John H. Myers
INDIANA UNIVERSITY
SPIRALING UPWARD:

Auditing Methods As Described By Montgomery And His Successors

Abstract: Audit emphasis this century has swung away from chasing entries through the books to values being “fairly presented” and then back again. Now, however, what was “chasing entries through the books” has become “verifying internal controls.” This verification is primary evidence that statement values are fair, and comparison of values to “things themselves” is corroborative evidence. Thus, auditors have not gone around in a circle, but in a radically changing environment they have spiraled upward. These conclusions are drawn from a review of the nine editions of Montgomery’s Auditing published through 1975 and from the two editions which Montgomery prepared of the Authorized American Edition of Dicksee’s Auditing.

A 1950 list of auditing methods by the American Institute of Ac-countants (now AICPA)1 included (a) analysis and review, (b) ob-servation, including both observation of physical assets and of how clerical employees do their work, (c) confirmation, (d) inquiry, and (e) computation. Compare, cross-reference, examine, investigate, scan, and trace might be added as subitems in the major list. These words also appear in the auditing literature of the early 1900’s and of today, but today do we do these things differently? The changed environment of larger masses of data, new means of handling them, increased audit responsibilities and greater understanding, have led to many changes in the use of these methods. Early in the century they were used primarily to trace transactions through the books. Later the emphasis changed to according the account bal-ances with the “things themselves.” Now the audit focus is on the integrity of the system for getting the transactions into the financial statements, while additional balance sheet auditing assures that ac-count balances accord with the “things themselves.”

This analysis of history is based on the nine editions of Montgom-ery’s Auditing plus the two editions of the Authorized American Version, which Montgomery prepared, of Dicksee’s Auditing. In addition to the main thread, several sub-threads became apparent, such as that of the relationship of auditing changes to the changing en-vironment. This report follows the sweep of history from edition to edition and picks up the various threads as they emerge and re-emerge.

1905: Point of Departure

The year 1905 is the starting point because it is the year of the first of the books, not solely Montgomery’s, but his Authorized American Edition of Dicksee’s widely used English Auditing text. This American Edition came only nine years after New York State (the first to do so) introduced the designation “Certified Public Accountant.” Montgomery stated in his preface that “we find our-selves, therefore, at the very threshold of what may be called a new era in the profession in the United States.”

Audit Objectives

The objectives of an audit and their ordering may be compared to today’s standards. In 1905 they were listed as:

1. The detection of fraud
2. the detection of clerical errors
3. the detection of errors in principle

Montgomery makes the statement that “the detection of fraud is the most important portion of the Auditor’s duties.”

Programs, Working-Papers and Instructions

The Audit-Notebook appears to have been a standard audit tool in 1905: printers sold several kinds of bound notebooks. They typically contained printed instructions of a general nature, blank pages for instructions applicable to the particular audit and specially ruled pages for the work done on the various accounts. The text states that the clerk who assumes responsibility should initial his work. Montgomery offered some uncomplimentary opinions about audit organization in which the “clerk is rigidly bound” and asserted how much better it would be “to leave him unfettered with printed instructions [and allowed] to go thoroughly into the whole system . . . and from what he sees let him outline his own method of procedure.”4 Nevertheless, this exhortation was followed by eighteen

The Appendix contains a note on the methodology used.

“Instructions for Audit.” They use the verbs obtain, examine, ascertain, report, compare, prove, determine, note, check, and “see-that,” but seldom do they tell the auditor what to look for when he ex-amines, how to ascertain, how to check systematically, or what “check” really means.

Tracing Transactions

Tracing transactions seems to have been the major work in an audit. First the auditor was to get a fist of all “books” and of all persons authorized to receive or pay out goods or money. Then “calling over” was to begin. One auditor called the transaction from one record to his teammate, who checked it into another. Opinion varied as to how many transactions were to be “called over.” One school of thought held that it was the auditor’s duty to trace every transaction back to its first source whereas, in the opposite view, the duty was to see that the balance sheet agreed with the books. No reference was made to the books, being in accord with facts or even to internal consistency. In the middle ground there was room for testing by use of aggregates such as the comparison of the sum of cash recorded as received for a day with the amount of the bank deposit for that day. There is no reference to sampling, namely, examining a few items and inferring that all of the items are equally well (or badly) handled.

