G. VARIABLE SAMPLING MULTIPLE CHOICE QUESTIONS FOR WEEK ONE

Which of the following major stages of the audit is most closely related to variables sampling?

Determining preliminary levels of performance materiality.

Performing tests of controls procedures.

Performing substantive procedures.

Searching for the possible occurrence of subsequent events.

G.24

Which of the following types of variables sampling plans has a tendency to select higher-dollar items for examination?

Difference estimation.

Mean-per-unit estimation.

Monetary unit sampling.

Ratio estimation.

G.25

Variables sampling methods can be used to estimate

Amount of Misstatement True Account Balance

a. Yes Yes

b. Yes No

c. No Yes

d. No No

G.26

When evaluating the results of an MUS application, the audit team should compare the upper limit on misstatements to the

Expected misstatement.

Incremental allowance for sampling risk.

Projected misstatement.

Tolerable misstatement.

G.27

When making a decision about the dollar amount in an account balance based on a sample, the audit team considers the risk of incorrect acceptance to be more serious than the risk of incorrect rejection because

The incorrect rejection decision impairs the efficiency of the audit.

The audit team will do additional work and discover the misstatement of the incorrect decision.

The incorrect acceptance decision impairs the effectiveness of the audit.

Sufficient appropriate audit evidence will not have been obtained.

G.28

The unique feature of monetary unit sampling is that

Sampling units are not chosen at random.

A dollar unit selected in a sample is not replaced before the sample selection is completed.

Auditors need not worry about the risk of incorrect acceptance decision.

The population is defined as the number of monetary units in an account balance or class of transactions.

G.29

When determining sample size under monetary unit sampling, an audit team does not need to make a judgment or estimate of

Audit risk.

Tolerable misstatement.

Expected misstatement.

Standard deviation.

G.30

Which of the following statements is correct about monetary unit sampling?

The risk of incorrect acceptance must be specified.

Smaller logical units have a higher probability of selection in the sample than larger units.

Each logical unit in the population has an equally likely chance of being selected in the sample.

The projected misstatement cannot be calculated when one or more misstatements are discovered.

G.31

One of the primary advantages of monetary unit sampling is the fact that

It is an effective method of sampling for evidence of understatement in asset accounts.

The sample selection automatically achieves high-dollar selection and stratification.

The sample selection provides for including a representative number of small-value components.

Expanding the sample for additional evidence is relatively simple.

G.32

Which of the following would not cause the audit team to select a larger sample of items under a monetary unit sampling application?

A reduction in the risk of incorrect acceptance from 10 percent to 5 percent.

An increase in the tolerable misstatement from $30,000 to $60,000.

An increase in the expected misstatement from $20,000 to $40,000.

All of these would result in selecting a larger sample.

G.33

Assume that an account with a recorded balance of $5,000 has an audited value of $3,000. By using monetary unit sampling, if the sampling interval is $1,500, the projected misstatement would be

$600.

$900.

$2,000.

$3,000.

G.34

If the is less than the , the audit team would conclude that the account balance is fairly stated.

Projected misstatement; tolerable misstatement.

Tolerable misstatement; projected misstatement.

Upper limit on misstatements; tolerable misstatement.

Tolerable misstatement; upper limit on misstatements.

G.35

If the upper limit on misstatements is calculated at $17,800 and the tolerable misstatement is $15,000, what is the minimum amount of adjustment necessary for the audit team to issue an unmodified opinion on the client’s financial statements?

$0.

$2,800.

$4,800.

$14,800.

G.36

(Appendix G.B) Alice Rathermel audited LoHo Company’s inventory using sampling. She examined 120 items from an inventory compilation list and discovered net overstatement of $480. The audited items had a book (recorded) value of $48,000. There were 1,200 inventory items Page 855listed, and the total recorded inventory amount was $490,000. What is the projected misstatement using mean-per-unit estimation?

$480.

$576,000.

$10,000.

$480,000.

G.37

(Appendix G.B) To determine the sample size for a classical variables sampling application, an audit team should consider the tolerable misstatement, risk of incorrect acceptance, risk of incorrect rejection, population size, population variability, and

Expected misstatement in the account.

Overall materiality for the financial statements taken as a whole.

Risk of assessing control risk too low.

Risk of assessing control risk too high.

G.38

Which of the following components is not used in determining the upper limit on misstatements?

Basic allowance for sampling risk.

Incremental allowance for sampling risk.

Projected misstatement.

Tolerable misstatement.

G.39

The projected misstatement is determined by multiplying the sampling interval by the

Risk of incorrect acceptance.

Incremental confidence factor.

Confidence factor.

Tainting percentage.

G.40

Which of the following steps involved with determining the upper limit on misstatements is ordinarily performed earliest?

Multiply the sampling interval by the tainting percentage.

Determine the audited value of the item and compare it to the recorded balance.

Calculate the basic allowance for sampling risk.

Calculate the incremental allowance for sampling risk.

G.41

A component of an account balance has a recorded balance of $10,000 and an audited value of $8,000. By using monetary unit sampling, if the sampling interval is $20,000, the projected misstatement would be

$2,000.

$4,000.

$5,000.

$10,000.

G.42

Which of the following statements is not true with respect to the calculation of the upper limit on misstatements?

The tainting percentage is determined based on the difference between the recorded balance and the audited value.

