.
(c)        Items to obtain information about the client’s business, the nature of transactions, or the client’s accounting or control systems.
(d)        Items to test procedures, to see whether particular procedures are being performed.

(A)       Considerations of audit sampling

5.4       The steps of audit sampling involve the following:
(a)        Design the sample:
Auditor should consider the specific audit objectives, the nature of the population from which samples are selected and the sample size when designing an audit sample.
(b)        Selection of sample:
Auditor should select sample items that are the representative of the population in respect of characteristics being tested.

For example, the auditor selects specific monetary units from within the accounts receivable balances, the audit effort is directed to the larger value items because they have a greater chance of selection and can reduce the sample size.

Ideally, the auditor should select items for the sample that all sampling units in the population have a chance of being selected.
(c)        Evaluation of sample results:
After the appropriate audit procedures have been applied on the samples, the auditor should analyse the errors in the sample and draw conclusions for the population as a whole.

(B)       Approaches of audit sampling

5.5       Two types of audit sampling:
(a)        Statistical sampling – uses the laws of probability to select and evaluate the results of an audit sample, therefore, the sampling risk is quantified for drawing the conclusion about the population.
(b)        Non-statistical sampling (judgement sampling) – the auditor considers sampling risk without using law of probability to measure it.
5.6       Statistical sampling techniques are broadly categorized into:
(a)        Attribute sampling (屬性抽樣)
(i)         usually applied in test of controls;
(ii)        an attribute is a characteristic that each member of the population either has or does not have (or correct, not correct).
(iii)       it can only show the deviations from some benchmark but cannot give the monetary effect of such deviation.
(iv)       For example, no initial on the issue of credit notes to customers.
(b)        Variable sampling (變量抽樣)
(i)         commonly used in substantive procedures;
(ii)        a variable is a characteristics that each member of the population has a varying amount or quantity, for example, the amounts owed by debtors.
(c)        Monetary unit sampling (貨幣單位抽樣)
(i)         the sampling unit is the individual monetary value (e.g. one dollar).
(ii)        it measures whether or not an individual monetary value is in error and by how much.
(iii)       the maximum amount of monetary overstatement or understatement error in the population will be expressed.
(iv)       it is used as an alternative to variables sampling methods for performing substantive tests.

(C)       Selecting the representative samples

(a)       What is a representative sample?

5.7       The characteristics of a representative sample are that the audit interest of the sample is approximately the same as that of the population.

(b)       Causes of selecting non-representative samples

5.9       The way to control the sampling risk may include:
(a)        increasing the sample size will reduce sampling risk.
(b)        using an appropriate sampling method will reasonably assure representativeness.
5.10     There are sampling risks when an auditor carries out both tests of control and substantive procedures:
(a)        Tests of control
(i)         risk of under reliance (信賴不足風險) – this is the risk that the assessed level of control risk based on the sample is greater than the actual compliance rate of the control.
(ii)        risks of over reliance (信賴過度風險) – this is the risk that the assessed level of control risk based on the sample is less than the actual compliance rate of the control.
(b)        Substantive procedures
(i)         risk of incorrect rejection (誤拒風險) – this is the risk that the sample supports the conclusion that the recorded transaction or account balance is materially misstated when, in fact, it is not materially misstated.
(ii)        risk of incorrect acceptance (誤受風險) – this is the risk that the sample supports the conclusion that the recorded transaction or account balance is not materially misstated when, in fact, it is materially misstated.

5.12     Examples of non-sampling risk include:
(a)        the use of inappropriate audit procedures,
(b)        misinterpretation of audit evidence, and
(c)        failure to recognize a misstatement or deviation.

(c)        Sample size determination

5.13     Examples of some factors affecting sample size:

Examples of factors influencing sample size for tests of control

Examples of factors influencing sample size for substantive procedures

5.14     The sample size can be calculated as:

Where the reliability factor, taken from tables based on the Poisson sampling distribution is associated with the level of assurance the auditors want or need to obtain from the test. Such a table is given below and it shows the relationship between risk levels, and the reliability factor.

5.15     Example
Calculate the sample sizes which should be used in tests of control in the following circumstances.
(a)        No errors anticipated in the sample, accept 5% risk that four or more items in 100 are incorrect in the population.
(b)        One error anticipated in the sample, accept 1% risk that three or more items in 100 are incorrect in the population.

Answer

(a)        Sample size = 3.0 / 0.05 = 60 items
(b)        Sample size = 6.61 / 0.04 = 165 items

(d)       Sample selection methods

5.17     Selection methods for statistical sampling:
(a)        Random sample selection (隨機抽樣)
ensures that all items in the population have an equal chance of selection, e.g. by use of random number tables (隨機數表(亂數表)) or computerized generator (隨機數產生器).
(b)        Systematic sample selection (系統選樣法)
involves selecting items using a constant interval (e.g. every nth item) between selections, the first interval having a random start.

For example, if a population to be sampled is 600 items and the sample size is 50, the sampling interval will be 12 (= 600/50). One of the first 12 items will be selected as the starting point and thereafter every twelfth item will be selected. In determining the starting point each of the first 12 items (in this example) should have a chance of being selected. The starting point may be selected haphazardly or randomly.

Systematic selection is particularly useful when sampling from non-monetary populations, for example dispatch notes.
(c)        Stratified sample selection (分層隨機抽樣)
The population is divided into different strata, each of which has similar characteristic, then sampling techniques such as the random selection method can be applied in each stratum.

Example:

5.18     Selection methods for non-statistical sampling:
(a)        Directed sample selection (判斷抽樣)
the selection of each item based on some judgemental criteria by the auditor. The criteria used may include:
(i)        items most likely to contain misstatements;
(ii)       items containing selected population characteristics;
(iii)      large dollar coverage.
(b)        Block (or sequence) sample selection (區段抽樣)
is the selection of several items in sequence. Once the first item in the block is selected, the remainder of the block is chosen automatically. For example an auditor may use a sample of 50 consecutive cheques to check whether cheques are 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 certain part of the period, and hence the errors found cannot be projected onto the rest of the population.

Nevertheless, block sampling can result in significant cost savings in audit time, and there are some occasions where practical considerations may require the use of block sampling, for example when visiting a branch.
(c)        Haphazard sample selection (隨意抽樣)
may be an alternative to random selection provided auditors are satisfied that the sample is representative of the entire population. It is the selection of samples without following a structured techniques regard to their size, source, or other distinguishing characteristics.

(e)       Audit sampling procedures

5.19     The application of sampling techniques in substantive procedures, illustrated below, involves the following steps:
(a)        designing the sample;
(b)        selecting a sample;
(c)        performing the audit procedures;
(d)        evaluating results of the tests; and
(e)        summarizing the results.