Inferences Based on Limited Observations
Inferences Based on Limited Observations
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Chapter 1 An Introduction to Assurance and Financial Statement Auditing 17
mes32502_ch01_001-034.indd 17 09/30/15 02:33 PM
on previous audits, understanding of the client’s internal control system, and knowledge of the client’s industry, is aware of items in an account balance that are more likely to contain mis- statements. For example, the auditor’s prior knowledge may indicate that individual accounts receivable involving certain types of customers are more likely to contain misstatements. The auditor can use this knowledge to specifically select those particular accounts receivable for examination. When the auditor has no special knowledge about which particular transactions or items may be misstated, he or she uses random sampling procedures that increase the likeli- hood of obtaining a sample that is representative of the population of transactions or account items. In such cases, the auditor uses the laws of probability to make inferences about poten- tial misstatements based on examining a sample of transactions or items.
The size of the subset of items the auditor examines is primarily a function of materiality and the desired level of assurance for the account or assertion being examined. There is an inverse relation between sample size and materiality, and a direct relation between sample size and desired level of assurance. For example, if an auditor assesses a small materiality amount for an account, a larger sample will be needed than if materiality were a larger amount. This occurs because the auditor must gather more evidence (a larger sample) to have a reasonable likelihood of detecting smaller errors. You can think of materiality as the “fineness of the auditor’s filter.” A lower materiality amount requires the auditor to use a finer filter in order to detect smaller errors, and it takes more work to create a finer filter. Similarly, as the desired level of assurance increases for a given materiality amount, the sample size necessary to test an assertion becomes greater.
Final PDF to printer
Chapter 1 An Introduction to Assurance and Financial Statement Auditing 17
mes32502_ch01_001-034.indd 17 09/30/15 02:33 PM
on previous audits, understanding of the client’s internal control system, and knowledge of the client’s industry, is aware of items in an account balance that are more likely to contain mis- statements. For example, the auditor’s prior knowledge may indicate that individual accounts receivable involving certain types of customers are more likely to contain misstatements. The auditor can use this knowledge to specifically select those particular accounts receivable for examination. When the auditor has no special knowledge about which particular transactions or items may be misstated, he or she uses random sampling procedures that increase the likeli- hood of obtaining a sample that is representative of the population of transactions or account items. In such cases, the auditor uses the laws of probability to make inferences about poten- tial misstatements based on examining a sample of transactions or items.
The size of the subset of items the auditor examines is primarily a function of materiality and the desired level of assurance for the account or assertion being examined. There is an inverse relation between sample size and materiality, and a direct relation between sample size and desired level of assurance. For example, if an auditor assesses a small materiality amount for an account, a larger sample will be needed than if materiality were a larger amount. This occurs because the auditor must gather more evidence (a larger sample) to have a reasonable likelihood of detecting smaller errors. You can think of materiality as the “fineness of the auditor’s filter.” A lower materiality amount requires the auditor to use a finer filter in order to detect smaller errors, and it takes more work to create a finer filter. Similarly, as the desired level of assurance increases for a given materiality amount, the sample size necessary to test an assertion becomes greater.\