Auditing – Mill Company Case study.
Auditing is the act of checking at another company/individual way of operations. The key audit area of any auditor is to check on controls and the reports (Needles, power & Crosson, 2012). All accounting and operation standards need to have been met. Controls are very key to any company. Controls reflect on the going concern of any business. A company without strong controls and adherence to the same faces the risk of extinction shortly. An auditor does not only check on the availability of the controls but also the adherence of the same controls.
After auditing the auditor does an auditing report which he then submits to the risk department (Whittington & Pany, 2001). The risk department is then supposed to ensure that the highlighted areas of compliance are rectified, and those guilty of breaching the policies are taken into account. Auditors should follow a laid down code when doing their work. To audit is checking what other people are doing. This involves perusal of previous documents, reported financials and also through observation. Auditors can obviously not peruse all documents in an organization. This is due to time and funding limitations when doing their work. Auditors are then left with only the option of sampling part of the documents.
Sampling is the act of statistically taking a pre-determined number of samples from a population. This population is then studied, and the results from their study are assumed to be a reflection of the whole population (Aczel, D, & Sounderpandian, 2002). Quality samples should meet the size regulations, be unique, selected randomly and not biased. In research and auditing sampling is very crucial as it determines the end results of the project. Error at this stage means that the whole project is flawed. This, therefore, means that auditors and researchers should be very careful when dealing with the sampling stage of their work.
In the case of Baker, it is important for an auditor to have set clear objectives before starting their work. Bakers objective were to assess that Mill Company was controlling risk at a low level as possible. The established rate of risk deviation was set at 20 percent. Any risk that is above that is to be avoided.
The first mistake that Baker did was to use discovery sampling method to estimate population deviation rate and also to try to achieve an upper deviation rate for his project. Discovery sampling is a sampling method that assesses whether the percentage error is not above the specified percentage of the population. With this method sampling takes into consideration the population size, confidence level, and the minimum unacceptable error rate. If the results show that there are no any errors, then the actual error rate is below the lowest unacceptable rate. Baker then proceeded to ensure that the consideration of the of the risk of evaluating risk control is so low that till the sample results have all been evaluated.
In determining the sample size to be considered Baker used the tolerable rate, expected population deviation rate and the population size. With this, he determined that he was to use a sample size of 80. This was later to change to 100 after he discovered that the actual population size was approximately 10,000.
This is not by the laid down procedure and policies of determining a sample and a correction of the same. Any auditor should ensure that they have the correct data before starting their work. Data like the population size should not be compromised as it determines the overall outcome of the audit. Upon discovery of his error, Baker moved on to make the sample size 100 from 80. This is an assumption which is dangerous during auditing. There is a well spelled out formula that can be used in such incidences. This formula also allows for correction of finite populations.
In checking the billing of Mill’s shipments Baker is simply checking the controls in revenue collection which is within his mandate in this project. On selecting the invoices to be audited Baker made another mistake. He took a sample of 100 which we have already proofed was wrong. In the 100 collected samples, he took 25 invoices from the first month of each quarter of the year. There are four quarters in a year making it 100 sample invoices. This makes Baker`s sample size to be biased (Kinney, W, & Martin 1994).
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A quality sample size should be chosen at a random. This can be done using the various sampling methods. These methods include cluster sampling, simple random sampling, stratified sampling or systematic random sampling. By picking invoice only from the first month of the quarter a lot of risks and gaps in control could have been left out. With the wrong sample, Baker’s audit report can be assumed to be irrelevant.
Upon testing the sample which had been acquired wrongly, eight deviations were found. Baker also left out a deviation in which there was a wrong billing of $9. This is unacceptable. The figure is negligible, but auditors need to remember that this is a representation of the whole population. With deeper digging into the population and more thorough sampling more of such transactions could have been discovered hence the company losing a lot of money. By leaving out, such a crucial deviation Baker was in the wrong.
Baker was also in the wrong by reducing the discovered error rate of 8 percent and allowing a further 5 percent as a sampling risk. This meant that the risk deviations discovered were reduced from the earlier achievement of 14 percent to a low of 5 percent. This can be described as accounts dressing to meet a laid down rate. This is an unethical practice in auditing.
Aczel, A. D., & Sounderpandian, J. (2002). Complete business statistics(Vol. 545, p. 2006). New York, NY: McGraw-Hill/Irwin.
Kinney Jr, W. R., & Martin, R. D. (1994). Does auditing reduce bias in financial reporting? A review of audit-related adjustment studies. Auditing,13(1), 149.
Needles, B., Powers, M., & Crosson, S. (2012). Principles of accounting. Cengage Learning.
Whittington, R., & Pany, K. (2001). Principles of auditing and other assurance services. Irwin/McGraw-Hill.