A separate incremental allowance for sampling risk is calculated for each misstatement discovered by the auditor.

If no misstatements are detected, the basic allowance for sampling risk equals zero.

The projected misstatement is determined by multiplying the sampling interval by the tainting percentage.

G.43

(Appendix G.B) Which of the following courses of action would an audit team most likely follow in planning a sample of cash disbursements if the audit team is aware of several unusually large cash disbursements?

Increase the sample size to reduce the effect of the unusually large disbursements.

Continue to draw new samples until all unusually large disbursements appear in the sample.

Set the tolerable deviation rate at a lower level than originally planned.

Stratify the cash disbursements population so that the unusually large disbursements are selected.

EXERCISES AND PROBLEMS

G.44

Monetary Unit Sampling (MUS) and Classical Variables Sampling.

Required:

For each of the following independent situations, indicate the advantages and disadvantages of MUS and classical variables sampling.

You are selecting a sample of customer accounts receivable balances for confirmation. The sample is to be selected from a population of customer accounts receivable, the total of which exceeds $4,000,000. This list comprises 4,000 individual customer accounts that are relatively similar in dollar amount with balances ranging from $800 to $8,000. In past years, you have identified a moderate level of misstatement in the client’s accounts receivable, although the level of misstatement was always less than the tolerable misstatement.

You are selecting a sample of accounts payable balances for confirmation with vendors. The population is a list of accounts payable to vendors; at year-end, the total (unaudited) accounts payable balance is $800,000. Amounts owed by the client to 200 separate vendors are included in this balance. Because the client has two major suppliers, a disproportionate amount of this balance ($500,000) is concentrated in these two accounts.

You are selecting a sample of customer accounts receivable balances for confirmation. The population is a list of customer accounts receivable; at year-end, the accounts receivable total is $2,500,000. Compared to most of your clients, the number of customer accounts included in this balance is relatively small, and the balances range from $1,000 to $525,000.

G.45

Sample Selection: Monetary Unit Sampling. Emerson Washburn is examining the accounts receivable of Anaheim Company and has decided to use MUS to select a sample of customer accounts for confirmation. Anaheim’s accounts receivable totaled $3,500,000 and comprised 3,000 different customer accounts ranging in amount from $200 to $125,000. Based on the characteristics of the population and acceptable risk of incorrect acceptance, tolerable misstatement, and expected misstatement, Washburn determined a sample size of 20 accounts.

Required:

Without making any calculations, briefly describe how Washburn would select a sample of customer accounts from the population of accounts receivable.

If Washburn selected a random starting point of 172,600, what are the first four dollars that would be selected? How would Washburn proceed to evaluate these items?

What would Washburn do if two of the dollars selected are contained within the same customer account?

Anaheim maintains its accounts receivable balances in a computerized file that has the following information: (1) customer number, (2) customer name, (3) total account balance, and (4) account status (current versus past due). For each of these elements, comment on any procedures that Washburn should perform before selecting the sample if the population were arranged based on these elements (for example, arranged numerically by customer number, alphabetically by customer name).

G.46

Sample Selection: Monetary Unit Sampling. You have been assigned to select an MUS sample from Whitney Company’s detailed inventory records as of September 30. Whitney’s controller gave you a list of the 23 different inventory items and their recorded book amounts. The senior accountant told you to select a sample of 10 dollar units and the inventory items that contain them.

ID Amount ID Amount ID Amount ID Amount

1 $ 1,750 7 $ 1,255 13 $ 937 19 $ 2,577

2 1,492 8 3,761 14 5,938 20 1,126

3 994 9 1,956 15 2,001 21 565

4 629 10 1,393 16 222 22 2,319

5 2,272 11 884 17 1,738 23 1,681

6 1,163 12 729 18 1,228

Required:

Prepare audit documentation showing a systematic selection of 10 dollar units and the related logical units. Arrange the items in their numerical identification number order and use a random starting point at the 1,210th dollar.

G.47

Sample Size Determination: Monetary Unit Sampling. The recorded accounts receivable balance for Warner Company was $500,000.

Required:

For each of the following independent sets of conditions, determine the appropriate sample size for the examination of Warner’s accounts receivable in MUS. Based on the differences in your calculations, identify the general relationship between different factors and sample size. (RIA = risk of incorrect acceptance, TM = tolerable misstatement, EM = expected misstatement).

RIA = 5%, TM = $50,000, EM = $10,000.

RIA = 5%, TM = $50,000, EM = $25,000.

RIA = 10%, TM = $50,000, EM = $10,000.

RIA = 10%, TM = $50,000, EM = $25,000.

G.48

Sample Size and Sampling Interval Determination: Monetary Unit Sampling. Reagan Simmons is conducting the audit of Ace Inc., and is using MUS to select a sample of inventory items for examination. The recorded balance in Ace’s inventory account was $1,200,000. In carrying out the sampling plan, Simmons established a risk of incorrect acceptance of 5 percent, a tolerable misstatement of $100,000, and an expected misstatement of $20,000.

Required:

What parameters would Simmons consider in determining the sample size for Ace’s inventory?

How would Simmons identify or establish each of these parameters?

Determine the necessary sample size for the audit of Ace’s inventory.

Based on the sample size determined in part (c), determine the appropriate sampling interval.

Briefly describe how Simmons would select the sample from a computerized inventory list that Ace maintains.