The purpose of this tracing was not only to see if the client’s accounting was accurate but also to acquaint the auditor with the nature of the transactions and of the system. Montgomery exhorted the auditor to ask “Where is fraud most likely to creep in? … If he can find a loop-hole let him be doubly vigilant there.”

Other Audit Steps

The major other steps cited are (a) verifying additions, (b) keeping control of a book until all work on it is done and summarized,
(c) comparison of opening balances to last year’s audited figures, (d) vouching, and (e) comparison to outside sources. Comparison appears to have been far less systematic than it is today. Montgomery did refer to comparing duplicate bank deposit tickets— containing detailed listing of checks—to the bank’s copy, comparing the “wages book” to the time clock records (but not to observing if the clock was used correctly). He also stated that confirmation of re
ceivables was “the only satisfactory verification,” but it did not be come a regular audit procedure until much later.

Montgomery made reference to the new adding and listing machinery used in banks and the consequent abolition of the practice of writing all checks in the customer’s passbook.

In the preface to the second American edition of Dicksee’s Auditing, Montgomery stated that the entire text had been revised, but that no material changes had been made in the general principles, which represented the best thought of the profession here and abroad.

1912: Montgomery’s First Edition Audit Objectives

In the 1912 edition, Montgomery pointed out that the major purpose of auditing was “to ascertain the actual financial condition and earnings of an enterprise for (a) its proprietors . . . ; (b) its executives . . . ; (c) bankers or investors who are considering the purchase of securities; (d) bankers who are considering the discounting or purchasing of its promissory notes.”6 Only under the heading “The Minor Objectives of Audit” did he list the detection of fraud, which had been the primary purpose of Dicksee in 1905 and 1909.

This change in the audit objective is significant. Whether it actually had happened and Montgomery was a good reporter, or whether Montgomery was advocating that it should happen, cannot be determined.

He distinguished between a balance sheet and a detailed audit. Although he provided no definition of these two types of audit until the 1940 edition, we can get a feeling for the meaning of the distinction from the following reference to the detailed audit.

In all cases where a complete examination is desired or desirable a detailed audit should be made. In those under-takings where there is no satisfactory internal check, the detailed audit is the only one which will cover the income and expenditures for the period under audit.

A balance sheet audit at this time meant, as its name implied, an audit of the balance sheet accounts. If an opinion was to be given on the income statement, a detailed audit seemed to be necessary. Apparently, many audits simply “certified” a balance sheet, by post-year-end examination of the assets and liabilities. Since income statement accounts were period accounts, they could be audited only by examining the details of the entries. Montgomery later states, however, that

If the auditor has satisfied himself that the system of internal check is adequate, he will not attempt to duplicate work which has been properly performed by someone else. His duty will then be to verify the assets and liabilities, and to make such an analysis of the Profit and Loss Account as will enable him to certify that it has been properly stated.

From this quotation, it seems that the basic distinction lay in the effectiveness of the system of internal control.

The Balance Sheet Audit

Montgomery started the discussion of the balance sheet audit with a list of five “General Principles,” as follows:

(1) … all of the assets shown by the books to have been on hand at a certain date were actually on hand.

(2) … whether any other assets, not on the books, should have been on hand.

(3) … the liabilities shown by the books to be owing at a certain date were actual liabilities.

(4) … whether or not all liabilities were in fact shown on the books.

(5) … whether or not the liabilities so shown were properly in curred.

Note two things about these general principles. First, they pertain to the books’ being in accordance with “facts.” Second, there is no reference to the capital account nor to the subsidiary accounts which show changes in the capital account. Montgomery seems to have believed that if assets and liabilities were correct, the difference must be correct, and that if this was true last year and is true this year, then the change, at least in the aggregate, must be correct.

Auditing Specific Balance Sheet Accounts

The audit of cash in bank in 1912 was described in the same words that would be used today: (1) get certificates and statements directly from the bank, (2) reconcile, (3) determine that the balance may be withdrawn.

The audit of accounts receivable (trade debtors) however, began with valuation, not existence. After five pages on valuation Montgomery stated “there is but one absolute method of ascertaining the accuracy … [of amounts] due from trade and other debtors, and that is to procure an acknowledgment of the debt from the debtor. This is, of course, impractical in most cases . . . .”l0 Thus, although confirmation was recognized in 1912 as an audit method, we cannot conclude that confirmation of receivables was widely used.

