Abstract Generally accepted audit standards (GAAS) mention and explain numerous variables for consideration when auditors plan audit samples for tests of balances. The auditing standards go to considerable length to explain the risk of incorrect acceptance and its relation to audit risk (audit effectiveness), inherent risk, control risk, and analytical procedures risk--even incorporating these variables in an audit risk model. However, the risk of incorrect rejection (RIR) receives scant attention. It is explained as a feature related to audit efficiency. Other than a brief mention, GAAS gives very little guidance on ways and means of exercising professional judgment to determine an appropriate RIR for an audit sampling application. This article presents a method that enables auditors to specify various RIRs and calculate a cost savings associated with an "optimal RIR." The method involves determining a substantive (test of balances) sample cost under an assumption of a "base" RIR that auditors might accept as a normal or firm policy starting point, then experiments with larger alternative RIRs (taking more risk of incorrect rejection) to calculate sample cost savings. The RIR that maximizes the cost savings is the optimal RIR that accounts for the audit costs in a specific audit situation. In this analysis, the RIR is no longer an arbitrary assessment.
Robertson et al. (Tue,) studied this question.