Chapter F, Problem 73EP

a.

To determine

State the way in which Person A would define a deviation condition.

Explanation of Solution

Tests of controls: Test of control is performed by the auditor to verify that whether the control process is effective and efficient enough or not.

The reports received had not been indicated that they have been verified by R’s receiving personnel and this is the situation which Person A would define about the deviation (the indication would be in the form of marks adjacent to the quantities verified and a signature on the receiving report).

b.

To determine

State the way in which Person A would define the appropriate population and indicate the steps that should be taken to ensure that it is complete.

Explanation of Solution

Person A would define the appropriate population as all receiving reports that are prepared during the year under audit. To ensure whether the population is complete, Person A should verify the population (by identifying the document numbers corresponding to the first and last) from the receiving reports prepared by R’s employees during the year under audit. Moreover, this list should also be reviewed for any gaps or overlaps in numeric sequence.

c.

To determine

Indicate the options that are available to Person M for selecting specific items for examination and state the precautions that should be taken before undertaking the selection of items.

Explanation of Solution

Company R’s electronic list could be used to select items for examination the following selection methods:

• Unrestricted random selection: Under this method Person A could use the computer programs to identify 100 random numbers from the receiving reports and select the related reports.
• Systematic random selection: Under this method, Person A would use computer programs to select a random number from a random starting point in the population and evade a fixed number of items based on the sampling interval, as follows

For instance: Assume that the sample size is 50 and the total receiving report in the population is 25,000:   

$\begin{array}{c}\text{Random numbers}=\frac{\text{Total number of receiving reports issued}}{\text{Sample sizes}}\\ =\frac{25,000}{\text{50 items}}\\ =\text{ 500 items}\end{array}$

• Haphazard selection: Under haphazard method, Person A would non-systematically select the receiving reports from the electronic list without any validation for the inclusion or exclusion of various receiving reports.
• Block selection: Under block selection method, Person A would use computer programs to rearrange the electronic list for selecting the receiving reports prepared by certain individuals, for certain types of vendors, or during certain dates.

d.

To determine

Compute the sample rate of deviation for the following deviations and explain the decision of Person A with respect to the functioning of the control:

1. 1. 2 deviations.
2. 2. 4 deviations.
3. 3. 10 deviations.

Explanation of Solution

Sample rate of deviation: It is a rate of deviation that ascertains the percentage of occurrence and accuracy of control. Sample rate of deviation is calculated by using the following formula:

$\text{Sample deviation rate}=\frac{\text{Number of deviation}}{\text{Sample size}}$

1. 1. Determine the sample rate of deviation for 2 deviations:

$\begin{array}{l}\text{Sample deviation rate}=\frac{\text{Number of deviation}}{\text{Sample size}}\times 100\\ =\frac{2}{100}\times 100\\ =2\%\end{array}$

In this case, Person A may relies on the internal control as planned. Because the sample rate of deviation of 2% is lower than the tolerable rate of deviation of 4%.  On the other hand, the sample rate of deviation of 2% is higher than the expected population deviation rate of 1.5%, thus, person A might also decide to increase the sample size.

1. 2. Determine the sample rate of deviation for 4 deviations:

$\begin{array}{l}\text{Sample deviation rate}=\frac{\text{Number of deviation}}{\text{Sample size}}\times 100\\ =\frac{4}{100}\times 100\\ =4\%\end{array}$

Calculate the ULRD by using AICPA sample evaluation tables.

According to the AICPA sample evaluation tables, the ULRD for 4 deviations of 100 sample size at 5% risk of overreliance is 9%.

Calculate the allowance for sampling risk.

$\begin{array}{c}\text{Allowance for sampling risk = Upper limit rate of deviation }-\text{ Sample rate of deviation}\\ \text{=9\%} -4\%\\ =5\%\end{array}$

In this case, Person A cannot rely on the internal control as planned. Because the sample rate of deviation of 4% is equal to the tolerable rate of deviation (4%). There has to be some allowance for sampling risk, which would place the ULRD above the tolerable rate of deviation.  Thus, Person A would either need to reduce the reliance on internal control or should expand sample to examine additional items.

1. 3. Determine the sample rate of deviation.

   $\begin{array}{l}\text{Sample deviation rate}=\frac{\text{Number of deviation}}{\text{Sample size}}\times 100\\ =\frac{10}{100}\times 100\\ =10\%\end{array}$

Determine ULRD by using AICPA sample evaluation tables.

According to the AICPA sample evaluation tables, the ULRD for 10 deviations of 100 sample size at 10% risk of overreliance is 16.4%.

Determine allowance for sampling risk.

$\begin{array}{c}\text{Allowance for sampling risk}=\text{Upper limit rate of deviation}-\text{Sample rate of deviation}\\ =\text{16}\text{.4\%} -10\%\\ =6.4\%\end{array}$

In this case, Person A cannot rely on the internal control as planned. Because the sample rate of deviation of 10% exceeds the tolerable rate of deviation (4%). Thus, Person A would either need to reduce the reliance on internal control or should expand sample to examine additional items.