Why auditor resort to sampling

Thus, items numbers 2, 4, 6, 11 and so on will be selected. The limitations of the systematic selection based on monetary values:. While using systematic selection method, care should be taken to ensure that the same item is not always selected. Such a selection refers to any non-systematic way of selecting sample unit.

Sampling units are selected without any bias. However it does not mean that the items are selected carelessly. The use of such method is not advisable as it would be difficult for the auditor to justify the basis of selection of sample units and to prove that certain items were not intentionally excluded..

Block sampling is the practice of selecting contiguous transactions. The auditor selects all items of a specified time processed on a particular day, week, or month. For example, selecting random sales invoices issued on certain days during the year, say, March 27, June 30, August The auditor applies appropriate auditing procedures to determine an audit value for each unit included in the sample.

However in some cases, selected sampling units. Generally, if the auditor concludes that the sample evaluation will not change even if supporting documents for a sampling unit are missing, he would not perform alternative procedures. If the missing evidence has material impact on sample evaluation, he would perform alternative procedures to verify the account balance.

It is not enough to quantify the errors in a population. The auditor should also see the qualitative aspect of the error.

In certain cases, the deviation rate may not be as relevant as the nature of the error discovered. For example if an error is caused because of fraud or collusion, additional auditing procedures need be applied. The cause of error and its impact on financial statements should be evaluated. Problem may be caused by inadequate definition as to what constitutes an error. For example, the control policy may require that payment to supplier will not be made unless purchase order and goods receiving notes are available.

The item selected by the auditor related to purchase of services such as electricity bill. Here the availability of purchase order and receiving note is not applicable. Improper definition of error. Such definition needs be revised. Qualitative evaluation involves error analysis. Such an analysis includes consideration of matters like:.

If no errors are found in the sample, then the projected population error is zero, and the allowance for sampling risk is no more than tolerable error. If errors are found, the auditor calculates the projected error. The error can be projected either using differential method of projection or ratio method of projection as follows:.

When the population is divided into sub population, the error projection is performed for each stratum separately and the total is compared with tolerable error.

The auditor intends to carry out pricing test. In designing the audit plan the auditor has set a materiality level of Rs. The auditor selected all high value items and the pricing errors overstatements on such items was Rs.

Of the remaining inventory 30 items were selected on a random basis and an overstatement of Rs. The auditor can conclude that the projected error of Rs. He would however consider the projected error in inventory pricing while evaluating overall effect on financial statements as a result of errors found in other account balances. Note that para 52 of ISA requires that the error be projected for each stratum separately. This should be stressed that it cannot be said that the above projected error of Rs.

The actual error may be more or less than Rs. Assume that in this case, the auditor has established Rs. As the projected error is too to tolerable error, the auditor should perform additional procedures, pursue the client to correct the errors, or modify the audit report.

In projecting error, those should be excluded which are the result of abnormal causes anomalous error. Next, the projected error and the anomalous error should be added to check whether they exceed tolerable error. The auditor should ask the client to pass journal entries rectifying the errors found in.

After calculating the projected misstatement the. The remaining part of projected misstatement will be compared with tolerable error. After performing the tests, the auditor should evaluate the sample results.

The objective of evaluation is to determine whether the preliminary assessment of the characteristics of population is confirmed or challenged.

In case of tests of controls, if the deviation rate is higher than tolerable rate, control risk is to be assessed at maximum. Control risk will also be accessed at maximum if deviation rate is quite close to tolerable rate.

If e deviation rate is lower than tolerable rate, control risk can be assessed at low and accordingly substantive tests may be restricted. However the auditor should be alert that there is a risk that actual deviation rate in the population may be higher than tolerable rate due to sampling risk. In other words, if the sample deviation rate plus allowance for sampling risks does not exceed the tolerable rate, the auditor would conclude that controls are reliable and would restrict year — end substantive tests.

If the sample results do not support reliance on controls, reliance will not be placed on controls and expanded substantive tests will be carried out. In case of substantive tests, if the amount of projected error is less than but close to tolerable error, the auditor should still be alert of further misstatements due to sampling risk.

The auditor should also compare actual deviation rate with expected deviation rate in order to confirm or dispel his preliminary assessment of control risk. If the actual deviation rate is greater than the expected rate set at planning stage, the auditor will modify the control risk i. If the auditor intends to evaluate control risk at low, he will have to perform test of control on extended sample size. Alternatively, if the control risk is assessed at high, the auditor should modify the substantive tests.

If the projected errors are more than the expected errors, the auditor should a ask the client to correct the errors, or b modify the audit report. If the direct method of testing holds up and the auditor's unable to challenge it, then there is no real reason to go towards any statistical analysis. The quickest and easiest way to wrap up an audit is to say, "Here are six pieces of paper that prove I do not have any sales tax liability," and going from there.

The problems arise when you find discrepancies in those audits and then you have to move to an indirect method of testing. The direct method of testing is very straightforward and involves testing actual source documents, lining them up and comparing them.

When you have a breakdown in the direct method, then sales tax auditors will resort to what they call indirect methods of testing. Indirect methods of testing is a fancy way of saying, "We are going to play guessing games with statistics. The auditor will look at current sales and they will perform statistical comparisons between past sales and current sales.

The problem with statistics is you are taking a population of transactions and you are taking a sample of that population. For example, say I have a restaurant and the restaurant had three years of sales that are included in the sales tax audit. Depending on which days I pick for my sample, it could significantly skew the results of the audit.

If I pick weekdays, I am probably going to see a lower transaction amount, and I am probably going to see more cash sales. On weekends where there are more large groups and more people go out to dinner, and there are larger transactions, I might see fewer cash transactions.