G.49

Sample Size and Sampling Interval Determination: Monetary Unit Sampling. Casey Paul is considering the use of MUS in examining Stanley’s accounts receivable, which were recorded at $300,000. Using the audit risk model, Paul has identified a necessary risk of incorrect acceptance of 10 percent and has established a tolerable misstatement of $25,000 and an expected misstatement of $10,000.

Required:

Determine the necessary sample size for the audit of Stanley’s accounts receivable.

Based on the sample size determined in part (a), what is the appropriate sampling interval?

Briefly describe how Paul would select the sample from a computerized customer list that Stanley maintains.

How would each of the following changes in Paul’s sampling plan impact the sample size and sampling interval? For each change, use the original parameters noted in the problem. (Verify your answer by calculating the sample size associated with each change.)

A reduction in the necessary level of the risk of incorrect acceptance to 5 percent.

An increase in the expected misstatement to $12,500.

A decrease in the tolerable misstatement to $20,000.

G.50

Sample Size and Sampling Interval Determination: Monetary Unit Sampling. Blythe Drake is conducting an audit of Newman and is using MUS to select a sample of customer accounts receivable for confirmation. Newman’s accounts receivable are recorded at $10,000,000 and comprise 2,000 customer accounts. Drake has established the following parameters for the investigation:

Risk of incorrect acceptance = 5%.

Tolerable misstatement = $250,000.

Expected misstatement = $50,000.

Required:

Determine the sample size and sampling interval that Drake used in the audit of Newman’s accounts receivable.

Based on the calculations in part (a), briefly describe how Drake would select customer accounts from the population of accounts receivable balances for confirmation.

Holding all other factors constant, determine the sample size and sampling interval assuming each of the following independent changes in Drake’s sampling parameters:

Because of improvements in Newman’s internal control policies related to accounts receivable processing from previous years, Drake believes that a risk of incorrect acceptance of 10 percent is now acceptable in the current engagement.

Because of the closeness of certain ratios to key debt covenants (particularly the current and quick ratios, which are highly influenced by accounts receivable), Drake believes that the tolerable misstatement should be decreased from $250,000 to $125,000.

Because of unusual circumstances in the previous year, some misstatements occurred in sales transaction processing that resulted in misstatements in accounts receivable. These misstatements are not anticipated to occur during the upcoming year. As a result, Drake believes that expected misstatement can be decreased from $50,000 to $25,000.

How do the changes noted in part (c) illustrate the relationship between sample size and various factors?

Describe the relationship between the sample size and sampling interval. Provide a brief explanation as to the nature of this relationship.

G.51

Sample Size Relationships: Monetary Unit Sampling. For each of the following cases, provide the missing information.

Recorded balance $1,500,000 $190,000 (C)

Sample size 115 (B) 124

Sampling interval (A) $ 4,222 $ 18,000

G.52

Sample Size Relationships: Monetary Unit Sampling. Noel Frehley is examining the accounts receivable of Kiss Company and is considering the use of MUS. Kiss’s accounts receivable are recorded at $400,000. Based on the necessary level of risk, Frehley has established a risk of incorrect acceptance of 5 percent. In addition, based on previous audits, Frehley estimates misstatements of $10,000. Finally, based on the overall level of performance materiality, Frehley has established tolerable misstatement at $20,000.

Required:

Determine the necessary sample size for Frehley’s examination of Kiss Company’s accounts receivable.

Assume that Frehley was interested in trying to reduce the necessary sample size. What are some options available in this regard?

Based on a discussion with the senior manager, Frehley knows that increasing the level of the risk of incorrect acceptance will reduce sample size. For the same level of expected misstatement, tolerable misstatement, and population size, determine the sample size for a risk of incorrect acceptance of 10 percent.

G.53

Projected Misstatement Calculation: Monetary Unit Sampling. For each of the following independent misstatements, identify the missing value:

1 2 3 4

Recorded balance $15,000 $30,000 (e) $12,000

Audited value $12,000 (c) $6,000 (g)

Tainting percentage (a) 5% 25% (h)

Sampling interval $50,000 (d) $25,000 $48,000

Projected misstatement (b) $5,000 (f) $24,000

G.54

Upper Limit on Misstatements Calculation: Monetary Unit Sampling. Jordan Thomas is using MUS to examine a client’s accounts receivable balance. Using a sample size of 100 items and a sampling interval of $12,300, Thomas identified the following misstatements:

Item Recorded Balance Audited Value

1 $15,000 $12,500

2 10,000 4,000

3 3,000 2,000

Required:

Calculate the upper limit on misstatements assuming a risk of incorrect acceptance of (1) 5 percent and (2) 10 percent.

Based on your calculations in part (a), comment on the relationship between the risk of incorrect acceptance and the upper limit on misstatements.

G.55

Upper Limit on Misstatements Calculation: Monetary Unit Sampling. Carson Allister is performing an MUS application in the audit of Bird Company’s accounts receivable. Based on the acceptable level of the risk of incorrect acceptance of 5 percent and a tolerable misstatement of $120,000, Allister has calculated a sample size of 75 items and a sampling interval of $25,000. After examining the sample items, the following misstatements were identified:

Item Recorded Balance Audited Value

1 $35,000 $28,000

2 10,000 8,000

3 6,000 3,000

Required:

Calculate the upper limit on misstatements for Bird Company’s accounts receivable.

