Your uncle Bob, a CPA, has recently started auditing and he wants your advice on some tests of sales transactions he is conducting. Bob selected a haphazard sample of 15 sales with a total book value of $75,000. In his sample, he found a total of $500 in net overstatement errors. The total sales balance per book is $10,000,000. Overall materiality for the engagement is $300,000. Tolerable misstatement for sales is $70,000. If the sample results indicate that Bob's best estimate of total misstatement in sales is $35,000, can Bob safely conclude that no additional work is needed in this area? Include in your answer a clear discussion of how sample results are compared to tolerable misstatement.
What will be an ideal response?
No, Bob cannot safely conclude that no additional work is needed. Bob has not considered sampling risk. His best estimate is a projected misstatement to the population. He has only sampled 15 transactions that amounted to less than 1% of the balance. Because this is a relatively small sample, the risk that the sample is not representative of the population is significant. If the true misstatement rate in the remainder of the population is higher, total misstatement could easily exceed tolerable misstatement. The approach that should be taken is to project the misstatement (that is, calculate the best estimate of total misstatement in the population) and incorporate an amount in consideration of sampling risk. There is an inverse relationship between sample size and sampling risk. Without statistical methods, judgments about sampling risk are difficult to make. Thus, sampling risk must be considered.
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