Audit of sales and collection cycle – Flashcards

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Sales Accounts
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Revenue, Accounts Receivable
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Sales' Business functions
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Process Customer Order Granting credit Shipping good Billing customers Recording sales
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Sales' Docs and Records
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Customer order Sales order Shipping document Sales invoice Sales transaction file Sales journal Accounts receivable master file Monthly statement
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Cash receipt accounts
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Cash in bank, Accounts Receivable
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Cash receipt business functions
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Processing and recording CR
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Cash receipt Docs and records
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Remittance advice Prelisting CR CR transaction file CR journal or listing
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Sales return and allowances Accounts
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Sales returns and allowances Accounts Receivable
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Sales returns and allowances business function
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processing and recording sales returns and allowances
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Sales returns and allowances docs and records
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Credit memo Sales returns and allowances journal
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Write off of uncollectible goods accounts
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Accounts Receivable Write off of uncollectible goods
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Write off of uncollectible goods business functions
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writing off uncollectible AR
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Write off of uncollectible goods docs and records
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Uncollectible accounts authorization form General Journal
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Estimate of BDE accounts
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BDE Allowance for uncollectible goods accounts
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Estimate of BDE business functions
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providing bad debts
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Estimate of BDE docs and records
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General journal
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Processing Customer orders
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a request for merchandise by a customer. Described by sales order, a document listing the description, quantity, and related info of goods ordered by a customer
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Granting credit
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Before goods are shipped, a properly authorized person must approve credit to the customer for sales on account
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Shipping goods
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First point in cycle where company gives up assets. Shipping doc prepared at time of shipment to initiate shipment of goods, indicating the description of the merchandise, the quantity and other data
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Billing customers and recording sales
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important that all shipments made have been billed, no shipment has been billed more than once, and each one is billed for the proper amount
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Processing and recording CR
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receiving, depositing, and recording cash. The most important concern is the possibility of theft; remittance advice→prelisting of CR
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Processing and recording sales returns and allowances
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seller accepts the return of goods or grants a reduction in charges. Company prepares a receiving report for returned goods and returns them to storage. Returns allowances are recorded in the sales returns and allowances transaction file. Credit memo issued
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Writing off uncollectible AR
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Uncollectible account authorization form issued indicating authority to write an account receivable off as uncollectible
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Providing for Bad Debts
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Because companies cannot expect to collect 100% of their sales, accounting principles require them to record bad debt expense for the amount they do not expect to collect
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Understanding IC (sales)
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auditors study the clients' flowcharts, make inquires of the clients using an internal control questionnaire and perform walkthrough tests of sales
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Assess Planned Control Risk (sales)
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o A framework for assessing control risk→ the transaction related audit objective o Identify the key internal controls and deficiencies for sales o After identifying the controls and deficiencies, the auditor associates them with the objectives o Assess control risk for each objective by evaluating the controls and deficiencies for each objective
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Adequate separation of duties
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helps prevent fraud and errors
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Proper Authorization
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the auditor is concerned about authorization of credit before a sale takes place, and about authorization of prices and discounts before goods are shipped
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Pre-numbered documents
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in order to prevent both the failure to bill or record sales and the occurrence of duplicate billings and recordings
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Assessing Planned Control Risk (sales)
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Adequate Separation of Duties Proper Authorization Adequate documents and record Internal verification process Pre-numbered documents Monthly statements
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Monthly statements to customers
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it encourages customers to respond if the balance is incorrectly stated
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Test of controls and substantive tests of transactions (Sales)
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Understand IC Assess Planned Control Risk Determine extent of Testing Controls Design Test of Controls Design Substantive tests of transactions
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Determine extent of testing controls (Sales)
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depends on the effectiveness of the controls and the extent to which the auditor believes they can be relied on to reduce control risk
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Design test of controls (Sales)
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For each key control, one or more tests of controls must be designed to verify its effectiveness. In most audits it is relatively easy to determine the nature of the test of control from the nature of the control. (Ex: if the internal control is to initial customer orders after they have been approved for credit, the test of control is to examine the customer order for proper initials.)