Provide a brief description of the meaning of the upper limit on misstatements calculated in part (a).

What would Allister’s conclusion be with respect to the fairness of Bird’s accounts receivable balance?

G.56

Upper Limit on Misstatements Calculation: Monetary Unit Sampling. The auditors mailed positive confirmations on 60 customers’ accounts receivable balances. The company’s accounts receivable balance comprised 2,356 customer accounts with a total recorded balance of $19,600,000, and the sampling interval was $280,000. The auditors received four positive confirmation returns reporting exceptions. Upon follow-up, they found the following:

Account 2333. Recorded balance $8,345. The account was overstated by $1,669 because the client made an arithmetic mistake recording a credit memo. The company issued only 86 credit memos during the year. The auditors examined all of them for the same arithmetic mistake and found no similar misstatements.

Account 363. Recorded balance $7,460. The account was overstated by $1,865 because the company sold merchandise to a customer with payment due in six months plus 15 percent interest. The billing clerk made a mistake and recorded the sales price and the unearned interest as the sale and receivable amount. Inquiries revealed that the company always sold on “payment due immediately” terms but had made an exception for this customer. Page 860Numerous sales transactions had been audited in the sales control audit work, and none had shown the extended terms allowed to Account 363.

Account 1216. Recorded balance $19,450. The account was overstated by $1,945 because an accounting clerk had deliberately misadded several invoices to create extra charges to a business that competed with his brother’s business. The accounting clerk (who was a temporary employee) had forged the initials of the supervisor who normally reviewed invoices for accuracy. The auditors examined all invoices for this and other customers processed by this clerk and found no similar misstatements.

Account 2003. Recorded balance $9,700. The account was overstated by $1,455 because of a fictitious sale submitted by a salesperson, apparently part of an effort to boost third-quarter sales and commissions. The auditors learned that the salesperson was employed from August 20 through October 30 before being dismissed as a result of customer complaints. They examined all other unpaid balances attributed to this salesperson and found no other fictitious sales.

Required:

Decide which, if any, of the account misstatements should be considered monetary misstatements and included in the calculation of the upper limit on misstatements using MUS.

Calculate the upper limit on misstatements and decide whether the evidence from these misstatements indicates that the accounts receivable balance is or is not materially misstated. (The tolerable misstatement for the accounts receivable was $1,000,000, and the auditors had already decided on a risk of incorrect acceptance of 5 percent.)

Are any additional procedures required of the audit team regarding account 1216 or account 2003?

G.57

Upper Limit on Misstatements Calculations: Monetary Unit Sampling. Assume that Parker Fran has calculated a sampling interval for Tide Inc.’s inventory of $10,000 and has conducted an examination of a sample of inventory balances. Fran has identified the following three misstatements:

Item No. Recorded Balance Audited Value

X-21 $ 3,000 $ 1,200

Z-24 550 440

AA-02 6,000 1,500

Required:

Calculate the upper limit on misstatements for the following levels of the risk of incorrect acceptance. In general, what relationship do you observe between the risk of incorrect acceptance and the upper limit on misstatements?

5 percent.

10 percent.

G.58

Upper Limit on Misstatements Calculations: Monetary Unit Sampling. Clyde Billy is conducting the audit of Hoops Inc. and is examining Hoops’s inventory balances. Billy plans to select a sample of inventory items for examination and will verify quantities and perform price tests to ascertain that the items are properly recorded according to generally accepted accounting principles.

Billy determined a sampling interval of $100,000 and, using systematic random selection techniques, has identified the following misstatements:

Item No. Recorded Balance Audited Value

10-865 $ 12,600 $ 8,400

20-954 110,000 95,000

30-781 55,000 44,000

40-269 80,000 60,000

Page 861

Required:

Using a 5 percent risk of incorrect acceptance, calculate the upper limit on misstatements.

Provide a brief description of the meaning of the upper limit on misstatements using the information calculated in part (a).

Reperform part (a) using a risk of incorrect acceptance of 10 percent.

What relationship do you observe between the acceptable level of the risk of incorrect acceptance and the upper limit on misstatements? Provide a brief explanation about what causes this relationship.

Based on the levels of the upper limit on misstatements determined in this example, what are the advantages and disadvantages of establishing lower and higher acceptable levels of the risk of incorrect acceptance?

G.59

Comprehensive Problem: Monetary Unit Sampling. Zachary Mayo is a new staff accountant participating in his first audit engagement. He has been assigned to the Foley Company engagement and is examining Foley’s accounts receivable. Foley maintains a computerized ledger of its accounts receivable balances, which are recorded at $5,000,000 and comprise 5,560 individual customer accounts.

Mayo established the following parameters for use in this year’s audit. In so doing, he relied extensively on parameters established in prior audits:

Expected misstatement is established at $100,000, which is the average amount of misstatement identified in the past five audits. During the past year, Foley has experienced a great deal of turnover among its sales processing personnel and has made some relatively large sales that present some unusual revenue recognition issues. In addition, accounts receivable have increased by almost 15 percent from the prior year.

The tolerable misstatement is 10 percent of the ending accounts receivable balance, or $500,000 ($5,000,000 × 0.10). Compared to previous years, Foley’s financial condition has slightly deteriorated. Its current and quick ratios, although still above levels necessary to satisfy its debt covenants, have deteriorated.

