Question

Your friend, Han Oh, has recently began working for an auditing firm and he wants your advice regarding some tests of sales transactions that he is currently undertaking with respect to one of his clients. Han selected a haphazard sample of 20 sales with a total book value of $150,000. In his sample, he found a total of $1,000 in net overstatement errors. The total sales balance per books is $40 million. Overall materiality for the engagement is $600,000. Tolerable error for sales is $140,000.

Required

a. What kind of testing is Han performing- compliance or substantive?

b, Could Han safely conclude that no additional audit work is needed in this area? Support your answer.

Answer 1

A)  As per the given case study, Han oh performing substantive procedure here because Substantive procedures are tests designed to obtain evidence to ensure the completeness, accuracy and validity of the data. Example - Inventory validation, Sales/Purchase invoice checking record matching, balance checks.

B) Han oh needs to be performed some additional work apart from the sampling he choose.

As defined in AS 2315,

• Sample items should be selected in such a way that the sample can be expected to be representative of the population. Therefore, all items in the population should have an opportunity to be selected. Random-based selection of items represents one means of obtaining such samples. Ideally, the auditor should use a selection method that has the potential for selecting items from the entire period under audit. As per Para 39 First of all, sampling choose by Han oh is only $ 150,000 that is only 0.375% and one cannot comment on overall integrity of sales of organisation.
• If the total projected misstatement is close to the tolerable misstatement, the auditor may conclude that there is an unacceptably high risk that the actual misstatements in the population exceed the tolerable misstatement. An auditor uses professional judgment in making such evaluations. If Han-oh found $1,000 overpayment error in sample then in percentage it is almost 0.67 $ per $100.In totality amount exceed the maximum tolerate limit is by $126,667 ( $266,667-$ 140,000 ).
• On last note If the materiality level is too high, auditors may not perform sufficient audit procedures to detect material misstatement. On the other hand, if it is too low, auditors may perform more work than necessary. In short, the level of performance materiality that auditors determine will need to reflect the identified and assessed risks of material misstatement for particular classes of transactions, account balances, or disclosures. In case study , overall materiality limit is $600,000 which is just 1.5%. Hence we can conclude that auditor needs more workings