 Hello, and welcome to the session. This is Professor Farhad and this session we would look at CPA exam questions that deal specifically with audit sampling. This topic is covered obviously on the auditing section of the CPA exam, as well as in an auditing course. This topic gives students a lot of headaches. One, it's maybe they don't have a good statistical background. They don't like the math part of it, or they don't simply they don't understand it or the teacher doesn't do a good job explaining it. So I hope through these questions, I get shed some lights. But if you want more explanations in detailed explanation, introductory explanation about this topic, I strongly suggest you check out my website, my auditing and attestation course. I have over 160 lessons, which is four or five lessons that deal with this audit sampling. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, tax, finance, as well as Excel tutorial. If you like my lessons, if you like my lectures, please like them, share them. Put them in playlist. If they benefit you, it means they might benefit other people as well. Share the wealth, subscribe and connect with me on Instagram. As I just stated on my website, farhatlectures.com, I do have a full pledged auditing course that will help you with this topic as well as many other topics, but specifically with sampling and I can assure you my sampling lessons are very, very good. So I strongly suggest you check it out if you really want to learn it. Okay. And don't shortchange yourself. I can help you add 10 to 15 points to your CPA exam. Check out my website. So what I will be doing is looking at, you know, a few questions. And those questions are important. I would not say their basics. You have to understand sampling. You have to understand audit sampling. You cannot walk into the exam, the audit section without really have a good understanding because they can pause, pose the questions in so many different ways. You have to have a good understanding of it. Let's go ahead and get started to see how much we know, how much we don't know, then take it from there. An auditor is sampling for attributes. As soon as you hear the word attribute, it means they're sampling for the internal control. That's good. Which of the following is correct regarding the sample size when the auditor determined that the expected rate is different from the originally expected. So when we sample for attribute, what is sampling for attribute? For example, we want to make sure that all the checks are signed by an authorized person. If all the checks are signed by an authorized person, it means the internal control are good. All what we're looking for is attributes. Are they signed by the authorized person? Yes or no, attribute. So before we start to check the checks, whether they are properly, the person that signed them is properly authorized, we set an expectation error rate. We think, for example, there's a chance that 2% are not signed. We expect that 2% of the checks are not signed. Then we're going to go ahead and select a sample of checks. Then we find out it's either 1% or 5%. So something other than the originally expected, the expected was 2%. We expect that 2%, but eventually we're going to find out whether it's 2, 1, or 5. So what happened when we have that deviation? What happened to the sample size? Let's see. If the expected rate has risen, the sample size would reduce. Well, if we increase our expected error rate, we started with 2, and now we think we're going to have more. In other words, we're going to have might have 3. Now we're going to increase in our expected rate. What do we do? Do we reduce the sample size? And the answer is no. If we expect to have more deviation, in other words, more people signing the checks who are not authorized, we're going to increase the sample size. And the reason is because we have more risk. We have to select more because the internal control are not working as we expected. So A is out. B, if the expected error rate has fallen, now we thought it's 2, but guess what? I think it's 1. Now we're looking at it. It's really 1. The sample size will increase? No. The sample size will go down. If we think it was 2%, and now we're finding out it should be 1% or even 0%, all the checks are properly signed, then we should not increase the sample size because the sample size means we have to do more work. If we can rely under control, that's the reason we test the controllers to rely or not to rely. If we think we can rely, we reduce the sample size so B is out. So if A and B are out, I can take out the immediately. If the expected rate has risen, obviously C must be the answer, the sample size will be increased. And the answer is yes. If I find out the expected rate should be higher than 2%, now I started to look at these things, then guess what? To compensate, I have to increase my sample size. Therefore, the answer is C. Let's take a look at this question. The sample rate of deviation plus the allowance sampling risk equal to what? So basically here, they're asking you, do you know even the basic terminology that we use? And it's very important to understand the basic terminology. So what is the sample rate of deviation here? We're looking at the deviation rate. It's a percentage. So we pulled 100 checks and we're looking, let's work with the same example. So we pulled 100 checks. And let's assume we're looking for the signature. The authorized people are the authorized people signing those checks. And we find out 4 were not signed the check. So 4 out of 100 is 4%. So the sample, notice the sample rate of deviation is 4%. So from this sample, we have a deviation of 4%. But remember, this is only a sample. So what does that mean? Think of when we have those polls for politicians, the president's approval rate. They would say the president's approval rate is 39% plus or minus 2%. So it could be 37%. It could be 41% because we sampled. Same thing would be when we sample for the internal control because we sampled, there could be more issues, more problems. So we add to the sampling deviation rate and allowance risk. Let's assume