Sampling Methods, Difference between Sampling and Non-Sampling Risk - Assignment Example

Auditing Questions & Answers Topic 6 questions Explain how audit sampling is used an audit Audit sampling is used in an audit to select accounts or transactions within a balance for the purpose of testing them. Audit sampling is done in such a way that an auditor applies the audit process to less than 100 percent of the items that are contained in a class of transactions or an account balance. The items that are selected, i.e. the sample, are used to evaluate some characteristics of the entire items the transactions or balance. Understand the difference between sampling and non-sampling risk Sampling risk is the risk that the sample that is selected by an auditor does not represent the population of items or transactions that are contained in an account balance for testing, and because of this, the auditor makes an inappropriate conclusion. On the other hand, non-sampling risk is the risk that an auditor makes an inappropriate inference due to a reason that is not related to sampling matters. This can arise when the auditor applies an inappropriate audit process, makes decisions on the basis of unreliable evidence or takes too little time to test the accounts that are at the highest risk of material misstatement. Differentiate between statistical and non-statistical sampling Statistical sampling encompasses random selection and use of probability theory to assess sample results, including the results of sampling risk. On the other hand, non-statistical sampling is a sample selection method that does not have the characteristics of statistical sampling. That is, non-statistical does not involve random selection and it does not encompass the use of probability theory to evaluate the sample results. Describe sampling methods Sampling methods include systematic selection, random selection, block selection, haphazard selection and judgemental selection. Systematic selection entails selecting a sample for testing by dividing the number of items in a population by the size of the sample, which results in a sampling interval, n. a starting point is then selected, which is an item within the population below n, and then the sample is arrived at by selecting the first item followed by each nth item after that. Random sampling involves choosing sample items from the population freely without influencing the items that are selected. This means that each item in a population has an equal probability of being considered as part of the sample. Block selection entails selecting items that are clustered together within the total number of items that are available. This requires the items to be sorted in sequence. Haphazard selection involves selecting a sample without applying a methodical technique. Judgemental selection entails selecting items that an auditor considers necessary to be included in the sample of items that need to be tested. Determine the factors that influence the sample size when testing controls Extent to which the material misstatement risk is reduced by the working efficiency of controls: An increase in the degree to which the auditor’s assessment of risk takes into consideration the relevant controls increases the sample size. Acceptable deviation: An increase in the rate of deviation that can be tolerated decreases the sample size. Rate of deviation from prescribed control: An increment in the projected rate of deviation of the population being tested increases the sample size. Auditor’s required confidence: A rise in the auditor’s desired degree of assurance that the rate of deviation that can be tolerated is not exceeded by the population’s actual deviation rate increases the sample size. Number of sampling units: An increment in the number of sampling units in the population may affect the sample size but the effect is negligible. Determine the factors that influence the sample size when substantive testing Risk of material misstatement: A rise in the auditor’s evaluation of the risk of material misstatement has the effect of increasing sample size. Application of other substantive procedures that are aimed at the same assertion: An increment in the application of other substantive procedures that are aimed at the same assertion has the effect reducing the sample size. Auditor’s required confidence level: A rise in the auditor’s anticipated level of assurance that actual misstatement does not exceed tolerable misstatement in the population increases the sample size. Tolerable error: An increment in the level of tolerable misstatement decreases the sample size. Expected misstatement level: A rise in the level of misstatement that the auditor expects to observe in the population increases the sample size. Outline how to evaluate the results of tests conducted on a sample When performing tests on controls, the auditor will determine whether the results of the tests applied to a sample offer evidence that the control that has been tested is operational within the whole population. When performing tests of balances and transactions, the auditor will determine whether the results of the tests performed on a sample offer evidence that the account balance or class of transactions that has been tested is fairly stated (meaning that it does not contain material misstatements). If a departure from the prescribed controls is discovered when testing controls, the deviation rate will be recalculated. When errors are discovered when testing account balances or transactions, the auditor is required to project the error to the population that is being tested. This involves evaluating whether an error is unique and there is no possibility that it will be repeated throughout the population being tested. A unique error is removed before applying the remaining errors to the population. Understand the difference between tests of controls and substantive tests Tests of controls are audit procedures that are designed to assess the operating effectiveness of controls in averting, or detecting and making corrections to, material misstatements at the assertion level. On the other hand, substantive tests or substantive procedures are audit procedures that are designed to identify material misstatements at the assertion level. Substantive tests include substantive tests of balances, substantive tests of transactions, and analytical procedures. Explain the factors that impact the nature, timing and extent of audit testing The factors that affect the nature of audit testing include the purpose of the test (i.e. to test controls, account balances, or transactions) as well as the method applied (i.e. observation, inspection, recalculation, confirmation, enquiry, analytical procedures or re-performance. Another factor that affects the nature of audit testing is the assertion that is being tested. The factors that affect the timing of audit testing include the nature of the client, the client’s inherent risk, and the audit strategy to be used. Extent of audit testing is mainly affected by the level of control risk. When control risk is low, it is necessary to increase dependence on tests of controls and decrease dependence on substantive testing of account balances and transactions. When control risk is high, there is need to perform little or no test of controls and augment dependence on substantive testing of account balances and transactions. Describe how auditors draw conclusions based on evidence Auditors draw conclusions based on their understanding of the client and the notable risks identified in the process of planning the audit as well as evidence gathered when performing the audit. Conclusions are made based on evidence gathered in the tests of controls and substantive tests, and the conclusions are related to each assertion and account. Misstatements that are identified are brought to the attention of the client management or even the client’s audit committee. Following negotiations between the auditor’s lead partner and the client, the lead partner will come up with an opinion pertaining to the truthfulness as well as fairness of the financial report of the client. Understand how auditors document details of evidence in working