The risk of incorrect acceptance is 10 percent, which is the same as that used in the previous year. In evaluating the components of the audit risk model, some of the issues related to the turnover among sales processing personnel as well as the more limited use of analytical procedures during the current audit represent important differences from previous years.

Mayo sent positive confirmations to Foley’s customers. His work identified the following differences between audited values and recorded balances.

Customer Recorded Balance Audited Value

R. Gerer $ 15,000 $ 10,000

D. Wings 25,000 20,000

L. Goss 60,000 30,000

K. David 120,000 90,000

Unfortunately, Mayo resigned from the firm shortly after identifying these differences. The only documentation you were able to locate was information related to (1) the levels of expected misstatement, tolerable misstatement, and risk of incorrect acceptance that was used in the Foley audit and (2) the four confirmations returned by customers indicating differences between their records and Foley’s recorded balances.

Required:

Mayo decided to use MUS primarily because it had been used in previous audits of Foley. Based on the nature of this sampling application and the composition of Foley’s accounts receivable, was the use of MUS appropriate?

Based on the parameters established by Mayo, determine the sample size and sampling interval he used in the sampling application.

Describe the sample selection process used by Mayo. Are you able to replicate or otherwise determine which customer balances he confirmed?Page 862

Based on the four overstatements identified by Mayo, calculate the upper limit on misstatements. Based on this upper limit on misstatements, what general statement can be made with respect to the extent of misstatement in the account balance?

What is your initial decision with respect to the fairness of Foley’s accounts receivable balance?

Review each of the parameters established by Mayo (expected misstatement, tolerable misstatement, and risk of incorrect acceptance). Do any differences in the current engagement raise questions with respect to the level of these parameters?

What are the potential effect(s) of the changes in parameters noted in part (f) on the sampling application?

G.60

Comprehensive Problem: Monetary Unit Sampling. Clint Walker was examining the accounts receivable of Country Music Inc. Its accounts receivable were recorded at $1,500,000. Based on past audits, Walker established tolerable misstatement at 10 percent of the recorded account balance and anticipated a very small level of misstatement in Country Music’s accounts receivable ($50,000). In his previous assessments of audit risk, risk of material misstatement, and analytical procedures risk, Walker had established a necessary risk of incorrect acceptance of 10 percent.

Required:

Calculate the sampling interval and sample size that Walker would use in the audit of Country Music.

Reperform the calculations in part (a) if Walker had established a risk of incorrect acceptance of (1) 5 percent and (2) 20 percent. Based on your calculations, describe the relationship between the necessary level of the risk of incorrect acceptance and the sample size and sampling interval.

[Note: Part (c) is unrelated to parts (a) and (b).] If Walker had detected the following four overstatements, determine the projected misstatement.

Recorded Balance Audited Value Sampling Interval

$ 3,500 $ 1,750 $ 8,000

1,000 200 8,000

12,000 10,000 8,000

5,000 4,000 8,000

Based on the results in part (c) and using a 10 percent risk of incorrect acceptance, calculate the upper limit on misstatements.

Reperform the calculation in part (d) using a risk of incorrect acceptance of (1) 5 percent and (2) 20 percent. Based on your calculation, describe the relationship between the necessary level of the risk of incorrect acceptance and the upper limit on misstatements.

Using a risk of incorrect acceptance of (1) 5 percent, (2) 10 percent, and (3) 20 percent, determine what Walker’s conclusion would be with respect to Country Music’s accounts receivable. How do different levels of the risk of incorrect acceptance influence the likelihood of concluding that the account balance is fairly stated?

G.61

Comprehensive Problem: Monetary Unit Sampling. Dylan Mays is auditing the accounts receivable of Channel Company. Channel’s accounts receivable were recorded at $2,000,000 and comprised more than 1,500 customer accounts. However, Channel’s ten largest customers’ balances comprised a high percentage of the recorded accounts receivable (over $500,000, or 25 percent). As a result, Mays is considering the use of MUS.

Based on prior audits and other judgments, Mays has established the following parameters:

Risk of incorrect acceptance 5%

Tolerable misstatement $120,000

Expected misstatement $ 24,000

Page 863

Required:

Briefly identify what factors Mays should consider in determining sample size and how these factors would be assessed.

Calculate the necessary sample size and sampling interval used by Mays in the audit of Channel Company.

Given the information in part (b), describe how Mays would select the sample from Channel’s computerized accounts receivable ledger.

[Note: Part (d) is unrelated to parts (b) and (c).] If Mays detected the following three misstatements, determine the projected misstatement.

Recorded Balance Audited Value Sampling Interval

$ 45,000 $ 40,000 $ 13,000

8,000 6,000 13,000

12,000 9,000 13,000

Based on the results in part (d) and a 5 percent risk of incorrect acceptance, calculate the upper limit on misstatements.

Based on the calculation in part (e), determine what Mays’s conclusion would be with respect to Channel Company’s accounts receivable.

G.62

Mistakes in a Monetary Unit Sampling Application. Kelsey Mead, CPA, was engaged to audit Jiffy Company’s financial statements for the year ended August 31.

For the current year, Mead decided to use MUS to select accounts receivable for confirmation because MUS uses each account in the population as a separate sampling unit. Mead expected to discover many overstatements but presumed that the MUS sample size still would be smaller than the corresponding sample size for classical variables sampling.