the allowance risk is 3%. So what is this sampling deviation rate? 3% plus the allowance for sampling risk. So the allowance is basically we're saying since we are sampling, there's always the risk of we did not collect the proper sampling size or the sampling population. Let's add 3%. So 7 plus 3 equal to 7%. What do we call the 7% we call the 7% the upper deviation rate. So the upper deviation rate is how much we think we how much we can deviate. How much we think the sample size has a deviation, upper deviation rate. So we could have up to 7% based on our sampling size plus the allowance risk. This is the upper deviation rate. Now, what about the tolerable deviation rate? Now this is important. What's the tolerable deviation rate? The tolerable deviation rate is how much we can tolerate, how much we can tolerate before we say we cannot rely on this on the control. So let's assume the tolerable, the tolerable deviation rate is 5%. If we could, we could only tolerate 5, then guess what? Then we, in those circumstances we don't rely on the control because we can tolerate 5 and the upper deviation is 7. Now, let's assume our tolerable deviation rate for this we can tolerate up to 9%. Well, if we can tolerate 9%, the upper deviation rate we expected to be 7, then we would rely on the control. And we'll work an example later on in the session with numbers, but this is what we're saying here. So the sampling deviation rate, the 4% plus the 3% the allowance for risk is equal to the upper deviation rate. So we have to know those terminology in heart and we have to know how they all interact with each other because they could give you a problem, simple problem, but if you don't have a basic understanding, you won't be able to get it right. The likelihood of assessing control risk too high relates to what? Now, do you understand what does it mean assessing control risk too high? Assessing control risk too high, it means I'm not going to rely on the control because their control risk is too high. They don't have a good internal control. That's what it means. The likelihood of assessing, remember we assess control risk. What is that going to do? That's going to relate to the effectiveness of the audit or is it to the efficiency of the audit? Let's walk through this logically. What happened if you think the control risk is high? The control risk is high. You are not going to rely on the control. What does that mean? It means you're going to do more substantive testing. It means you're going to increase your sample. You're going to do more work. You're going to audit more transaction. You're going to do more work. Well, what is that going to relate to? If you assess control risk too high, is it going to relate to the effectiveness of the control or to the efficiency of the control? Well, if you do more work, if you do more work because the internal, you think the control risk is too high, that's going to affect the efficiency of the audit. It means you're doing more work. Maybe you don't have to do more work, but it relates to the efficiency. Now let's assume why it's not effectiveness because if you do more work, you're going to be effective. The more work you do, the more effective you are because you're looking at more samples. That's good. So it doesn't relate to your effectiveness. It relates to your efficiency. You're doing more work. Maybe you're not supposed to do more work because you assess the control risk too high. If you assess the control risk too high by mistake, you are less efficient. Therefore, the answer is B. You are still effective. Why? If you do more work, you're definitely effective because you're trying to catch everything you can catch. Which of the following illustrate the concept of sampling risk? So simply put, do you know what sampling risk is? That's what they're asking. Now, they can ask these questions in so many different ways. Let's take a look at what we mean by this question in this context. One, a randomly chosen sample may not be representative of the population on a whole on a characteristic of interest. Well, look, this looks like a sampling risk definition. So I would say I will keep A, I will take out B, I will keep C, take out D. So what is sampling risk? I always like to give this example because it relates as a student, it's going to relate to you very well. Now, let's assume I have a class of 100 students. I don't have classes that large, but let's assume I do have class that large. And let's assume I have 100 students and I have 10 rows. Okay, 10 rows in my class and each row will have 10 students. And here's what happened. If I ask the first row about their accounting major, what's their major? I'll just ask the students to give me their major at the first row. And in this row, 6 out of 10 students, they say their major is accounting. Well, I would conclude, I will go ahead and conclude that 60%, 6 out of 10 is 60, 60% of the students in my class, which is, let's assume this is a finite to be more specific. Let's make it a little bit more realistic. This is a financial accounting course. Financial accounting means everybody takes this course, marketing students, finance students, economics, business students, management, everyone. So if I sample the first row and I found out 6 out of 10 students are accounting, let's assume I also sample the first and the second row. And in the second row, I also had 6 out of 10 students are accounting major. And I conclude, you know what? 60% of this class is accounting major. It's a problem. Why? I'll tell you why. Because accounting students, because that's their major, they're most likely to sit in the front, to sit in the front. Therefore, when I select it from the front, my sample is biased because most likely the accounting students sits in the front. So what I need to do, I need to select from all over the room, then basically make a decision based on my sampling. But if I select from the front, I could have a sampling risk. It means my randomly chosen sample may not be representative of the whole classroom because people that sit in the front, if they're more likely accounting students, maybe