Activity Based Risk Evaluation Model of Auditing

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Observation

Observation is an evidence gathering activity that refers to the observation by the auditor of a procedure being performed, usually by an employee of the client entity. (Observation is different to inspection and physical examination.) The auditor commonly observes the performance of procedures during two audit stages:

• in the client acceptance/retention stage, to obtain or strengthen an understanding of the nature of the client's business, and
• in the control testing stage, to gather evidence of the effectiveness of operation of a control procedure.

Auditors use observation in the control testing stage to gather evidence that a particular control procedure is operating in the manner planned (i.e. as the procedure was designed to be performed). For example, auditors observe that the client's staff performing the control procedure are the staff who were proposed to perform the procedure; that the staff perform the procedure at the planned time; and that the performance of the procedure is supervised as planned.

Observation of a control procedure provides incomplete but highly reliable evidence as to the effectiveness of operation of a control. The evidence is incomplete as observation only provides evidence in relation to the effectiveness of a control at, or near to, the point in time the procedure was observed. The evidence, however, is highly reliable as it is evidence gathered first hand by the auditor and is entirely independent of the client. Of course, this assumes that the auditor making the observation is competent and appropriately experienced .

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