Mead reasoned that the MUS sample would automatically result in a stratified sample because each account would have an equal chance of being selected for confirmation. Additionally, the selection of negative (credit) balances would be facilitated without special considerations.

Mead computed the sample size using the risk of incorrect acceptance, the total recorded book amount of the receivables, and the number of misstated accounts allowed. Mead divided the total recorded book amount of the receivables by the sample size to determine the sampling interval and then calculated the standard deviation of the dollar amounts of the accounts selected for evaluation of the receivables.

Mead’s calculated sample size was 60 and the sampling interval was determined to be $10,000. However, only 58 different accounts were selected because two accounts were so large that the sampling interval caused each of them to be selected twice. Mead proceeded to send confirmation requests to 55 of the 58 customers. Each of the three accounts originally selected for the sample had insignificant recorded balances under $20. Mead ignored these three small accounts and substituted the three largest accounts that had not been selected by the random selection procedure. Each of these accounts had balances in excess of $7,000, so Mead sent confirmation requests to these customers.

The confirmation process revealed two differences. One account with an audited value of $3,000 had been recorded at $4,000. Mead projected this to be a $1,000 misstatement. Another account with an audited value of $2,000 had been recorded at $1,900. Mead did not count the $100 difference because the purpose of the procedure was to detect overstatements.

In evaluating the sample results, Mead decided that the accounts receivable balance was not overstated because the projected misstatement ($1,000) was less than the allowance for sampling risk.

Required:

Describe each incorrect assumption, statement, and inappropriate application of sampling in Mead’s procedures.

G.63

Sampling Application Evaluation: Variables Sampling. The law firm of Spade & Associates hired Dylan Sayers to review the audit of the 2017 financial statements that Hammer & Wimsey, CPAs, had completed for Golden Sound and Records Company. Specifically, Page 864the attorneys engaged Sayers to determine whether the audit of Golden Sound’s inventory of sound equipment and CDs conformed to generally accepted auditing standards. After Golden Sound declared bankruptcy three months ago (eight months after the 2017 audited financial statements were issued), stockholders sued Golden Sound, alleging distribution of misleading financial statements, and Hammer & Wimsey hired Spade & Associates to prepare a defense in the event that Hammer & Wimsey were included later in the lawsuit. The first time Golden Sound had been audited was 2017.

Golden Sound’s business had grown rapidly. The company had 40 stores in 2015, opened 36 more in 2016, and added 23 more (for a total of 99) during 2017. The following accounting information shows the growth of the inventory:

June 30

2015 2016 2017

Sound equipment $5,800,000 $10,000,000 $12,200,000

CDs 2,200,000 6,800,000 9,000,000

Total inventory $8,000,000 $16,800,000 $21,200,000

Number of stores 40 76 99

Sayers reviewed the Hammer & Wimsey audit documentation and prepared this summary:

In April 2017, Bobby Earl (Hammer & Wimsey audit manager on the Golden Sound engagement) met with Golden Sound’s managers and discussed the procedures for taking the physical inventory as of June 30. Mikki LaTouche (Golden Sound’s chief financial officer) suggested that the auditors’ inventory observation be conducted at the stores located in large cities where Golden Sound had started business. According to LaTouche, “These stores are well stocked with a representative selection of all types of equipment and musical releases available across all the stores. The store managers are well acquainted with the inventory and can conduct an accurate counting with experienced store employees. The newer stores carry less stock, and the managers are relatively new to their jobs. You’ll get a more accurate inventory-taking observation in the more established stores.”

Earl agreed and noted in the audit documentation that the prospect of sending audit teams to distant stores in the Midwestern and Southeastern states (where Golden Sound had established new stores in the past year or so) would be very costly in terms of auditors’ time and travel expenses. Together, LaTouche and Earl selected eight of the stores in the Western Region. Earl supervised experienced audit teams as they observed the inventory counts at these eight stores. The auditors observed that the Golden Sound store managers gave good instructions to the inventory takers and that the count records were in good order. Test counts showed only minor mistakes, which the managers promptly and conscientiously corrected.

Everyone was interested in making accurate counts because Golden Sound had no reliable perpetual inventory records, and the financial statement amounts for inventory were determined by this physical inventory. In fact, Earl wrote in the internal control communication to the board of directors and in the management letter addressed to the CFO the observation that Golden Sound needed to establish reliable inventory records for physical control and profit enhancement. The auditors determined the following inventory amounts in the eight stores. Using the total inventory of $1,712,700 in these stores, Earl divided by eight to find the average per store, then multiplied by 99, and projected the total inventory in the amount of $21,194,663. Because this amount was only $5,337 less than the recorded balance of inventory in the general ledger, Earl and the reviewing partner did not perform further work and incorporated the recorded inventory amount of $21,200,000 in the 2017 financial statements along with a standard unmodified auditor’s report.

Required:

Complete Sayers’s engagement by evaluating the Hammer & Wimsey conduct of the inventory portion of the Golden Sound 2017 audit. Organize your answer using the fundamental principles of “Responsibilities” and “Performance” in Chapter 2.

G.64

Monetary Unit Sampling. Georgie Costanza, CPA, is auditing the accounts receivable of Vandalay Industries and is considering the use of MUS techniques. Costanza has a number of questions regarding the use of MUS and has asked you to provide answers to them.

