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Audit Sampling (boon to auditors)

CA Yashwanth Lathore 
on 07 March 2011

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Introduction:

Traditionally, an audit was conducted to check all the transactions without any exception in the programme. Obviously it was a wasteful exercise since the time and cost involved in it and the result obtained out of it was not that much justifiable. Even if we do 100% verification, such procedures do not guarantee that financial statements are free from any material misstatements. Due to the substantial shift in favour of internal control and procedure in recent days, the chances of occurring fraud and error has drastically came down. Hence the sampling kind of audit tool came into picture together with proper defensible approach.

(The perspective will change in case of statutory auditors and internal auditors. Statutory auditors are mainly concerned with framing an opinion on the financial statements and the latter are concerned with the value addition to the client together with the providing an approval that the results provided in financial statements are true and fair. Here i have tried to focus on internal auditors perspective as the assistants are required to complete the assignment covering the aspects like law compliance, accounting principles and presentation together with com[pletion of audit within the stipulated time.)

 

Audit Sampling:

It is an auditing tool from which the auditor selects sample items in such a way that the sample can be expected to be representative of the population. Generally a large manufacturing concern is associated with a large volume of transactions, where the audit cannot be completed within a timeframe. Hence the sampling techniques play a vital role in the audit procedures.

But again by placing in front of us the time and cost constraint, we cannot get away from risk of giving wrong opinion. Here, we should remember an old Kannada idiom saying the snake should die but stick should not break.  In this paper, I have made an attempt to put a light on as to handling of such scenarios by the audit assistants. What I am trying to convey is that an audit should be completed within time and ensuring everything is appropriate to a reasonable extent.

 

Precautions to be taken before applying sampling technique:

Before, starting up an audit procedure, an audit assistant should evaluate the internal controls and practices in place at the organization for recording or recognizing a transaction or an event. Such a study reveals us to what extent reliance can be placed on such a system. Once the audit risk and materiality level is computed, the areas should be identified that which are the areas that should audited on sample basis and which are compulsorily to be audited cent percent.

An assistant should observe the discrepancy pattern in the previous reports and accordingly plan his sampling techniques that he should cover those aspects whether such deviations are occurring even in the current audit period also or not together with new observations based on his computations (discussed at the end).

 

Factors affecting the selection of sample -

  • Integrity of the management
  • Unusual pressures on management
  • Management experience & knowledge
  • Nature of Entitys business & complex nature

Lets get started

The two major methods of sampling are Judgmental sampling and Statistical sampling.

In judgmental sampling, sample size is determined based on personal experience and the knowledge of the clients business. This is a quite common application because of simplicity. But unfortunately the same was criticized as it is neither objective nor scientific.

Another method is a statistical sampling; in this case sampling is based on mathematical laws rather than merely a judgment or any experience. The risk of personal bias in selection of sample items is eliminated in this type of sampling.

 

Some of the important methods of sampling methods are

°  Simple random sampling: In this case, the unit in a population has an equal chance of being selected. It is applied in case of population representing homogenous. For example, sales invoice value ranging Rs.5,000 to Rs.25,000 but not Rs.25 to Rs.50,000.

°  Stratified Sampling: In this case, the whole population is tested in a separate groups called strata. Each strata is tested on percentage according to the materiality level and the basis of stratification done. For example

Less than Rs.10000

B/w Rs.10K Rs.20K

More than Rs.20000

5%

10%

15%

 

°  Block Sampling: In this case, a block has to be selected among the population for instance first 200 invoices of September or in that block, we can bifurcate it as 50 invoices each block and select any of the block. Here, again there is risk of bias in selecting the block.

°  Cluster Sampling: This involves dividing the entire population into various groups known as clusters. Here the clusters are randomly selected rather than individual items and continue the audit.

Sl NO

Method

Example(For 1000 invoices)

1

Random Sampling

Pick any 100

2

Stratified Sampling

Value > 10000  -  5%

Value > 20000  -  10%

Value > 30000  -  15%

3

Block Sampling

Bifurcate into 10 blocks, select any 3 blocks and check entire block.

4

Cluster Sampling

Bifurcate into groups according to their importance and verify.


Conclusion and Solution

Now the problem is not resolved yet that out of these, which method should be followed in order to be on safer side and may be in providing value addition to the client.

In my opinion, the combination of the above methods will place us in a safer position as in terms of verifying legal compliance, accounting principles, proper disclosure and presentation.

Generally, we use MS-Excel in our audit. The said application acts as an important audit tool which helps us in performing the sampling procedure.

Lets take up an example of sales invoice verification. Supposing there are 1000 sales invoice comprising of:

EOU Sales

150

DTA Sales

500

Service charges

250

Exempted sales(NO CE)

75

Direct export

25

Total

1000 invoices

 

1.     First we should decide the percentage of sales invoice to be checked. ( here we consider it as 30% )

2.    Later it can be ascertained which should be on sample basis and which should be 100% percent checked.

3.    We should filter the invoices which we will be verifying 100%. In MS-excel, we should filter out the export invoices.(or mark it in different color code to recognize it as to be audited)

4.    Next step, on the basis of weightage, we should decide the percentage check to be done on each cluster/ group(in our case, it is sales according to their nature like DTA/EOU etc)

5.    Once we know which invoices to verify and begin the process, we should have a fair knowledge about the common mistakes that may likely to arise. (For instance, sales recognition, wrong valuation, wrong class selection in case of VAT, Indirect income being recognized as direct income under sale etc)

6.    The verification of invoices should be such that the sampling should cover all cases at least to some extent depending upon the value of the same. (It is to be noted that sampling method like 1 in 5 or 1 ion 10 will not be that much helpful since it may not cover entire class of transaction in the instant case)

7.    Additional Procedure

(this can be done either after or before sampling is adopted, preferably before sampling because indications of errors in items can be included in sampling)

I suggest to have a own computation in respect of crucial segments viz VAT, Central Excise duty, service tax or CST Computation mechanism in the excel or any such facilities available in ERP.

In this procedure, we can easily find out variations by comparing with those figures exported from tally or any financial records. Here, we can cover 100% by utilizing the excel facilities. This procedure is an additional in our sampling process which helps us in identifying the problematic areas and makes us keen on such transactions. The purpose behind to do own computation is to compare the result with the extracted figures, which can be easily tracked the possible deviations or discrepancies.

 

So, I wind up this article by saying that lets all decide not to follow 1 in 5 or 1 in 10 kind of sampling methods unless we do not have alternatives like excel or any system tools, the only reason behind the same is to adopt a mechanism which should cover entire class of transactions.

I hope this article provides a little light on sampling basis in our audits.

Awaiting response.




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