Technologies as a Source of Audit Evidence

The focus of much of the currently available--and rapidly growing--body of literature regarding audit technologies is on the technologies themselves, both the hardware and the software. However, to understand how audit efficiencies are created--or audit costs reduced--through the use of both high-powered computers and available software, it is important to clearly recognize their role in the audit process.

According to SAS 31, Evidential Matter:

Most of the independent auditor's work in forming his opinion on financial statements consists of obtaining and evaluating evidential matter concerning the assertions in such financial statements.

Professional standards explicitly require that "sufficient competent evidential matter is to be obtained...to afford a reasonable basis for an opinion regarding the financial statements under examination." However, GAAS provide the auditor with a relatively flexible framework within which to decide what constitutes "sufficient competent evidential matter." It is not surprising that significant variation exists in the specific procedures applied on individual audits.

It is important to recognize that audit technologies and audit procedures may be usefully thought of as being synonymous. Broadly defined, audit technologies encompass the full set of tools available to the auditor for gathering and evaluating evidential matter. While many, if not most, new audit technologies are computer based, it is important to also focus on the use of the information being produced by the technologies, rather than only on the mode of delivery. To understand the efficient use of new technologies in auditing, it is critical to recognize how they are used by the auditor as a source of audit evidence.

Two New Audit Technologies

It may be helpful to classify new audit technologies as either: 1) technologies that automate existing, established audit procedures; or 2) technologies that introduce new approaches to auditing.

Type 1: Technologies that automate existing, established auditing procedures. New audit technologies are often applied in the automation of existing, well established procedures. The particulars will differ across individual audits and auditors. However, examples are the use of spreadsheet software to generate year-to-year variation calculations for analytical review and the application of computer software to perform test footings of client ledgers and trial balances.

The key to identifying Type 1 applications is to compare the nature of the test being performed through use of the new technology to that which was performed in the past. If the two are essentially the same then the application is of the automating type. For example, if you adopt spreadsheet software to perform essentially the same calculations for follow-up in analytical review procedures as you had previously performed with a calculator or adding machine, then you have an automating application. The medium may be different, but the message-- the evidential matter produced--remains the same.

Type 2: Technologies that introduce new approaches to auditing.

In contrast, the application of a newly-adopted technology may generate evidential matter that was not previously utilized by the auditor. In these cases, the new technology introduces a new approach to auditing. Continuing with the analytical procedures example introduced above, the adoption of multiple regression analysis, where only simple year-to-year variation analyses had previously been performed, would be an example of a technology that introduces a new approach to auditing. A similar example is the incorporation of industry data, retrieved from a CD-ROM data base, in analytical procedures where previously such data was not part of the process.

However, as with identification of the automating technologies, the key here is the comparison of the evidential matter produced with the new technologies to that which was generated through the procedures performed in the past. Again, the focus is on the message--the evidential matter being generated--rather than on the medium being used to produce that message.

The sidebar on page 60 offers a detailed illustration of the differences between these two types of new audit technologies.

Using New Technologies

Clearly, judgments concerning the nature and extent of audit procedures are critical to ensuring the quality of the audits being performed. From the standpoint of efficiency, the auditor's goal is to plan and execute the set of audit procedures that will generate "sufficient competent evidential matter" at the lowest possible cost in the particular engagement circumstances.

The discussion that follows explains how audit efficiencies are achieved for the two types of new audit technologies described above.

Type 1: Technologies that automate existing, established auditing procedures. By definition, the evidential matter produced on a particular audit with this type of new technology is the same as that previously generated. Enhanced audit efficiency results from the use of this type of technology when the evidential matter is produced at a lower cost than had previously been the case. Frequently, these lower costs result when the savings from the reduction of previously necessary staff time more than offset the cost of acquiring and applying the new technology.

Type 2: Technologies that introduce new approaches to auditing. Audit efficiencies are produced with new technologies when something old is replaced by something new. However, an important distinction exists between the two types of new technology. In the case of Type 1 technologies, the medium changes, but the message remains the same. For Type 2 technologies, the delivery medium may also change when new approaches to auditing are adopted. However, with this latter type of new technology, the message -- the evidential matter produced -- is changing as well.

Audit efficiencies can be produced in two ways with Type 2 technologies. First, the new technology may produce and process evidential matter at lower cost than its predecessor; this is similar to the creation of efficiencies with the Type 1 technologies discussed above. However, in many cases, the cost of acquiring and using the new technology may substantially exceed the cost of the audit procedures previously employed. Fortunately, there is a second, and potentially much more potent way in which audit efficiencies can be produced through Type 2 technologies. Substantial efficiencies can result when the auditors are able to both substitute the newly available evidential matter for the previously generated evidence, and assign greater weight to the new than to the old.