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Required:

Under generally accepted auditing standards, can Costanza use nonstatistical sampling in the examination of Vandalay accounts receivable?

What are the advantages to using statistical sampling in the audit?

What are the risks associated with sampling, and to what type of losses do they expose Costanza?

How does Costanza establish the appropriate level of the risk of incorrect acceptance?

Is Costanza permitted to specify that certain items be examined, or do all items need to be randomly selected?

How can Costanza increase the likelihood that the items in the sample are representative of the population?

Other than the dollar amount of the misstatements, are any other factors important for Costanza to consider with respect to the misstatements?

G.69

Sample Size Determination: Classical Variables Sampling. The recorded inventory balance for Faulk Company was $1,000,000 and comprised 2,500 customer accounts.

Required:

For each of the following independent sets of conditions, determine the appropriate sample size for the audit of Faulk’s inventory using classical variables sampling (mean-per-unit estimation). Based on the differences in your calculations, identify the general relationship between different factors and sample size. (RIA = risk of incorrect acceptance, RIR = risk of incorrect rejection, TM = tolerable misstatement, EM = expected misstatement, SD = standard deviation.)

RIA = 5%, RIR = 5%, TM = $50,000, EM = $20,000, SD = $40.

RIA = 10%, RIR = 5%, TM = $50,000, EM = $20,000, SD = $40.

RIA = 10%, RIR = 10%, TM = $50,000, EM = $20,000, SD = $40.

RIA = 5%, RIR = 5%, TM = $30,000, EM = $20,000, SD = $40.

RIA = 5%, RIR = 5%, TM = $50,000, EM = $10,000, SD = $40.

RIA = 5%, RIR = 5%, TM = $50,000, EM = $10,000, SD = $30.

G.70

Sample Size Determination: Classical Variables Sampling. Shannon Solomon, CPA, is auditing the accounts receivable of Warner Company and is using mean-per-unit estimation. Accounts receivable were recorded at $2,000,000 and comprised 1,250 individual customer accounts. Solomon established the following parameters for the audit of accounts receivable:

Using firm policy, tolerable misstatement for accounts receivable is established at 6 percent of the recorded account balance.

Based on prior audits of Warner’s accounts receivable, the standard deviation of audited values is estimated to be $100.

Based on prior audits of Warner’s accounts receivable, Solomon estimates that accounts receivable will be misstated by 4 percent of the recorded account balance.

Solomon is now establishing the acceptable levels of the risk of incorrect acceptance and the risk of incorrect rejection for the audit of Warner Company’s accounts receivable.

Required:

What factors should Solomon consider in establishing acceptable levels of the risk of incorrect acceptance and the risk of incorrect rejection?

What are the advantages and disadvantages of Solomon’s establishing lower levels of the risk of incorrect acceptance and the risk of incorrect rejection?

If Solomon establishes levels of the risk of incorrect acceptance and the risk of incorrect rejection of 5 percent, what is the resultant sample size?

Determine the sample size for each of the following combinations of risk of incorrect acceptance and risk of incorrect rejection:

Risk of incorrect acceptance of 5 percent, risk of incorrect rejection of 10 percent.

Risk of incorrect acceptance of 10 percent, risk of incorrect rejection of 5 percent.

Risk of incorrect acceptance of 10 percent, risk of incorrect rejection of 10 percent.

Based on the sample sizes you calculated in parts (c) and (d), determine how the levels of sampling risks affect sample size?

G.71

Evaluating Results: Classical Variables Sampling. Kyle Berry is using mean-per-unit estimation in the audit of Leonard’s inventory balances. Leonard’s inventory is recorded at $240,000 and comprises 1,200 different items. Berry determined a sample size of 120 items and performed the appropriate substantive procedures. Based on this sample, he determined the following:

Average audited value (per item) $204

Standard deviation of audited values $ 22

A summary of some additional parameters estimated by Berry follow:

Tolerable misstatement $ 17,500

Expected misstatement $ 7,500

Risk of incorrect acceptance 5%

Risk of incorrect rejection 10%

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Required:

What is Berry’s estimate of the audited value of Leonard’s inventory?

Calculate the precision and precision interval for Leonard’s inventory. Provide a brief description of the meaning of the precision interval.

What is Berry’s conclusion with respect to Leonard’s inventory balance?

Using a risk of incorrect acceptance of (1) 1 percent and (2) 10 percent, calculate the precision and the precision interval for Leonard’s inventory.

Based on your answers to parts (b) and (d), explain how the risk of incorrect acceptance affects the precision interval and conclusions about the fairness of the account balance.

G.72

Evaluating Sample Results: Classical Variables Sampling. You are auditing Hernandez Inc.’s accounts receivable balance using classical variables sampling. Hernandez’s accounts receivable comprised 2,500 customer accounts and were recorded at $3,500,000.

Using a risk of incorrect acceptance and a risk of incorrect rejection of 5 percent, you selected a sample of 200 accounts for examination and confirmed the accounts with the customers. The total recorded balance of these 200 accounts was $1,000,000; based on your confirmations as well as an investigation of differences reported by customers, you determined an audited value of $900,000. Tolerable misstatement was established at $175,000.

Required:

What is the sample estimate of Hernandez’s accounts receivable balance using mean-per-unit estimation?

If you used difference estimation or ratio estimation, how would you expect the sample estimate to be different?

In what circumstances should each of the different methods of classical variables estimation be used?

