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The life of audit sampling techniques to test inventory.


Although audit sampling is a useful technique, practitioners often have problems using Statement on Auditing Standards no. 39, Audit Sampling, to test inventory substantively. This article identifies some of the problems and possible solutions.



Consider the case of Company X, a manufacturer that is being audited. Company X's fiscal yearend is December 31. However, it will not take a physical inventory until January 31. Therefore, the auditor will have to test the company's rollback to December 31.

It is important for the auditor to observe the physical inventory of Company X. To determine if the client is correctly counting the inventory, the auditor select 30 inventory tags from the 250 used and recounts the related inventory. The auditor finds 3 tags with errors. An investigation of the errors determines that all three of the errors were made by the same person.

Should the auditor

* Assume this is a sampling application and project the error results to the entire population?

* Assume Company X's inventory counting procedures are being tested and (1) have the client recount all the areas counted by the person who made the error or (2) have the client recount the entire inventory?

The answer is not as obvious as it might seem. The auditor could project the inventory count errors to the entire population if he or she believed the errors noted were representative of that population and were not systematic.

However, if the errors involve 3 missing bolts in a box of 50, 2 missing tape recorders in a box of 20 and 1 missing personal computer on a pallet of 30, will the projected error be meaningful? And how does the auditor adjust the inventory tags to reflect the projected error?

The objective of the auditor's test is to determine whether the client has counted the inventory accurately, not to determine the correct amount of inventory items. Since all three errors were made by the same person, it appears more appropriate to have the client recount all the areas originally counted by that individual, instead of recounting the entire inventory. However, if the auditor determines that several counters made the errors, he might consider a recount of the entire inventory, depending on materiality and other factors.


Company X had raw material receipts totaling $5 million between January 1 and January 31. Five of the receipts are each over $500,000 and total $4.5 million. Forty other receipts, all less than $20,000, make up the remaining $500,000. The materiality level is $400,000.

If the auditor vouches all five receipts over $500,000 and selects the next seven largest receipts, which total $125,000, has he

* Performed audit sampling according to SAS no. 39?

* Examined certain items 100%, which is not a sampling application?

Clearly, the auditor has examined less than 100% of the raw material receipts. However, SAS no. 39 says, "Any items that the auditor has decided to examine 100 percent are not part of the items subject to sampling." Thus it appears the above test should be documented as a "high-dollar test" and not as audit sampling.

In this case, the auditor correctly determined it would be more efficient to test 12 receipts through high-dollar testing rather than selecting a sample of receipts, as the cumulative total ($375,000) of unexamined receipts is below the $400,000 materiality level. The auditor would document this as a high-dollar test. (See the exhibit on page 111 for an example of how the auditor might prepare the high-dollar testing documentation for Company X.)

Any errors identified would not be projected to the raw material receipts population. Even though less than 100% of the population was examined, audit sampling techniques were not used.


Once the auditor has determined the inventory quantities are accurate, he must decide if their related prices also are correct. For purposes of using sampling to test the pricing of Company X's inventory, its largest asset, the auditor determined a high level of assurance was needed and the tolerable error was low.

Even though the auditor noted the person who priced the inventory was new to Company X, based on the prior year's results he determined that the expected error rate was low. But, since the auditor noticed there were 300 more inventory items this year (for a total of 1,500), he increased the sample size from 90 to 120 items. But there are still two potential concerns.

First, did the auditor need to increase the sample size based solely on the increase in the number of inventory items? The American Institute of CPAs accounting and auditing guide Audit Sampling says, "The number of items in the population should have little effect on the determination of an appropriate nonstatistical sample size for substantive tests."

As a result, the auditor probably did not need to increase the sample size just because the items in the population subject to sampling increased. However, small population sizes (for example, a few hundred items) have more of an impact on the sample size as the population increases or decreases.

A second concern the auditor had was, if he noticed a price was incorrect by an immaterial amount, should he record it as an error? The answer to this question is yes. All errors, regardless of their materiality, should be recorded as errors and the error results projected to the population when audit sampling is used in a substantive test.

Although audit sampling is helpful when the auditor is substantively testing inventory, problems do arise when it is used. The auditor must use his judgment to determine how these problems should be resolved, based on the facts and circumstances of the situation.

Sean Windsor, CPA, a manager in Coopers & Lybrand's accounting and SEC directorate, New York City, writes about the problems an auditor may encounter when using audit sampling techniques to substantively test inventory.
COPYRIGHT 1991 American Institute of CPA's
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Copyright 1991, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
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Author:Windsor, Sean
Publication:Journal of Accountancy
Date:Jan 1, 1991
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