How to Deal with Sampling Risk During an Audit
Although you can never guarantee that an audit is 100-percent accurate, the sample of records you choose is crucial to helping you achieve as much accuracy as possible. The choices you make when determining which records to review can help you reduce (but never eliminate) your sampling risk. A number of factors contribute to risk:
You’re looking at the records of a company you know only from the outside.
Management may be hiding errors.
The company may have made inadvertent mistakes in its reporting.
Employees may be trying to deceive you.
When selecting a sample of records to audit, you can run into two different types of detection risks: the risk of incorrect rejection and the risk of incorrect acceptance. Knowing both types of risks exist and keeping your auditor eye out for them can lower your chance of error. After you figure out about these two risks, you can discover how your firm sets the appropriate sampling risk percentage.
The risk of incorrect rejection
Sometimes you may decide that a certain record doesn’t represent the whole population of records, but it actually does. In other words, you incorrectly reject your sample and then gather more records in the same population to sample. This scenario most often happens when you second-guess yourself, which means it most often happens to inexperienced auditors. You’re looking at a lot of records, and sometimes you just get overwhelmed.
Making this type of error has two potential consequences:
It negatively affects the efficiency and cost of the audit, because you end up doing more work.
It tends to irritate the client.
To prevent this mistake, do thorough research before determining the size and content of your sample, choose the best sampling method, and realize that you’ll trust your judgment more with each job you successfully complete.
The risk of incorrect acceptance
Sometimes you may think a sample record is representative of the whole population when it’s not. For example, you may have a sample of 100 records out of an entire population of 500 records for accounts receivable. You compare the facts and circumstances of the 100 records to your client’s books and find no errors. You deem accounts receivable as being materially correct based on your sample. However, unknown to you, the other 400 records contain numerous errors that materially affect accounts receivable and gross receipts. Not good.
If you fail to detect a material misstatement in the company’s records because you’re looking at the wrong records, your audit’s effectiveness decreases. In the worst-case scenario, you could issue an unqualified report when it isn’t deserved.
The auditing firm you work for has policies that dictate many procedures you employ while sampling. Setting guidelines to be used across the board within the firm ensures audit consistency, increases efficiency, and reduces the amount of professional judgment that auditors have to use in the field.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