Thirteen rules were given for verifying inventories. The client was to take a physical inventory and then, as rule one, the auditor was to “secure original stock sheets, no matter how rough and soiled they may be.”11 They should be certified and initialed by the persons (a) who “took the stock,” (b) who made calculations and footings and (c) who fixed the prices. The second rule was to “see to it” that these certifiers were “dependable and took the matter seriously.” Starting with rule three, the rules were more familiar: test calculations; prove footings; ascertain that purchase invoices have been entered for items in stock and amounts for freight included; compare prices with recent invoices; see if quantities are reasonable; compare to prior period; consider saleability of stock; and see if subsequent sales are priced at such a level as to recover costs with a proper margin. Physical verification was not mentioned.
In a subsequent section on goods in process, Montgomery stated the near impossibility of verification in cases where no cost system was in existence. “The difficulty of the task must not excuse the auditor from further inquiry.”12 No further directions were offered. Where there was an “adequate” cost system, the auditor should make a comparison of some of the items “with actual physical inventories.”13 Does Montgomery mean the “rough and soiled stock sheets,” or that the auditor should inspect the items himself? One cannot tell.

For accounts payable the first topic discussed was satisfying one-self that all obligations to trade creditors appeared on the books. As in his American edition of Dicksee, the ideal way “would be to read all incoming mail for some days before and after [the balance sheet] date. . . . Unfortunately, the auditor rarely has the opportunity [to do so]. … In the absence of this shortcut”‘4 Montgomery stated two major items that must be determined: that all payables shown on the books are also shown on the balance sheet and that all actual payables, even if not shown on the books, are included among the liabilities. He did suggest determining if all payables shown on the books were truly liabilities of the client. As a check, he advocated comparing balances with the statements from these creditors and examining receiving reports for the period immediately preceding the balance sheet date.

In his discussion of the detailed audit, Montgomery lists two “General Principles . . . which govern the detailed audit of income and expenses:

(1) … earnings shown by the books are properly accounted for and whether . . . any are omitted

(2) … expenses and losses are properly stated and support ed.”

Contrary to the practice of not many years before (and perhaps even of 1912) Montgomery stated “the least important part of the audit is the verification of postings and footings …. It will have to be a very small business indeed where there can be any justification for verifying every posting and every footing. . . . An analysis . . . demonstrates the fact that the percentage of frauds which have been concealed by false postings and incorrect footings is small.”16
Basically, the detailed audit which Montgomery recommended was a thorough review of an internal control system such as would be performed today. The steps in auditing that system included, among others,

(1) inquiry made or personal watch kept to see who opens the mail and what record is made

(2) ascertain that all cash sales are accounted for [Montgomery did not suggest a method to use in order to “ascertain”]

(3) compare some order books to ledgers

(4) test, for a few days, cash discounts

(5) confirmation of accounts receivable (“Every year the objections to this practice grow less, and no doubt within a few years verification of customers’ outstanding balances by correspondence with the auditor will be the rule rather than the exception.”)

(6) schedule all securities owned and ascertain that all interest or dividends have been collected.

The list continues with many steps still being performed in auditing internal controls.

The final chapter on the detailed audit focuses on assets and lia-bilities and the procedures seem to be the same as those set forth for the balance sheet audit.
In summary the audit of 1912 was different from that of 1905. The same tracing and footing were done, but to a lesser extent. Al-though there was some emphasis on external evidence, there was a strong tendency to rely on internal record-keeping and documentation without comparing balances to facts.

With this observation, it is possible to skim through subsequent editions for subtle indications of change. The exact year may be difficult to pinpoint, but the broad sweep and changing business environment can be observed.

In the preface to the second edition (1916) Montgomery stated that “No radical changes have occurred in [auditing] theory or practice …. The income tax has come to stay.”18 In recognition of the arrival of the income tax, Montgomery included material on it, later removed from the 1920 reprint of this edition to a separate tax book.

