The accounting firm of Mason & Jarr performed the work described in each of the following separate cases. The two partners are worried about properly applying auditing standards regarding sampling. They have asked your advice.
Required:
Write a report addressed to Mason & Jarr stating whether they did or did not observe the essential elements of auditing standards in each case. When applicable, refer to the appropriate professional standards regarding audit sampling.
a. Mason selected three purchase orders for the purchase of raw materials from LIZ Corporation’s files. He started at the beginning in the accounting process and traced each one through the accounting system. He saw the receiving reports, purchasing agent’s approvals, receiving clerks’ approvals, vendors’ invoices (now stamped paid), entry in the cash disbursement records, and canceled checks. This work gave him a first- hand familiarity with the cash disbursement system, and he felt confident about understanding related questions in the internal control questionnaire completed later.
b. Jarr observed the physical inventory at SER Corporation. She had a list of the different inventory descriptions with the quantities taken from the perpetual inventory records. She selected the 200 items with the largest quantities and counted them after the client’s shop foreperson had completed his count. She decided not to verify the count accuracy of the other 800 items. The shop foreperson miscounted in 16 cases. Jarr concluded the rate of miscount was 8 percent and that as many as 80 of the 1,000 items might be counted incorrectly. As a result, she asked him to recount everything.
c. CSR Corporation issued seven separate commercial paper notes near the fiscal year- end to finance seasonal operations. Jarr confirmed the obligations under each series with the independent trustee for the holders, studied all seven indenture agreements, and traced the proceeds of each issue to the cash receipts records. d. At the completion of the EH& R Corporation audit, Mason obtained written representa-tions as required by generally accepted auditing standards from the president, the chief financial officer, and the controller. He did not ask the chief accountant at headquarters or the plant controllers in the three divisions for written representations.
e. Jarr audited the Repairs and Maintenance account of Kerr Corporation by vouching all entries of more than $ 5,000 (totaling $ 278,000) to supporting documents. She compared the sum of all remaining entries ($ 75,000, a material amount) in relation to the prior- year total of $ 56,000 and decided the amounts were reasonable and did not perform any additional procedures with respect to these entries.
SOLUTION
TO: Mason & Jarr, CPAs
FROM: Consultant-Advisor
SUBJECT: Application of Audit Sampling Standards (AU 530)
At your request, I have reviewed the audit work in the case files you provided. Herein are my conclusions about proper application of the audit sampling standards in (AU 530).
Work to understand the accounting system: The sample of three purchase orders and subsequent tracing the cash disbursement documents and procedures is not considered “audit sampling,” and AU 530 does not apply. The work was properly done for the purpose of obtaining a preliminary understanding of internal control, not for making a judgment about the effectiveness of control procedures. Audit sampling standards apply to samples taken for the purpose of reaching a conclusion about an entire population of data—in this case, the cash disbursements controls—not about work done to obtain a general understanding of a client’s internal control. (AU 530, A3)
Inventory count accuracy test: The sample of inventory items for recounting is a sampling application covered by AU 530. Jarr took the sample for the purpose of making an overall judgment of the accuracy of the counting procedure. However, the sample did not meet AU 530 requirements because it does not appear to have been representative (AU 530.08). Only the largest-quantity items were chosen, and the others were ignored. These items were probably the most likely to be miscounted.
In addition to the preceding concern, Jarr did not appropriately consider sampling risk in projecting the results to the population (AU 530.A24). Simply stated, the rate of miscount (8 percent) assumed that the entire population was misstated to the same extent as the sample (16 200 = 8 percent). This is not appropriate.
Short-Term debt outstanding: The audit of all of the outstanding commercial paper notes is not a sampling application. Audit sampling is the application of audit procedures to less than 100 percent of the items in a balance (AU 530.05). Jarr’s work examined all items comprising the short-term commercial paper amount on the balance sheet.
Written representations: Audit sampling is not involved in the procedure of obtaining written representations. Although it might initially appear that Mason “sampled” client officers to obtain written representations, this evidence is considered to represent the entire body of evidence under examination.
Written representations are ordinarily obtained from those members of management with overall responsibility for financial and operating matters, such as the chief executive officer, chief financial officer, and others with equivalent positions whom the auditor believes are responsible for and knowledgeable about, directly or through others in the organization, the matters covered by the representations. Such members of management normally include the chief executive officer and chief financial officer or others with equivalent positions in the entity. (AU 580.A2)
Jarr divided the Repairs and Maintenance account into two “populations.” Under AU 530, this is acceptable and, in fact, the recorded or book value of the items is specifically mentioned as an example of a characteristic that may be used to subdivide a population (AU 530.05)
While the process of subdividing the population appears to have been appropriate, Jarr’s selection of sample items within these groups was not. She audited all items in one population (the $278,000 expense entries each more than $5,000), which was not a sampling application. Nor was the second population ($75,000 for which each entry was less than $5,000) a sampling application; Jarr applied analytical procedures with respect to these entries (AU 530.05).
Instructors should feel free to observe that the “analytical comparison” is very casual, and the $75,000 of smaller entries is actually not audited very well. The purpose of auditing the larger entries was to reach a conclusion about the entire account, even though very little audit effort was given to the population of smaller entries.