Learning ObjectivesLO6 Develop a simple audit program for an account balance, considering the influences of risk and tolerable misstatement.

a. Specify objectives and a population of data.

b. Determine sample size and select sample units.

c. Evaluate monetary error evidence from a balance audit sample.

LO7 Apply and integrate the chapter topics to analyze a practical auditing situation/case/scenario.

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Substantive Procedures for Auditing Account BalancesSubstantive tests of details auditing is the performance of procedures to obtain direct evidence about the dollar amounts and disclosures in the financial statements.

Substantive procedures include: analytical procedures, and test of details of transactions and balances.

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Risk Model ExpansionDetection risk (DR) is actually a combination of two risks:

Analytical procedures risk (APR) The probability that analytical procedures will fail

to detect material errors. Risk of incorrect acceptance (RIA)

The probability that tests of details procedures will fail to detect material errors.

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Risk Model Expansion

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Expanded risk model:AR = IR * CR * APR * RIA

Only risk of incorrect acceptance can be controlled by the auditor. Solve the risk model for RIA:

with AR, IR, and AP held constant RIA varies inversely with CR or control risk.

Sampling RiskIn sampling for substantive procedures, the auditor faces two sampling risks.

The risk of incorrect acceptance (beta risk) Accepting a balance as materially correct when

material misstatements have occurred. The risk of incorrect rejection (alpha risk)

Deciding a balance is materially misstated when it is not.

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Sampling RiskRisk of incorrect acceptance is considered the more important of the two.

Incorrect acceptance leads to audit failure.Incorrect rejection leads to additional audit

procedures to determine actual misstatement. Auditor will determine that the amount is not

materially misstated.Audit effectiveness (the right conclusion) is

more important than efficiency (least work).

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Sampling Steps for Account Balance Audit1. Specify the audit objectives.

2. Define the population.

3. Choose an audit sampling method.

4. Determine the sample size.

5. Select the sample.

6. Perform the substantive-purpose procedures.

7. Evaluate the evidence.LO6

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Plan the ProceduresThe first three steps represent the problem-recognition phase.

The client’s implicit assertions with respect to balances include existence, completeness, valuation, ownership and presentation.

Are the client assertions about the balances accurate?

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1. Specify the Audit ObjectivesObjective is to decide whether the client’s assertions about existence, rights, and valuation are materially accurate.

Hypothesis testing: auditors hypothesize that the book value is materially accurate and test that hypothesis.

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2. Define the PopulationDefinition of population must match objectives.

Examine individually significant items. Individual items that exceed materiality.

Apply stratification to the remaining population. Subdivide the population by account balance size.

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3. Choose an Audit Sampling MethodAuditor will decide whether to use statistical or judgmental sampling methods.

For statistical sampling methods, classic variables sampling methods and attribute sampling methods (dollar unit sampling) are available.

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Perform the ProceduresSteps 4 to 6 represent the evidence-collection phase.

Sample size determination requires consideration of several factors. It is important to get the sample size right, to avoid over-auditing or under-auditing.

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4. Determine the Sample SizeThe sample size is based on the following:

risk of incorrect acceptance (RIA), risk of incorrect rejection (RIR), material misstatement amount, expected dollar misstatement in the population, variability within the population, and size of the population.

DUS can be used to calculate a sample size.

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5. Select the sampleRandom or non-random methods, as in sample selection for test of controls.

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6. Perform the substantive purpose procedures.Substantive-purpose audit program produces evidence to support or refute management assertions.

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7. Evaluate the EvidenceEvaluate the evidence:

Determine amount of known misstatement. Total amount of errors actually uncovered by

procedures. Determine the likely misstatement.

Project the misstatement found in the sample to the population. Average difference method. Dollar-unit sampling projection method.

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7. Evaluate the EvidenceConsider sampling risks:

Auditor uses professional judgment and experience to consider these risks.

Quantitative evaluation: Follow up on all differences uncovered to

determine any misunderstanding of GAAP, simple mistakes, intentional irregularities, or management override of controls.

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7. Evaluate the EvidenceEvaluate the misstatement:

Known misstatement and likely misstatement are combined and compared to materiality.

Sample risk gives rise to “possible misstatements.” Misstatements that remain undetected in units not

sampled. Can be calculated where statistical methods are

used.

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Timing of Substantive ProceduresAccount balances can, in part, be audited at an interim date.

Auditor will extend the interim date audit conclusions to balance sheet date.

Audit work is performed at interim dates: to spread auditor’s workload over the year, and to allow for timely production of audit report

following year end. Poor controls, or significant business risk may

preclude performing procedures at interim.

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