For example, in certain situations the auditor may be able to eliminate or significantly reduce detailed testing of sales transactions if he or she is willing to place substantial reliance on a multiple regression- based analytical procedure. But, to achieve these greater benefits, the auditors must be willing to stop performing or significantly reduce the extent of previously used auditing procedures. In addition, the auditors must be willing to place substantial audit reliance on a new form of evidential matter with which they may be much less familiar.

Evaluate on an Audit-by-Audit Basis

We do not recommend that individual technologies be thought of as being purely Type 1 or Type 2 in all situations. Rather, an understanding must be developed of the "technology in use" on an audit-by-audit basis. Further, this understanding must be developed within the historical context of each audit, with a knowledge of the audit procedures performed in the past and the manner in which they will change if a new technology is adopted.

Individual Auditors "Make it Happen"

The benefits of new audit technologies will not be realized on individual audit engagements unless the auditors involved "make it happen." Audit efficiencies clearly do not result simply from the availability of new audit technologies. Rather, any audit efficiencies that are achieved will occur when auditors actively reduce or eliminate some procedures that were performed in the past. Adoption of a new technology without active replacement of something previously performed can have disastrous results from the standpoint of audit efficiency. Not only will cost savings not result, but the cost of the audit will increase by the cost of acquiring and using the new technology.

New Must Replace the Old

A difficult task for managers of audit technology is persuading auditors to adopt a technology that introduces a new approach to auditing. However, the most difficult task may be persuading auditors to abandon sources of audit evidence with which they have become comfortable. The challenge in the management of new audit technologies is achieving both of these tasks simultaneously. If traditional procedures are not sufficiently reduced in the year when a new technology is adopted it may be difficult, if not impossible, to ever realize efficiencies by using that particular technology.

Manage the Process

The adoption of new technologies must be actively managed to ensure maximum benefit from their use, and everyone involved in the audit must take an active role in this management process.

AN ILLUSTRATION OF THE TWO TYPES OF NEW AUDIT TECHNOLOGIES

The basic scenario. Accounts receivable is a material item in the financial statements of the company being audited. The auditor is particularly concerned with obtaining evidence regarding the "existence" of the recorded accounts receivable balance as of the balance sheet date.

The past audit approach. In the past the auditor has relied heavily on confirmations of year-end balances to provide assurance regarding the existence of the recorded accounts receivable. The sample for confirmation has typically been selected manually by the auditor from a hard copy printout of the client's accounts receivable trial balance. Addresses for the selected customers have then been obtained from a separate print out of the customer master file, and the confirmation letters have been manually typed.

The introduction of new audit technology. In the current-year audit of accounts receivable, the auditor has decided to apply new technology which draws on the enhanced capabilities and ease of use of available computer-based audit technologies. The two independent scenarios that follow illustrate differences in the two different "types" of new audit technologies that might be applied in this situation.

Type 1: Technologies that automate existing, established auditing procedures. The auditor has decided to use computer assisted audit techniques to automate portions of the accounts receivable confirmation selection and preparation process. Specifically, a computer program is now being used to read the client's accounts receivable trial balance file. The selection criteria previously applied by the auditor have now been incorporated into the computer program, and are used in selecting the individual accounts to confirm. Once the individual accounts have been selected the computer program retrieves the appropriate addresses from the customer master file. Finally, the completed confirmation letters are computer generated and laser printed.

Audit efficiencies will result in this case if the auditor is able to select and generate the accounts receivable confirmations at a lower cost using computer-assisted audit techniques than had been possible with the previous manual approach.

The audit evidence being produced is essentially unchanged.

Type 2: Technologies that introduce new approaches to auditing. Relatively simplistic analytical procedures have always been employed by the auditor as part of the testing of the year end receivables balance. However, in the current year the auditor decides to perform substantially more rigorous analytical procedures. Specifically, the auditor has decided to develop a multiple regression-based model for predicting the year end accounts receivable balance. The prediction generated by the model will then be compared to the client's balance to determine the reasonableness of the reported amount.

Clearly, audit efficiencies will not result in this case if the regression model is simply used in addition to all of the other audit procedures that have traditionally been performed. One way that substantial efficiencies could result is if the auditor is able to significantly reduce or eliminate the use of accounts receivable confirmations, and place reliance instead on the substantive audit evidence produced through use of the multiple regression model.

Evidential matter is generated through the new technologies which was not previously utilized by the auditor.