papers. Auditors document details of evidence in working papers by showing a summary of the components of an account balance or providing details of the testing of the account balance. The documentation process involves keeping records of each phase of the audit and the method applied such that the key information is included in the working paper. Such information includes details relating to the risk assessment phase of the audit and details pertaining to the risk response phase of the audit. The working paper generally includes the name of the client; the period to which the audit relates; and particulars of the working paper such as the date when the paper was prepared, the preparer of the working paper and the paper’s reviewer(s) and review date; and cross referencing information. The working paper is stored in either a permanent file (file that includes client details relating to more than one audit) or the current file (file that contains client information that applies to the current audit). Topic 10 questions Explain the procedures performed as part of the engagement wrap-up including gathering and evaluating audit evidence When performing an the engagement wrap-up, an auditor reviews the proposed audit procedures to make sure that they are completed, completes any items that are open (such items include to-do items and review notes), makes sure that all essential documents are in the working paper files, and gets rid of any unnecessary documents. The auditor also reconsiders his or her evaluation of the fraud risk and internal control, reviews materiality, evaluates any existing misstatements, and carries out the events procedures that follow. Understand the considerations when assessing the going concern assumption used in the preparation of the financial report An auditor needs to assess and determine whether the going concern assumption is the right basis that was relied upon in the process of preparing the financial report. In other words, the auditor needs to assess the viability of the business entity in terms of whether the business can continue to be operational in the foreseeable future with no need or intention to be liquidated, to cease trading or to require protection from creditors. When carrying out the going concern assumption assessment, the auditor considers the viability of the business entity from the perspectives of an auditor, the managers of the business and those responsible for the governance of the business. Compare the two types of (material) subsequent events to determine what effect they have on the financial report. There are two kinds of subsequent events: Type 1 and type 2 subsequent events. Type 1 subsequent events are events that can have an impact on the estimates that are contained in the financial report or suggest that the going concern assumption in regard to part of or the entire entity is not appropriate. Type 1 subsequent events provide additional evidence relating to the condition(s) that existed in an entity at the end of the year. Such events need to be adjusted for in the financial report. Type 2 subsequent events are events that do not give rise to changes in the amounts in the financial report. Type 2 subsequent events offer evidence in relation to the conditions that arose before the end of the year. Such events do not need to be recorded in the financial report, but are evaluated for being included in the disclosure note. Analyse misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements A misstatement is a discrepancy between the amount, classification, presentation or disclosure that is needed for an item to be in conformity with the financial reporting framework that is applicable. Qualitative and quantitative consideration of misstatements comprise the risk of undetected errors not being found, the impact of the misstatements on conformity with agreements or covenants, whether the misstatements are judgemental misstatements or errors, whether there are any unadjusted misstatements that were made prior to the existing period and can affect the results of the current period, the likelihood that existing discrepancies may become material in the future, the relevance of the misstatements to the known users of the report, the sensitivity of the misstatements, the impact of reconciling discrepancies in different financial details and the quantity of the misstatements. Evaluate conclusions obtained during the performance of the audit and explain how these conclusions link to the overall opinion formed on the financial report Conclusions regarding an audit are made by assessing all of the audit evidence that is available and determining whether it is adequate and proper to decrease the risk of material misstatement in the financial report to a level that is acceptably low. Two types of opinions can be formed in relation to the financial report: modified and unmodified opinions. A modified opinion is made in reference to the materiality as well as the incidence of the intrinsic misstatement or uncertainty and the auditor has either not been able to get sufficient relevant audit evidence or the qualified audit opinion is not adequate as to disclose the misleading or incomplete scope of the financial report. Auditors can also make unmodified opinions, in which case there are no material misstatements in the financial report. Describe the components of an enhanced audit report An enhanced audit report contains the following items: title of the report, the entity to which the report is addressed, an introductory paragraph, the management’s as well as the auditor’s responsibility in regard to the report, the auditor’s opinion in relation to whether the report is true and fair in all the required aspects, other matters such as the reporting responsibilities, the signature of the auditor, the date when the report was prepared, and the address of the auditor. Identify the types of modifications to an audit report The different types of modifications that can be made to an audit report are as follows: the audit report conclusion can be unmodified; it can be unmodified with an emphasis of matter; it can be modified with a qualification; it can be modified with an adverse opinion; or it can be modified with a disclaimer of opinion. Describe why Corporations Act breaches are important to understand It is important to understand breaches of the Corporations Act because most of the breaches attract considerable penalties in accordance with the stipulations of the Act. Some of the breaches of the Corporations Act 2001 (Cth) include insolvent trading, contraventions of accounting standards, fraud by employees or officers of an entity, repeated non-lodgement or late lodgement of financial reports and annual statements, being in charge of managing a company even as one is prohibited from doing so under the Corporations Act, and directors’ failure to reveal any conflict of interest that they may have in regard to the dealings of the corporation among others. It is important to understand the various breaches of the Corporations Act 2001 in order to avoid getting involved in any contraventions of the Act that may lead to the penalties that are associated with such breaches. Understanding the Corporations Act 2001 breaches is also important since it can help in protecting the integrity and reputation of a company as well as the firm’s employees and other stakeholders. Explain what reporting is required to management and those charged with governance. Auditors have to report various issues that they find in their audit work to the managements of organisations as well as those charged with governance. The reporting that is required touches on various issues as required in several auditing standards. For instance, if the auditor has identified a case that involves fraud, or is in possession of information that suggests the occurrence of a fraud, he or she is required, under ASA 240, to communicate the issues to a relevant level of management. In the same way, in case the auditor identifies material nonconformity with regulations and laws, he or she is required to communicate such findings to those who are responsible for governance as required under ASA 250. Read More