Audit Sampling Case Memo - Essay Example

: (1) the existence of the inventory; (2) the rights or obligations of inventory; (3) the completeness of the inventory as stated in the balance sheet; (4) the valuation of inventory on hand, and whether it is presented according to GAAP along with (5) the presentation or disclosure of inventories in the financial statements (Whittington & Pany, 2006). RF= the reliability factor for the specified risk of incorrect acceptance. This is taken from figure 13-5 in Boynton & Johnson (2010), and for a risk of incorrect acceptance of 37% as listed, the reliability factor is 1.0. EF= the expansion factor for anticipated misstatement.

This is obtained from figure 13-6 in Boynton & Johnson (2010). With a risk of incorrect acceptance at 37%, the expansion factor is given as 1.15. In Boynton & Johnson (2010), the risk of incorrect acceptance is listed at 37%. There are scenarios that would explain why 37% is chosen instead of higher or lower percentages. An important element mentioned by Whittington & Pany (2006) is the level of overall audit risk. Audit risk is based on the following formula: Audit risk (AR) is the overall allowable audit risk that a material misstatement will remain undetected.

Inherent risk (IR) is a risk of a material misstatement in the financial statements, assuming a company had no internal controls. Control risk (CR) is the risk that a material misstatement could occur in an assertion and will not be detected by internal control. Detection risk (DR) is the risk that the auditors’ substantive testing will not find a material misstatement (Whittington & Pany, 2006). The setting of the risk of incorrect acceptance at 37% is not an exact science. If circumstances arise where auditors place inherent risk and control risk at high levels, and do not engage in other tests of the balance assertion, then the risk of incorrect acceptance would have to be set at a low level.

However if a decrease in inherent risk or control risk occurs, then a