1921: Effect of World War I

Between 1916 and 1921 the United States went to and returned from war. There were radical changes in the economy. Many firms prospered, many failed, and some prospered mightily and then failed. There were significant fluctuations in prices. “The profession met the test of war and inflation and has tremendously increased in prestige.”19 Economic conditions put pressures on auditors to accept new disclosure and valuation principles to “improve” clients’ apparent results.
In spite of great economic changes, the increased prestige of the profession, and added client pressures, no changes in audit methods were apparent in the 1921 edition. There were, however, some changes in emphasis. No longer was there, as in 1905, a list of audit procedures. Instead, as Montgomery stated in the preface, “As a whole this book purports to be an audit program, but it is general, not specific, and leaves something to the skill and imagination of the auditor.”20 “At the outset the auditor should carefully read the schedule of assets to be verified and then outline a definite plan.”21 These two concepts (leaving detail of the audit up to the skill of the individual and having him make a definite program), although not new, seemed to become increasingly important from edition to edition.

Another increased emphasis was on reliance on “internal check.” A whole chapter on this topic, though brief, now appeared. Its location, before the first chapter on the balance sheet audit of cash, indicated Montgomery’s view of its importance. He even went so far as to say “[l]t may be that a complete system of internal check will make it unnecessary for the auditor to visit the branch office, although such cases are rare.”22 This was a major change from fifteen years earlier when, at best, there was a grudging acceptance of auditing some (as opposed to all) transactions in a block.

A third increased emphasis can be seen from two of Montgomery’s statements. One extends the concept of an audit. Its basis should be the “connection between the entries supporting the asset accounts and the things themselves [emphasis his].”23 The second statement is that “an entry on the books which purports to record an asset is nothing more than a book record and that there can be no good excuse for accepting such an entry as final [emphasis his].”24 This emphasis on the things themselves and “nothing more than a book record” did not, as might have been hoped, lead to instructions to confirm balances owing or observe physical assets. The same inventory rule as in previous editions still came first: “secure the original stock sheets, no matter how rough and soiled they may be.”25 Later, however, in the numbered list of inventory steps, the next to last was the clear-cut command “[S]elect some items from the inventory sheets and verify by inspection of the goods on hand.”26 Confirmation of all receivables and inspection of all physical assets were not yet generally accepted auditing procedures.

1927: Time of Prosperity

In the preface of his fourth edition of 1927 Montgomery drew at-tention to two major events affecting auditing since the previous edition in 1921. First, the preoccupation with the effects of the war and immediate post-war problems had abated. Second, there had been a large increase in the volume of trade. Montgomery foresaw challenging opportunities for the profession in more comprehensive auditing and in other services. With pressures on the first four months of the year, he saw two ways for rendering a more com-prehensive service: by doing more in some directions and less in others, and by doing substantial work before year-end.

The suggestion to do more before the year-end and less afterwards was not a change in audit method; it was a change in emphasis. In this edition there were two other significant changes in emphasis.

One change related to the confirmation of receivables. In this edition, Montgomery gave the method a paragraph heading of its own saying “[i]t is difficult but not impracticable. Whenever the opportunity exists, the auditor should verify the correctness … by requesting confirmations . . . .”27 He promptly diluted this strong statement by saying “or at least he should inform the debtors what amounts are standing to their debit so that they may have an oppor-tunity to call attention to any inaccuracies.”28 (Or, instead of a dilution, is this a first reference to negative confirmations?)

The other change was toward observation of inventory taking. In the 1921 edition there was, in effect, a single statement about selecting a few items from the inventory sheets for audit observation. In the 1927 edition there was a paragraph headed “When the auditor supervises the inventory taking.”29 The steps taken to control the inventory taking were essentially those that we would follow today. Was the use of the word “supervise” instead of “observe” merely because the niceties of the distinction had not yet been worked out, or was the auditor at that time doing what today would be considered the client’s work?

Among the other evolutionary items, with respect to land titles, Montgomery was more specific about the documents to be obtained and what those documents should contain; for example, a letter from an attorney or a title company, properly signed, stating that title was in the name of the client and whether encumbered.

Referring to “tests” Montgomery explained that these meant

1. To try by subjecting to some experiment or by examination or comparison; to subject to conditions that disclose the true char acter,

2. An examination made for the purpose of proving or disproving some matter in doubt.

“Tests” do “eliminate unnecessary and time-consuming work and . . . substitute necessary and constructive work.”31 Sampling, as we use the word today, might or might not be suggested by his first ex-planation. There was no hint that statistical sampling was included.

