ACC 491 Week 5 Audit Sampling and the Audit Plan Example

Seventy-Eight Invoices and Ninety-Five Dollar Units: An Attribute Sample for a Credit Approval Control, a Monetary Unit Sample of Receivables and the Resulting Audit Plan for a Composite Janitorial Supply Distributor

[Student Name]

University of Phoenix

ACC/491: Contemporary Auditing I

Week 5 Assignment

[Instructor Name]

[Date]

The distributor, its populations and all figures are composites written for a model paper; sampling tables, standards and research findings come from the sources listed.

A composite distributor sells cleaning chemicals, paper products and floor equipment to schools, hospitals and building service contractors. In the year under audit it issued about 18,400 invoices and ended with $9.2 million of receivables from 2,300 customers. The audit team has decided to rely on the credit approval control if it proves effective and to confirm receivables using monetary unit sampling. Sampling lets an auditor reach a conclusion about thousands of items, but only if the sample is designed for the conclusion and evaluated with its uncertainty included. This paper designs and evaluates both samples and turns the results into the audit plan.

An Attribute Sample for Credit Approval

The control requires the credit department to approve any order that would take a customer over its credit limit, evidenced by an approval code in the system. A failure would allow sales to customers who cannot pay, overstating collectible receivables. The team sets a tolerable deviation rate of 6%, the highest rate at which it would still rely on the control, an expected deviation rate of 1%, based on last year's testing, and a 5% risk of overreliance, since reliance will reduce substantive work. Using the standard statistical table for these inputs, the sample size is 78, with one deviation allowed before the upper limit is likely to exceed the tolerable rate (American Institute of Certified Public Accountants, 2019).

The team selected 78 over-limit orders at random from the full year and examined each for an approval code. It found no deviations. At a sample of 78 with no deviations, the upper deviation limit at 5% risk is about 3.8%, below the 6% tolerable rate. The control can be relied on. Had the team found two deviations, the upper limit would have exceeded 6%, and it would have assessed control risk as high and increased substantive testing.

Designing the Monetary Unit Sample

Monetary unit sampling treats each dollar of the receivables balance as a sampling unit, so large balances are more likely to be selected. The team uses performance materiality for receivables of $300,000 as tolerable misstatement and expects $50,000 of misstatement based on prior years. Because the credit control proved effective, it accepts a 10% risk of incorrect acceptance. The confidence factor for no errors at 10% risk is 2.31, and the expansion factor is 1.5.

Sample size equals book value times the confidence factor, $9.2 million times 2.31, divided by tolerable misstatement less expected misstatement times the expansion factor, $300,000 less $75,000. The result is about 94.4, rounded to 95. The sampling interval is $9.2 million divided by 95, about $96,842. The team chose a random start and selected every 96,842nd dollar, sending confirmations to the 95 customers whose balances contained a selected dollar.

Evaluating the Results

Confirmations and alternative procedures revealed two misstatements. A school district's balance of $12,000 should have been $10,800, because a credit for returned floor pads was not recorded, an overstatement of $1,200 and a tainting of 10%. A hospital system's balance of $150,000, larger than the sampling interval, was overstated by $4,000 because of a duplicate invoice.

For the item smaller than the interval, projected misstatement is the tainting times the interval, 10% of $96,842, or $9,684. For the item larger than the interval, the actual misstatement of $4,000 is used, because every dollar of such items is effectively sampled. Projected misstatement is $13,684.

The allowance for sampling risk has two parts. Basic precision is the confidence factor times the interval, 2.31 times $96,842, about $223,705. The incremental allowance for the one projected error is the increase in the confidence factor for one error, from 2.31 to 3.89, less one, 0.58, times the projected $9,684, about $5,617. The upper misstatement limit is $13,684 plus $223,705 plus $5,617, about $243,006. That is below tolerable misstatement of $300,000, so the team concludes that receivables are not materially misstated, after management corrects the two known errors.

Nonresponses and Selection Details

Of the 95 confirmations, 81 were returned. For the 14 customers who did not respond, the team examined cash received after year end and, where payment had not arrived, matched the balance to signed delivery receipts and invoices. All 14 were supported. Two customers had balances large enough to include more than one selected dollar; each was confirmed once and counted once in the evaluation. Credit balances in receivables, where customers had overpaid, were set aside and tested separately, since monetary unit sampling does not select zero or negative balances.

Sampling Risk and Judgment

Statistical sampling measures sampling risk, but it cannot remove nonsampling risk, such as failing to recognize a misstatement in a confirmation reply. Elder et al. (2013) reviewed research showing that auditors sometimes fail to project misstatements or to allow adequately for sampling risk when using nonstatistical methods, and Hall et al. (2001) found that haphazard selection tends to underrepresent some items even when sample sizes increase. The team's use of random selection and formal evaluation addresses both concerns.

The Remaining Audit Plan

The results shape what follows. Because credit approval is effective and receivables passed, the allowance for doubtful accounts will be tested by reviewing subsequent collections and the aging, with less detailed customer-by-customer analysis. Revenue cutoff will be tested for five days on each side of year end. Inventory will be observed at the main warehouse and test counts made, with price testing for 40 items selected by value. Accounts payable will be tested by a search for unrecorded liabilities in January disbursements. The duplicate invoice finding leads the team to add an analytical review of credit memos issued after year end. Finally, the team will accumulate all misstatements and compare the total with overall materiality before forming its opinion.

Conclusion

An attribute sample of 78 invoices showed that credit approval operated effectively, with an upper deviation limit of 3.8% against a tolerable rate of 6%. A monetary unit sample of 95 receivables found two misstatements, projected to $13,684, with an upper misstatement limit of about $243,000, below the $300,000 tolerable misstatement. Together the results support reliance on credit controls, a clean conclusion on receivables and a focused plan for the work that remains.

References

American Institute of Certified Public Accountants. (2019). Audit sampling: Audit guide. AICPA.

Elder, R. J., Akresh, A. D., Glover, S. M., Higgs, J. L., & Liljegren, J. (2013). Audit sampling research: A synthesis and implications for future research. Auditing: A Journal of Practice & Theory, 32(Suppl. 1), 99-129. https://doi.org/10.2308/ajpt-50394

Hall, T. W., Herron, T. L., Pierce, B. J., & Witt, T. J. (2001). The effectiveness of increasing sample size to mitigate the influence of population characteristics in haphazard sampling. Auditing: A Journal of Practice & Theory, 20(1), 169-185. https://doi.org/10.2308/aud.2001.20.1.169