What impact does a lower tolerable deviation rate have on sample size?

A lower tolerable deviation rate signifies that the auditor is allowing for a smaller margin of error when assessing the effectiveness of internal controls or the risk of misstatement in financial statements. This means that the auditor requires a higher level of assurance regarding the population being tested, as they are aiming for a stricter standard in terms of acceptable deviations or errors.

To achieve this higher assurance, a larger sample size is necessary. This is because increasing the sample size helps to mitigate the risk of overlooking significant errors that could indicate problems within the control system or account balances. Essentially, with a lower tolerable deviation rate, the auditor needs to evaluate a broader range of transactions to gather sufficient evidence that supports that the actual deviation rates in the population are lower than the established threshold.

In practice, this means that when the tolerable deviation rate is set lower, the auditor must increase the sample size to confidently conclude that the controls are effective or that the financial statements are free from material misstatement, thereby achieving the desired level of assurance while reducing the sampling risk.