Chapter F, Problem 75EP

a)

To determine

Describe the relevance of work done in the past audit with respect to testing given control activity.

Explanation of Solution

Based on the factors recognized in the past audit, it seems that a sample size of 55 invoices was suitable. Additionally, the computation of the ULRD and choice to decrease the dependence on the control activity was also suitable.

b)

To determine

Explain the early thoughts of staff accountant regarding the viability of increasing his reliance on given activity in the present audit.

Explanation of Solution

In the previous year audit, Firm B&B was not able to determine that the control was functioning efficiently with a 10 percent risk of overreliance. Specified this finding, along with the fact that staff accountant did not notice any key changes or recitation pertaining to these controls in the present year, it appears dubious that a raised reliance on the control activity is feasible.

c)

To determine

Explain the manner the staff accountant decided to increase the reliance on the control activity affect the sample size in the present audit. Identify the specific factors that will be affected by this decision.

Explanation of Solution

To raise the reliance on given control activity in the present audit, staff accountant needs to decrease both the risk of overreliance and the tolerable rate of deviation. This will leads to the requirement for a bigger sample size.

d)

To determine

Compute the sample size in the current audit. Identify whether this sample size consistent with the expectations compared to that examined in the previous year.

Explanation of Solution

Compute the sample size in the current audit:

• The acceptable risk of overreliance (ROO) is 5%. Therefore, sample size table for 5% risk of overreliance is used to determine the sample size.
• Expected population deviation rate (EPDR) is 1%.
• The tolerable rate of deviations (TRD) is 6%.
• The sample size is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the sample size is 78 items.

As expected, this is a bigger sample size than the previous year’s audit sample.

e)

To determine

Identify the factors resulted in the increased sample size from prior year and the extent to which each factor contributed to this increase.

Explanation of Solution

Even though it is difficult to define the accurate growth causing after modifications in these individual factors, the sample size for the previous-year audit and modifications in the factors in the present audit are as follows:

Situation a (previous year audit sample):

• The acceptable risk of overreliance (ROO) is 10%. Therefore, sample size table for 10% risk of overreliance is used to determine the sample size.
• Expected population deviation rate (EPDR) is 1%.
• The tolerable rate of deviations (TRD) is 7%.
• The sample size is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the sample size is 55 items.

Situation b (current year audit sample based on modified factors):

• The acceptable risk of overreliance (ROO) is 5%. Therefore, sample size table for 5% risk of overreliance is used to determine the sample size.
• Expected population deviation rate (EPDR) is 1.5%.
• The tolerable rate of deviations (TRD) is 7%.
• The sample size is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the sample size is 66 items.

Situation c (current year audit sample based on modified factors):

• The acceptable risk of overreliance (ROO) is 10%. Therefore, sample size table for 5% risk of overreliance is used to determine the sample size.
• Expected population deviation rate (EPDR) is 1%.
• The tolerable rate of deviations (TRD) is 6%.
• The sample size is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the sample size is 64 items.

From the above calculations, it is observed that decreasing the ROO from 10% to 5%, resulted in the increase of sample size by 11 items $\left(66\text{items}-\text{55}\text{items}\right)$. Decrease in the TRD from 7% to 6% also resulted in the increase of sample size by 9 items. This shows that the modifications in the factors independently changing the sample size.

Staff accountant should note that the present year audit sample size is bigger than the above calculated sample sizes. This indicates that the collaborative outcomes of these modifications are bigger than the individual outcomes.

f)

To determine

Identify the number of deviations permissible to rely on given control activity for the given situation.

Explanation of Solution

Upper Limit Rate of Deviation (ULRD): it is a statistical measure used by the audit team to adjust the sample rate of deviation for the acceptable level of sampling risk. The rate of deviation has a probability of totaling or over and above the true population rate of deviation.

Computation of ULRD for deviations:

Compute the ULRD:

• The acceptable risk of overreliance is 5%. Therefore, sample evaluation table for 5% risk of overreliance is used to determine the ULRD.
• Sample size is 100.
• The number of deviations realized by the audit team is 0.
• The ULRD is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the ULRD is 3.

Compute the ULRD:

• The acceptable risk of overreliance is 5%. Therefore, sample evaluation table for 5% risk of overreliance is used to determine the ULRD.
• Sample size is 100.
• The number of deviations realized by the audit team is 1.
• The ULRD is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the ULRD is 4.7.

Compute the ULRD:

• The acceptable risk of overreliance is 5%. Therefore, sample evaluation table for 5% risk of overreliance is used to determine the ULRD.
• Sample size is 100.
• The number of deviations realized by the audit team is 2.
• The ULRD is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the ULRD is 6.2.

Based on the above calculations, staff accountant would require finding one or few deviations to be dependent on the control activity at the scheduled level.

Specified rate of deviations are observed in previous year’s audit, in addition to the lack of modifications in internal control or recitation pertaining to these controls during the present year, escalating his reliance on internal control does not seem to be viable.

g)

To determine

Identify the number of deviations permissible to rely on given control activity for the given situation.

Explanation of Solution

Computation of ULRD for deviations:

Compute the ULRD:

• The acceptable risk of overreliance is 10%. Therefore, sample evaluation table for 10% risk of overreliance is used to determine the ULRD.
• Sample size is 100.
• The number of deviations realized by the audit team is 0.
• The ULRD is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the ULRD is 2.3.

Compute the ULRD:

• The acceptable risk of overreliance is 10%. Therefore, sample evaluation table for 10% risk of overreliance is used to determine the ULRD.
• Sample size is 100.
• The number of deviations realized by the audit team is 1.
• The ULRD is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the ULRD is 3.9.

Compute the ULRD:

• The acceptable risk of overreliance is 10%. Therefore, sample evaluation table for 10% risk of overreliance is used to determine the ULRD.
• Sample size is 100.
• The number of deviations realized by the audit team is 2.
• The ULRD is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the ULRD is 5.3.

Compute the ULRD:

• The acceptable risk of overreliance is 10%. Therefore, sample evaluation table for 10% risk of overreliance is used to determine the ULRD.
• Sample size is 100.
• The number of deviations realized by the audit team is 3.
• The ULRD is the value set up at the crossing of the row in the second point and the column in the third point.

Therefore, the ULRD is 6.6.

Based on the above calculations, for a TRD of 6%, the staff accountant should permit up to two deviations and decide on to rely on the control at the scheduled level.

h)

To determine

Explain the effect of the risk of overreliance on the ULRD by comparing the results in requirements (f) and (g).

Explanation of Solution

ULRD computed in requirements (f) and (g) shows that there an inverse relationship between the ROO and ULRD. In other words, lower the overreliance risk higher the ULRD and vice versa.

In practical point of view, for higher levels of the risk of overreliance, the audit team can spot a higher number of deviations and however, the audit team relies on internal control at the scheduled level.