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Design Substantive Tests of Transactions (sales)
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relatively difficult because they vary considerably depending on the circumstances
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Controls over sales returns and allowances
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Materiality: in many cases, sales returns and allowances are so immaterial auditors can ignore them Emphasis on the occurrence objective: auditors emphasize testing recorded transactions to uncover any theft of cash from collection of accounts receivable that was covered up by a fictitious sales returns or allowances
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Test of Controls and Substantive tests of transactions for CR
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Determine whether CR was recorded Prepare proof of CR Test to discover lapping of AR
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Determine whether CR was recorded
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trace from pre-numbered remittance advices or prelists of cash receipts to the CR journal and subsidiary accounts, receivable records as a substantive test of the recording of actual cash received. Most difficult fraud to detect when occurs before recorded in CR journal
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Prepare proof of CR
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CR recorded in CR journal for a given period are reconciled with the actual deposits made to the bank during the same period. Can help uncover recorded CR that have not been deposited. Not useful in discovering CR that have not been recorded in CR journal or time lags in making deposit
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Test to discover lapping of AR
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easily prevented by separation of duties and a mandatory vacation policy for employees who both handle cash and enter CR into the system. Detect by comparing name, amount and dates shown on remittance advices with CR journal entries and related duplicated deposit slips
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Control over write-offs of uncollectible AR
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Concern is the possibility of client personnel covering up an embezzlement by writing off accounts receivable that have already been collected; auditor examines approvals by the appropriate persons
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Effects of results of test (CR)
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•Results of the tests of controls and substantive tests of transactions have a significant effect on the remainder of the audit, especially the substantive tests of details of balances •If results are unsatisfactory, necessary to do additional substantive test •Most significant effect is on confirmation of AR; the type of confirmation, the size of sample and timing of the test are all affected
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Audit Sampling
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when the auditor decides to select less than 100% of the population for testing to make inferences about the population (for sales and collection)
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Representative sample
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one which the characteristics of the sample approximately the same of the population; sampled items are similar to items not sampled To increase likelihood of sample being representative, use care in designing the sampling process, sample selection, and evaluation of sample results; can be non-representative due to non-sampling risk and sampling risk
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Non-sampling risk
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risk that audit tests do not uncover existing exceptions in the sample; caused by auditor's failure to recognize exceptions or inappropriate or ineffective audit procedures
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Sampling risk
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risk that an auditor reaches an incorrect conclusion because the sample is not representative of the population estimate of the sampling error and the reliability of that estimate
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Ways to reduce sampling risk
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•Adjust sample size: increasing sample size reduces sampling risk and vice versa •Use of an appropriate method of selecting sample items from the population to increase the likelihood of representatives
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Statistical sampling
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applies mathematical rules, auditors can quantify sampling risk in planning the sample and in evaluating the results
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Non-statistical sampling
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auditors do not quantify sampling risk. Auditors select samples they believe will provide the most useful info, and reach conclusions about populations on a judgmental basis
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Non-probabilistic sample select methods
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Direct sample selection Block sample selection Haphazard sample
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Direct sample selection
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auditors deliberately select each item in the sample based on their own judgmental criteria instead of using random selection (ex: items most likely to contain misstatements, items containing selected population characteristics and large dollar coverage)
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Block sample selection
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auditors select the first item in a block and the remainder of the block is chosen in sequence. Acceptable to use block samples only if a reasonable number of blocks is used
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Haphazard sample
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selection of items without any conscious bias by the auditor •Shortcoming is the difficulty of remaining completely unbiased in the selection •Useful in situations where the cost of more complex sample selection methods outweighs the benefit obtained from using these approaches
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Probabilistic sample selection methods
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Simple random sample selection Systematic sample selection Probability proportional to size and stratified sample Probability proportional to size Stratified sampling
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Simple random sample selection
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every possible combination of population items has an equal chance of being included in the sample. Used when there is no need to emphasize one or more types of population items
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Systematic sample selection
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auditor calculates an interval and then selects the items for the sample based on the size of the interval. Auditor must consider possible patterns in the population data that can cause sample bias
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Probability proportional to size and stratified sample
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advantageous to select samples that emphasize population items with larger recorded amounts
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Probability proportional to size
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take a sample in which the probability of selecting any individual population item is proportional to its recorded amount
