Question

Answer the following questions briefly and concisely.

1. What is audit sampling? 2. Define the following terms: a. Error in the context of tests of controls b. Error in the context of substantive tests 3. What are the two components of detection risk? Explain each component briefly. 4. Can you eliminate sampling risk? Explain. 5. Describe the relationship between sampling risk and sample size.

Answer 1

solution

Audit sampling means examining less than 100% of item in the population. In other words while conducting audit auditor usually doesn't have enough time for detailed examination due to large number of transaction. therefore it is very helpful for auditor to take sample from the popution and make a judgement from it for entire population and on the basis of there judgement he can able to draw an opnion on the positon of financial statement in their report.

why it is required :  it is required in the following situations
1. where auditor has time constrain

2 where mostly item are identical

3. where Internal control are very high

4. where number of transaction are very high

Where it may not be suitable : it not be suitable in the following situation

1. Where the transactions in very high in amount

2. Where the transaction with the related party

3. few transaction having unusual nature

4. significant entries near/ at the end of the year

2. (a). Error in the context of test of control

Tolerabel error :- maximum error in population that auditor is ready to accept for a given sample size. if smaller tolerrable error, big sample size is needed.

this error is occur while test of control that maximum rate of devation from established procedure of Internal control

Expected Error: This is an error which auditor can expect that errors are definatly contain in the financial statement. if the possibility of of error in population than large sample size is required.

sapmling Risk: It is arise from possiblilty that auditor;s conclusion based upon sample may be different from conclusion that whould have been reached if same audit procedure were applied on entire population

In complilance procedures:

Risk of under reliance : Based upon the sample auditor concludes that internal control system is not adequate however actully it is not so

RIsk of Over reliance : Based upon sample auditor conclude that that Internal control are very effective however it is not so in reality

2(b) error in context of substansive procedures :

Tolerable error in context of substanve procedures It is occure maximum in monetory term like $20000 etc in this case if auditor has smaller tolerable error that big sample size in needed and vise versa
Expected error : This case an auditor make a mind that there is certain size of error or an make expectation about error in there mind
Sampling risk :

In substansive procedure : Risk of incorrect rejection : on the bases of sample auditor conclude that transction balance are materially misstated where as in fact these are not

Risk of incorrect acceptance : Based upon sample auditor conclude that transactions balances are not materially misstated while in fact these are misstated  

3. component of detection risk : Detection risk is the risk that an auditor's substansive procedure will not detect a material misstatement  

component of detection risk : It is non sampling risk that is inherent and control risk there is inverse relation in detection risk and combined level of inherent and control risk

Inherent risk: Inherent risk is the susceptibility of an account balance or class of transaction to a material misstatement, assuming that there were no internal control

Control risk : control risk is the risk that material misstatement will not be prevented or detected and corrected on a timely basis by the internal control system.

4. sampling risk: The risk that the auditor conclusion based on a sample on may be different from the conclusion if the entire population were subjected to the same audit procedure. sampling risk can lead to two types of errorneous conclusion.

sampling risk can be acceptabely low level but it cannot be eliminate from base due to inherent limitations

Inherent limitation :

cost effectiveness cost of implementation of control may be more than its benefits usually management dose not implement best control

Human error: Human error which may occur while carrying out internal control system

Concusion among employees: Employee may commite fraud through collusion it may be among themselves or outsiders

Abuse of authority: the person responsible for exercising control can himself override it.

Manipulation by management: manipulation by high level management may not be detected by control system Example manipulation in estimates appearing in financial statements.