they like me. That's why they sit in the front. They want to be physically close to their teachers. They want to make sure that the teacher sees them, that they're paying attention. It doesn't matter. The point is you got the point that there's a sampling risk up front. OK, so A is definitely there. Two, an auditor may select an audit procedure that are appropriate to achieve the specific objective. Is this called a sampling risk? Now, here you are using the wrong procedure. It has nothing to do with the sampling. You did not perform the procedure properly. It has nothing to do with whether you selected the right or the wrong sample. So two is not sampling risk. Two is you're just simply selecting the wrong procedure. OK, so obviously the answer is A, we can take out C. Let's look at this question. In this question, it involves a lot and I keep it for last because you have to have a good understanding of what we're doing. So let's take a look at this question. An auditor had identified a control activity that will reduce the assessment of control risk if it's operating effectively and efficiently. That's excellent. That's why we assess control risk to see if it's working effectively and efficiently, then we can rely on the control. The auditor has decided to perform sample for attribute. That's what you do. You sample for attribute for internal control. The auditor believed that the actual error of this activity is two percent. OK, so let's look at this. Expected, they expect two percent. They expect the actual error to be two percent, but they can tolerate five percent. So they expect two, they can tolerate five. The auditor want to reduce sampling risk to a ten percent. Now, there is the sampling risk here. It means what is the chance that we are taking with this sampling procedure? Ten percent. So we can take a chance of a ten percent that we are being wrong in this procedure. So sampling risk is ten percent. It means there's a 90 percent chance we are correct. The appropriate sample size is determined and selected. So now we selected the appropriate sample size and an error of three percent is discovered. Now, the actual error, after we sampled, the actual error was three percent. Remember, we expected two, the actual was three. The chart is examined that indicate the upper deviation rate is six point four. OK, now, again, here we have to understand the how we come up with the upper deviation rate. The upper deviation rate is based on the sampling risk and we use tables. Here they're giving you the upper deviation rate. The upper deviation rate equal to six point four percent. Which of the following statement is correct? So we have a lot. They could ask you a lot of questions about this topic. Let's focus on one thing at a time. The allowance for sampling risk equal to three point four percent. Is this statement correct? Is this statement correct? OK, and I hope you remember from earlier that it is correct. Let's go back to earlier. Let's go back to the earlier question. Remember, the first or the second question here, we ask you about this. Oops, sorry. OK, let me clear this. Let me clear this so we can see this. The sample deviation rate plus the allowance equal to the upper deviation rate. OK, what did we have in this problem? In this problem, we had the sampling rate of deviation, which was three percent. They told us the upper deviation rate from the table when we looked up the upper deviation rate from the table equal to six point four. Well, the sample rate of deviation when we sampled is three percent. Well, this must be the plug, which is three point four. The allowance for sampling risk equal to three point four. Therefore, that one is correct. So the first one is correct. So I'm going to keep one, take out B, keep C, take out D. So that's correct. So the allowance for sampling risk is three point four. Two, the auditor should determine that the control is working effectively and reduce control risk since the sample rate is three percent below the tolerable rate of five percent. OK, now what they're saying in number two is the auditor should conclude that the that the control is working effectively and reduce the control risk since the sample rate, which is the actual sample rate is three percent is below the tolerable rate of five percent. Is this how you make your decision? Is this how you make your decision? And the answer is no, that's not how you make your decision. How do you make your decision? You would look at the upper deviation rate and you compare this to the tolerable rate. I can tolerate five percent, but I could have six point four. No, I'm not going to rely. Why? Because the upper deviation rate could be higher than the tolerable rate. I can only tolerate five percent. So we don't rely. Don't rely under those numbers. Therefore, two is out. So we don't determine that the control is working effectively and we're not going to reduce the internal control. We're not going to reduce the control risk. Therefore, C is out. If the upper deviation rate from, you know, from the table here, from the table here was four percent, then we would have accept that number two will be correct. So we would compare the upper deviation rate, which is six, six point four percent to the tolerable rate, and therefore we don't rely. I know this is a lot of information. I totally understand this. There's a lot of information here that you need to absorb. That's why you will need to go to my auditing course and learn about sampling from A to Z, from A to Z with examples, with practice. So you have a good understanding. And when you walk into the exam day, sampling will be a good question for you to get. Why? And definitely you're going to get sampling. There is no way you're not going to get sampling. Why? Because you are confident and you can show them through the answers. As always, I would like to remind you to like this recording, subscribe, check out my website. If you want to add 10 to 15 points to your CPA exam, this is a long-term investment in your lifetime. Don't shortchange yourself and stay safe, especially during those coronavirus days. Good luck.