If you calculate a sample estimate of $3,000,000 and precision of $750,000, form a precision interval for Hernandez’s accounts receivable using mean-per-unit estimation. Briefly describe the meaning of the precision interval as well as your conclusion with respect to Hernandez’s accounts receivable balance.

G.73

Comprehensive Problem: Classical Variables Sampling. Jessie Howe is examining Met Company’s accounts receivable balance and has decided to use mean-per-unit estimation. Met’s accounts receivable were recorded at $650,000 and comprised 2,000 individual customer accounts. Howe established tolerable misstatement at 5 percent of the recorded balance. Based on prior experience with Met, Howe assessed expected misstatement at $22,500 and estimated a standard deviation of the mean audited value of $30.

Required:

Using the preceding parameters, identify the appropriate sample size for the following combinations of risk of incorrect acceptance (RIA) and risk of incorrect rejection (RIR):

RIA = 1%, RIR = 5%.

RIA = 1%, RIR = 10%.

RIA = 5%, RIR = 10%.

What factors would Howe consider in establishing the risk of incorrect acceptance and the risk of incorrect rejection?

Based on the results in part (a), explain how the risk of incorrect acceptance and the risk of incorrect rejection influence the determination of sample size.

If Howe had determined an audited value of $330 per account and a standard deviation of audited values of $30, determine the precision interval for each of the following combinations of the risk of incorrect acceptance (RIA) and risk of incorrect rejection (RIR). In each of these cases, what is Howe’s conclusion with respect to Met’s accounts receivable?

RIA = 1%, RIR = 5%.

RIA = 1%, RIR = 10%.

RIA = 5%, RIR = 10%.

Based on the results in part (d), explain how the risk of incorrect acceptance and risk of incorrect rejection influence the precision interval and evaluation of results.

G.74

Comprehensive Problem: Classical Variables Sampling. Wade Wallace designed a classical variables sampling application to examine the accounts receivable for Rasheed Inc. After considering several possibilities, Wallace decided to use mean-per-unit estimation. The following parameters are noted through a review of Wallace’s audit documentation:

Recorded balance of accounts receivable $800,000

Number of customer accounts included in accounts receivable balance 2,000

Risk of incorrect acceptance 5%

Risk of incorrect rejection 20%

Tolerable misstatement $50,000

Expected misstatement $10,000

Standard deviation of audited value $52

Required:

Describe how Wallace would establish each of these parameters.

What is the appropriate sample size for this application?

Assume that Wallace is considering an increase in the necessary level of the risk of incorrect acceptance to 10 percent. How would this increase affect the sample size?

Using a 5 percent risk of incorrect acceptance, assume that Wallace determined a $380 average audited value per item and a $50 standard deviation of audited values. Construct the precision interval for Rasheed’s accounts receivable.

Based on the precision interval in part (d), provide Wallace’s conclusion with respect to Rasheed’s accounts receivable.

Repeat parts (d) and (e) assuming that the average audited value per item is $405. Why does Wallace’s conclusion differ from that reached in part (e)?

G.75

Monetary Unit and Classical Variables Sampling. Indicate whether each of the following characteristics applies to monetary unit sampling (MUS), classical variables sampling (CVS), both MUS and CVS (both), or neither MUS nor CVS (neither).

May be used in conjunction with substantive procedures.

Tends to select higher dollar items for examination.

Is more effective in identifying overstatements.

Incorporates assessments of tolerable misstatement in determining sample size.

Incorporates assessments of the population variability in determining sample size.

Controls the audit team’s exposure to the risk of incorrect rejection and the risk of incorrect acceptance.

Requires the audit team to project discovered misstatements to the population.

Can expose the audit team to nonsampling risk.

May be used in conjunction with the study and evaluation of internal control.

Is more appropriate for use when a higher number of misstatements is anticipated.

G.76

Evaluating Sample Results: Nonstatistical Sampling. Finley Gunny is using nonstatistical sampling in the examination of Highway Company’s accounts receivable, which were recorded at $350,000. Gunny determined a tolerable misstatement of $15,000 and a sample size of 49 items.

Required:

How does Gunny determine sample size using nonstatistical sampling?

If the items selected by Gunny had an aggregate recorded balance of $50,000 and an aggregate audited value of $45,000, calculate the estimated audited value.

What would Gunny conclude with respect to the fairness of Highway’s accounts receivable?

G.77

Nonstatistical Sampling. Marley Brown is planning the substantive procedures for the audit of Longhorn Company’s inventory, which had a recorded (unaudited) balance of Page 871$6,500,000. In prior audits, Brown used monetary unit sampling but is now considering the use of nonstatistical sampling. Brown has established a tolerable misstatement of $250,000 and a sample size of 71 items.

Required:

Compared to monetary unit sampling, what are the advantages and disadvantages to Brown’s using nonstatistical sampling in this year’s audit of Longhorn’s inventory?

Compare the factors used by Brown in determining sample size under monetary unit sampling to those that would be used in nonstatistical sampling.

Brown is considering increasing the use of analytical procedures in order to reduce the tests of details of the inventory. What factors would she consider in deciding whether to perform more extensive analytical procedures?

If the items selected by Brown had an aggregate audited value of $970,000 and an aggregate recorded balance of $1,000,000, what would be the conclusion with respect to the fairness of Longhorn’s inventory?