1934: Results of Boom and Bust

The period between the 1927 edition and the 1934 edition was marked by the end of the economic boom and the still unequalled depression. Montgomery stated
Owing to the fact that for nearly a third of a century the general trend of basic commodity prices and other elements of manufacturing and construction costs was upward, appraisals during that time quite generally reflected values greater than cost. In recent years, however, many businesses have found that present replacement values were so much lower than those at which their plants were carried on their books, that they have written down their book values to place them on the basis of current reproduction costs.

An example was Goodyear Tire & Rubber Company which reduced Capita! Surplus by four million dollars upon reduction of “appreciation of land” and “unrealized appreciation in subsidiary company property accounts.” Although there may have been a tendency for accountants and auditors to be criticized for these changes in valuation, the profession increased its prestige during this period.

Two statements in the 1934 edition relate to the increased respon-sibilities being accepted by the auditor. The first was that “[t]he balance sheet and the detailed audit are considered together.”33 This is a strong clue that the auditor was taking responsibility for the details of the increment in owners’ equity from one period to the next, and that emphasis was not solely on balance sheet auditing.

The second was with respect to inventory. In the 1905 edition, Dicksee and Montgomery had referred to a leading English dictum: “where circumstances . . . are not such as to arouse the suspicions of an ordinarily capable and diligent Auditor, he is justified in relying upon the valuation of stock-in-trade which has been certified to him by the manager. It is altogether likely that American decisions will follow this general rule.”34 In the 1934 edition, however, Montgomery stated “in the majority of cases the auditor can make, at a reasonable cost to his client, such an examination as will enable him to certify to the balance sheet without qualification and to accept a reasonable degree of responsibility with respect to inventory.”35 The examination necessary in order to take responsibility does not specifically include observation of the physical inventory-taking.

Several points worthy of note indicate a changed application of traditional auditing procedures

1. Montgomery combined, as stated previously, the discussion of the balance sheet and the detailed audit.

2. The client’s employees are “preparing lists.” Montgomery says “obviously the auditor should avoid all clerical work which is not absolutely necessary.”36 This is a distinct step forward from the position set forth in the 1905 work, where he stated that a client’s clerk instead of the auditor “might” prepare the trial balance.

3. In the 1905 edition there was a reference to relying on output from adding and listing machines. In 1934 there is a reference to tabulating machines and possible errors in punching cards, and to the danger of omitting or duplicating a card.

4. The use of block sampling with respect to accounts receivable confirmations was referred to.

5. Whereas in the 1927 edition there was an oblique reference to negative confirmation, in this edition there is a full discussion of affirmative and negative confirmation. “No doubt within a few years the verification of customers’ outstanding balances by correspondence with the auditor will be made the rule rather than the exception.”

6. With respect to investments which should have been on hand all year, Montgomery recommends now that serial numbers beginning and end of year be compared for a few representative items.

1940: Response to Regulation

In the sixth edition of 1940, only six eventful years after the fifth, Montgomery referred to the “enormous output of rules, regulations, and good advice emanating from state and national agencies.”38 In 1934, the year of the fifth edition, the impact of recent regulations could hardly have been foreseen, but the effect of the last seven years shows up in the sixth edition. Such laws as those creating the Securities and Exchange Commission and spelling out its duties, and those regulating wages and hours and working conditions, affected both business and the accounting profession. Some members of the profession asserted that the security laws placed such burdens on auditors that they would not be able to survive. It was a period of rapid movement forward along trends which had been started earlier. One important event was the McKesson and Robbins case in 1938.

The McKesson and Robbins disclosures showed very clearly that the fraudulent practices would have been disclosed several years earlier if the auditors had confirmed receivables with the debtor and had observed the inventory. The Committee on Auditing Procedure of the American Institute of Accountants issued its “Extensions of Auditing Procedure” less than a year later. It said that where practicable, reasonable, and material the direct communications with the debtors become regarded as generally accepted auditing procedure. Similarly, the auditor must be present at the inventory taking and by suitable observation and inquiry satisfy himself as to the effectiveness of the methods of inventory taking, in addition he may require physical tests of inventories to be made under his ob-servation. The profession generally interpreted the requirements to be ones that must be met in all cases unless the auditor could defend his decision that confirmation or observation was not practicable, reasonable, and material. Not until nearly thirty years later was there a relaxation of the Institute requirement that its members state the omission in the scope area of their opinion letters.

