Question

1. a. Explain how MUS applies to auditing of sales and collections.

b. Describe the advantages and disadvantages of MUS versus classical variables sampling.

Answer 1

Classical variables sampling considers each record as a sampling unit. Therefore each record has an equal chance of being selected for the sample, unlike MUS, which favours higher dollar value records. MUS treat each dollar as a sampling unit. While MUS is best used in situations where there are few expected errors

Monetary unit sampling

Uses attribute-sampling theory to express a conclusion in dollar amounts rather than as a rate of occurrence; designed primarily to test for overstatement errors

Advantages of MUS

1. When small number of differences expected, usually results in a smaller sample size than classical variable sampling
2. Automatically results in a stratified sample because items are selected in proportion to their dollar amounts (when applied using probability-proportional-to-size sample selection procedure)
3. Does not require assumptions about distribution of misstatements

Disadvantages of MUS

1. Selection of zero or negative balances requires special design consideration
2. MUS assumes that the audited amount of the sample item is not in error by more than 100%
3. When more than one or two misstatements are detected using an MUS approach, the sample results calculations may overstate the allowance for sampling risk

Steps in MUS

Planning
1. Determine the test objectives
2. Define the population characteristics
a. Define the population
b. Define the sampling unit
c. Define the misstatement
3. Determine the sample size, using the following inputs:
a. The desired confidence level or risk of incorrect acceptance
b. The tolerable misstatement
c. The expected population misstatement
d. Population size
Performance
4. Select sample items
5. Perform the auditing procedures:
a. Understand and analyze any misstatements observed
Evaluation
6. Calculate the projected misstatement and the upper limit on misstatement
7. Draw final conclusions

Advantages of Classical variable Sampling

1. When larger number of differences expected, usually results in smaller sample size than monetary-unit sampling
2. Effective for both overstatements and understatements
3. Selection of zero balances usually doesn't require special sample design considerations

Disadvantages of classical variable sampling

1. Some classical variable sampling techniques do not work well when little to no misstatement is expected
2. To determine sample size, auditor must estimate the standard deviation
3. If few misstatements detected, true variance tends to be underestimated (therefore, projected misstatements and related confidence limits unreliable)

How MUS applies to sales and collection cycle

The sales and collections cycle in a business refers to the set of processes that begin when a customer purchases goods or services and ends when the company receives complete payment for the purchase. As part of the year-end audit of a company's financial statements, external accountants test sales transactions and the internal controls over those transactions to ensure that the company is not materially misstating its revenues or accounts receivable.

Test of Controls

An auditor tests the controls the company has set up for the sales cycle to determine how strong and reliable they are. If they are strong, the auditor can reduce the amount of transaction testing he must do. Common internal controls over the sales cycle include numbered sales invoices, purchase order authorization over a certain limit and authorization over receivables write-offs. The auditor selects a random sample of transactions and examines the related purchase orders, invoices and customer statements. If the control being tested is numbered sales invoices, for example, the auditor ensures that all numbers in a section are accounted for and that none are missing. If the control is that all purchase orders are approved by management, the auditor checks for a manager's signature on each document. If control errors are found, the auditor increases the amount of transactional testing he must do.

Fraud

The purpose of an external financial statement audit is to provide assurance on the numbers and not to uncover employee or owner fraud. However, many of the sales cycle audit procedures can lead to the discovery of fraud. A common employee scheme is to steal customer payments and write them off in the accounting system so that the receivable no longer shows. If an employee has access to both the accounting system and the incoming mail, the auditor spends more time reviewing receivable write-offs to ensure that they were authorized and legitimate. A review of purchase orders often can uncover another common fraud where an employee creates sales to fictitious companies and steals the product.

Internal Auditing

A company also can audit its own procedures and transactions to ensure that controls are strong and effective. An internal audit is more likely to focus on employee fraud, and internal auditors design controls over processes that thwart the opportunity for it. Sales cycle examples include separating job duties that otherwise would allow theft and cover-up and implementing a mandatory vacation policy so fraud schemes cannot be maintained on a daily basis.