I’m trying to study for my Accounting course and I need some help to understand this question.
John Doe, CPA, is interested in testing the fairness of the ending inventory balance during the audit of ABC Co. John has relatively little experience using statistical sampling methods and, quite frankly, doesn’t like to turn anything over to random chance—especially the selection of items to test. John used a judgmental method of selecting items for testing. The method involves testing the inventory-item balances that he deems most risky or most likely to be misstated. John identified items to test based on size of balance, findings from prior years, age of inventory, description, and professional judgment.
He selected 26 items with a total book value of $720,000. In his “sample,” he found a combined $80,000 in overstatement errors. The book value of inventory on the entity’s records is $1,090,000. Overall materiality for the engagement is $500,000. John’s policy is to use 50 percent or less of overall materiality as tolerable misstatement for any one account.
a. What is your opinion of John’s method of selecting his “sample”?
b. Evaluate John’s results. Does he have sufficient evidence to conclude the balance is fairly stated?