What Is the Allowance for Sampling Risk?
Learn how auditors use a calculated margin for error to manage uncertainty and draw reliable conclusions about financial data from a limited sample.
An allowance for sampling risk is an auditing concept that functions as a margin for error. Because it is often impractical for auditors to review every transaction, they select a sample to test and draw conclusions about the entire set of data. This allowance is a calculated buffer to account for the possibility that the sample is not perfectly representative of the whole, acknowledging the uncertainty of not testing 100 percent of the population.
The Foundation of Sampling Risk
The primary reason for audit sampling is efficiency, as examining every transaction in a large company would be too time-consuming and expensive. This practice introduces sampling risk, where the auditor’s conclusion from the sample might differ from the conclusion they would reach by examining the entire population. For instance, a sample could contain fewer errors than the whole, leading to an incorrect conclusion that records are accurate. Conversely, the sample could contain a disproportionately high number of errors, causing the auditor to believe a material problem exists when it does not.
It is important to distinguish this from non-sampling risk, which includes human errors like misinterpreting results or applying an incorrect procedure. While non-sampling risk can be reduced through proper planning and supervision, sampling risk is an inherent consequence of not testing the entire population.
Determining the Allowance for Sampling Risk
Determining the allowance for sampling risk begins with the auditor establishing a tolerable misstatement for an account. This is the maximum error the auditor will accept without the balance being considered materially misstated, and it is set during the audit’s planning phase.
Next, the auditor identifies any misstatements in the selected sample. The total error is then used to calculate a projected misstatement for the entire population. For instance, if an auditor finds $1,000 in errors within a sample representing 10% of the total account value, the projected misstatement for the entire account would be $10,000.
The allowance for sampling risk is the additional buffer added to this projected misstatement. The size of this allowance is influenced by several factors. A primary driver is the desired level of confidence; a 95% confidence level requires a larger allowance than a 90% level. Sample size is another factor, as smaller samples create more uncertainty and require a larger allowance. The variability of items in the population also plays a role, as a more varied population increases the necessary size of the allowance.
Evaluating Audit Sample Results
After determining the projected misstatement and the allowance for sampling risk, the auditor evaluates the results. They combine the projected misstatement and the allowance to arrive at the upper limit on misstatement. This figure represents the maximum likely misstatement in the population based on the sample evidence.
The evaluation compares this upper limit on misstatement to the tolerable misstatement established during planning. If the upper limit is less than the tolerable misstatement, the auditor can conclude that the account balance is not materially misstated. The sample results support the fairness of the recorded amount because the highest likely error is within the acceptable threshold.
If the upper limit on misstatement exceeds the tolerable misstatement, the sample results do not support that the account is fairly stated. The auditor must then take further action, such as expanding the sample size, performing alternative procedures, or requesting that management investigate and correct the records.