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Stratified sampling
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divide the population into subpopulations, usually by monetary size, and take larger samples from the subpopulation with larger sizes
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Occurrence (exception) rate
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estimate the percentage of items in a population containing the characteristic or attribute of interest • Used to estimate the exception rate in the entire population, meaning it is the auditor's "best estimate" of the population exception rate
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Sampling error
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sample exception rate differs from the actual population exception rate
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Computed upper exception rate (CUER)
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auditor wants to know the most the exception rate is likely to be, rather than the width of the confidence interval estimate
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Non-statistical sampling in tests of controls and substantive tests (14 steps)
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1. State the objective of the audit test 2. Decide whether audit sampling applies 3. Define attributes and exception conditions 4. Define the population 5. Define the sampling unit 6. Specify the tolerable exception rate (TER) 7. Specify acceptable risk of assessing control risk is too low (ARACR) 8. Estimate the populate exception rate (EPER) 9. Determine the initial sample size 10. Select the sample 11. Perform the audit procedures 12. Generalize from the sample to the population 13. Analyze Exceptions 14. Decide the acceptability of the population
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State the objective of the audit test
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stated in terms of the transaction cycle being tested (ex: objectives in sales/collection cycle are usually to test effectiveness of IC over sales and CR and to determine whether sales and CR transactions contain monetary misstatements)
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Decide whether audit sampling applies
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applies whenever the auditor plans to reach conclusions about a population based on a sample
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Define attributes and exception conditions
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unless auditors clearly define each attribute in advance, the staff person who performs the audit will have no guidelines to identify exceptions
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Define the population
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the set of items the auditor wishes to generalize. Define population in advance, consistent with the objectives of the audit tests. Sample must be selected from the entire population as it's been defined
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Define the sampling unit
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based on the definition of the population and the objective of the audit test. The physical unit that corresponds to the random numbers the auditor generates
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Specify the tolerable exception rate (TER)
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TER represents the highest exception rate the auditor will permit in the control being tested and still be willing to conclude the control is operating effectively • A larger sample size is needed for a low TER than for a high TER to gather evidence about effectiveness of control or absence of monetary misstatement
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Specify acceptable risk of assessing control risk too low (ARACR)
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ARACR measures the risk the auditor is willing to take of accepting a control as effective when the true population rate is greater than TER; auditor's measure of sampling risk •High ARACR means auditor willing to take a fairly substantial risk of concluding that the control is effective after all testing is complete •Common for auditors to use ARACR of high, medium, or low •Inverse relationship between ARACR and planned sample size
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Estimate the population exception rate (EPER)
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used to plan appropriate sample size; if EPER is low, a relatively small sample size will satisfy the auditor's tolerable exception rate
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Determine the initial sample size
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use TER, ARACR, EPER, and population size; population size least significant factor
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Select the sample
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choose the items in the population to include in the sample; auditor should not inform client too far in advance of sample items selected
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Generalize from the sample to the population
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sample exception rate (SER) equals the actual number of exceptions divided by the actual sample size. Two ways to generalize from sample; • Add an estimate of sampling error to SER to arrive at a CUER for a given ARACR • TER-SER, and evaluate whether it is sufficiently large for concluding that the true population exception rate is acceptable • When SER>EPER used in designing the sample, auditors conclude that the sample results do no support the preliminary assessed control risk
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Analyze Exceptions
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analyze individual exceptions to determine the breakdown in the IC that allowed them to happen; factors can include carelessness of employees, misunderstood instructions, or internal failure to perform procedures
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Decide the acceptability of the population
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TER-SER to evaluate whether the difference is sufficiently large; • If difference is large, the control being tested can be used to reduce assessed control risk as planned • When TER-SER is too small to conclude that the population is acceptable, or when SER>TER, four courses of action o Revise TER or ARACR o Expand the Sample Size o Revise Assessed Control Risk o Communicate with the Audit Commitment or Management • The auditor needs to retain adequate records of the procedures performed, the methods used to select the sample and perform the tests, the results found in the tests and the conclusions reached
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Statistical Audit Sampling
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statistical sampling model most commonly used for tests of controls and substantive tests of transactions •Calculation of initial sample sizes and upper exceptions rates uses tables developed from statistical probability distributions •Based on the Binomial distribution, each possible item in the population has one of two possible values
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Sampling distribution
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frequency distribution of the results of all possible samples of a specified size that could be obtained from a population containing some specific characteristics • Allows auditor to make probability statements about the likely representativeness of any sample that is in the distribution
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