Question

Nathan Matthews conducted a test of controls where the tolerable deviation rate was set at 6 percent and the expected population deviation rate was 3 percent. Using a sample size of 150, Matthews performed the planned test of controls. He found six deviations in the sample, and he calculated the computed upper deviation rate to be 7.8 percent.
Required:
1. Based on the sample results, what allowance for sampling risk is included in the computed upper deviation rate of 7.8?
2. Assume that Matthews preliminarily assessed control risk as “ low.” Given the results above, the auditor could decide to do one of three things:
a) Increase the sample size,
b) Increase the preliminary assessment of control risk, or
c) Not adjust the preliminary assessment of control risk.
Describe how Matthews could justify each of those three actions

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1. If Matthew increases the sample size, he could increase his reliance on the sample and have higher confidence level thus reducing allowance for sampling risk. (Remember confidence level + sampling risk always equal to 100. If the sampling risk is 3.8% the confidence level is 96.2%). If the allowance for sampling risk lessens and the upper deviation rate becomes lower than tolerable deviation of 6%, you can rely on the internal control. For example , if you increase sample size to make your confidence level at 98%, the sampling risk would be 2% which when added to the sample deviation rate (we just use the original figure for simplicity) of 4%, the upper deviation rate would be 6% which is equal to tolerable error. So you can conclude that internal controls of the company are reliable....

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