An empirical investigation of the auditor's decision to project errors

Statement on Auditing Standards No. 39 requires that auditors project to the population being sampled the dollar errors in tests of details of balances. This study uses an archival approach to examine auditors' sample error projection decisions for inventory and accounts receivable errors from audits conducted by three large accounting firms. This archival approach provides a rich environment for describing the auditor's sample projection decision. We suggest that sample evaluation consists of both error quantification and error resolution. Consistent with previous experimental research, auditors often fail to quantify errors by projecting them to the population. The decision to project an error is related to several factors, including the materiality of the error, direction of the error, type of test, and audit firm characteristics. Error immateriality was the most common documented reason for not projecting an error. Although most errors were small in relation to planning materiality, failure to project seemingly immaterial amounts may increase audit risk by an unacceptable amount, especially if sampling risk is not considered. The auditors in our study did not explicitly consider sampling risk in making error projections. Consistent with previous research, error containment was also associated with the decision to not project errors. We suggest that this strategy is used for large errors as part of the auditor's resolution of the error. Professional standards indicate that auditors should consider qualitative aspects of errors (AU § 350.27), but do not address whether error containment is appropriate. The results of this study suggest the need for further guidance and additional research in the use of error containment, and of the consideration of sampling risk in the evaluation of errors.