I might see larger than average daily sales. Two weekdays versus two weekends, if taken as a sample and applied to that population could yield very different results from a statistical standpoint. Even if the restaurant is diligent enough to track its daily sales, if I am using a statistical method to arrive at those sales, versus what the restaurant has, I could get a huge discrepancy.

One of the easiest tests the auditors run is through an observation test. The CDTFA will send an auditor into a business for a couple of days to look at the sales transactions, whether the employees are ringing everything up correctly and whether they are charging tax. Then, the auditor will sit there and literally record every single transaction, and they will compare that against the POS system reports to see if there are any discrepancies.

That is the observation test. If there is an error within that test, then they will perform certain actions based on that error. The other thing they can do is they can take the POS system reports in a current period and look at the cash to credit card ratio.

A lot of the time, they will take your credit card ratio, which can be verified by your Ks and say, "Okay, here is the percentage of credit card sales based on current.

Here is the amount of cash sales and we are just going to project that across the quarter. The problem that we see with indirect methods of testing, taking the cash to credit card ratio, for example, the auditor comes in and says, "I am going to do two days of testing in a business.

I am going to come in on Tuesday at lunchtime and I am going to come in Sunday afternoon. What the auditor is saying is that two days of testing are going to be used as a sample.

They are going to take that sample and they are going to apply it to a population, with the population being a total dataset. They are going to take a two-day sample and they are going to apply it to a three-year period of a population. The three-year population is over one thousand days. The auditor is going to take two days of sales, and they are going to say, "These two days of sales, Tuesday at lunchtime and Sunday afternoon, are representative of this entire thousand days of sales.

Some businesses do more credit card sales on the weekends and some businesses are seasonal and will have more frequent sales at certain times than others. With restaurants, families go out for dinner on Saturday nights and those tend to be larger checks. Larger checks tend to be paid by credit cards.

Little hinges swing big doors. These little statistical changes can have a huge impact on the liability. One of the reasons I advocate for having someone represent you in a sales tax audit who understands statistics, is because of these situations.

We find so many statistical errors. The auditors are not statisticians, so we find many errors in the way that they are doing their statistical analysis, the tightness of their controls, their procedures and the way they are applying samples to populations.

Whenever possible, you want to avoid indirect methods of testing and focus on direct methods because direct methods of testing are much more reliable than their indirect brethren. Auditors may decide to use verification of taxable differences rather than base the audit on total sales and claimed deduction basis. This method is preferred when records are available, but the verification of gross receipts or deductions is unnecessary due to the low number of transactions.

It may also be used when the taxpayer reported taxable measure is based on a listing of transactions, the capitalization of tax reimbursements, or by markup of taxable purchases.

The accuracy of lists and tapes of taxable items is verified by determining if you failed to tax any items that should have been taxed and by verifying that all the items you charged tax on were indeed taxable. Auditors employ several types of tests and sampling during a sales tax audit. The degree of complexity ranges from very simple direct testing to increasingly complex statistical sampling.

There are also industry-specific tests, such as a markup test or pour test , which are frequently used in retail settings, restaurants and bars. Taxable Measure Basis An audit made on a taxable measure basis generally places emphasis on the verification or accumulation of taxable differences as compared to an audit performed on a total sales and claimed deduction basis using individual lead schedules.

The auditor will verify that all sources of revenue and deductions have been examined. Taxable measure basis may be preferable for the CTFA in a number of cases. For example, when records are available, but verification of total gross receipts and deductions is not necessary because taxable transactions are few in number and the taxpayer has reported taxable measure only based on a listing of these transactions, capitalizing tax reimbursement, or by markup of taxable purchases.

Another circumstance is where the total gross reported is not an important factor in determining taxable measure. For example, this is the case with service enterprises, contractors, public utilities, manufacturers and wholesalers applicable for sales tax purposes.

Other cases include circumstances when direct audit of records will not yield results for the CTFA and indirect audit is necessary, or where the taxpayer has prepared returns on a taxable sales basis and audit time can be conserved by conforming to this method. The CDTFA makes a comparison between recorded and reported total gross an important procedure, for it may disclose that sales, gross receipts, or fuel used, for one month or one department or branch of a business was not included in the reported totals.

Through this comparison the CDTFA may discover classes of transactions or use erroneously considered nontaxable by the taxpayer. If the taxpayer has reported on the basis of lists or tapes of taxable items, the auditor will verify the correctness of these lists by:. If the taxpayer reported on a basis of the tax actually charged to the customer and has credited that amount, the clerical accuracy of the posting to that account, as well as the computations made in converting the tax accrued to taxable is measured by the following tests:.

For example, debits to the accrual account will be scrutinized by the CDTFA to determine that these charges represent proper deductions from the amount of tax accrued. A reconciliation of the tax accrual account and the tax reported will be made by the CDFA auditor. Consideration also will be given to sales and use taxes collected for and paid to other states. Deductions claimed or netted will be tested by the auditor to ensure they are allowable.

The CDTFA uses short tests to come up with a decision as to whether to proceed or to accept as correct that item being tested. Selecting all items of a population for examination may be appropriate in the following situations:.

Narrate the circumstances under which the auditor would resort to the following techniques Selecting specific items. The auditor may decide to select specific items for examination in the following circumstances:. High value or key items:. If the selected items are of high value, or exhibit some other characteristic, for example, items that are suspicious, unusual, particularly risk-prone or that have a history of error.

All items over a certain amount:. The auditor may decide to examine items whose recorded values exceed a certain amount so as to verify a large proportion of the total amount of a class of transactions or account balance.