For the first time, Montgomery provided a definition of the balance sheet audit.b The balance sheet audit specifically included the review of the system of internal control and covered not only balance sheet accounts but also the income and “surplus” statements. The last part of the definition resembled the wording of the audit opinion. Consistency within the period was required, leaving out consistency with prior periods.

Whereas in the previous edition the auditor supervised the inventory taking, he now became an observer. The securing of “the original stock sheets, no matter how rough and soiled they may be … .” was fourth instead of first among the inventory instructions. First was “[i]n advance of the inventory taking, obtain copies of the client’s inventory instructions to its employees . . . .”40 Not only did this place the auditor as observer but also it gave him a chance to request the changes if the inventory was not planned properly. There was a several page section on “corroboration by physical test and observation.”

Montgomery expanded the section on auditing records in the form of punched cards. He concerned himself with mispunched, omitted or duplicated cards, as he did in 1934, as well as with whether or not the equipment added correctly. His suggested method was to compare the machine total to a hand-generated total of a test group of cards.

1949: World War II

During the period between the editions of 1940 and 1949, the United States had experienced World War II. There had been many
bNote that the definition is different from what it seemed to be in 1912. [A] “balance sheet” audit means the minimum examination of the financial statements, system of internal control, accounting procedures, accounting records, and other supporting evidence, which the auditor believes is appropriate in the particular case and in accordance with generally accepted auditing procedure to enable him to express an opinion as to the position of the company, the results of operations for a period, and the conformity of the balance sheet and statements of income and surplus with generally accepted principles of accounting consistently applied.39

changes in the measurement of income subject to tax, which produced new accounting methods, but with respect to auditing methods, little change is apparent, only a change in emphasis.

During this period, when so many young men went into the armed services, there was a tremendous shortage of personnel to do the “dog-work” of auditing, the detailed footing and ticking. As yet, few women had entered public accounting. The clients’ bookkeeping departments were also short of staff. This labor shortage not only accelerated the adoption of bookkeeping and tabulating machines, but also it accelerated the trend toward reliance on internal control.
Audit emphasis on internal control is evidenced in the book by a restructuring of the chapters on the audit of the balance sheet. The typical chapter was divided into four major parts, the second of which was “Internal Control,” and the third, “Auditing Procedures.” In addition, a seventy-three page appendix of internal control questionnaires for many types of business was supplied; the first one, (twenty-three pages) was for industrial and commercial businesses. The emphasis on internal control affected “the technique of auditing, but not the fundamentals of auditing procedure. . . . [The auditor] must thoroughly understand the way the [bookkeeping or tabulating] machine operates . . . [and] know at what points errors may arise, how they are revealed mechanically, and how they are corrected.”

In addition to the emphasis on internal control there were required more analyses of trends, tests of reasonableness, tests of relationships, understanding of the business, and hard thinking about what really needed to be done. During the war the closing of plants for a week of inventory-taking was severely curtailed, as President Roosevelt had ordered war plants to keep producing and said that if bookkeepers couldn’t find another way, they would just have to do without; the boys at the front needed supplies. Now the client (in taking inventory) and the auditor (in observing inventory) had to develop methods to count without a complete shutdown. Evidence of their success is that after the war, although some plants went back to the annual inventory closing, many did not.
Statistical sampling was used heavily in production quality control during the war but for auditing statistical sampling was still a new idea, and its time had not yet come.

1957: Years of Stability The eight years following the 1949 edition were not ones of war or radical economic change. The lull in the pressure “to put out fires” gave auditors (and authors) time to recognize the basic evolution of accounting principles and auditing procedures, and the expanded services provided by the public accounting profession. The eighth edition of Montgomery’s Auditing in 1957 was authored by Lenhart and Defliese, Montgomery having died in 1953.
Although the computer had arrived, and accountants were just beginning to utilize it, it was not yet a factor in audit methods. In fact, discussion of the computer in this edition was in the “Manage-ment Services” chapter where it was covered in a section on electronic data processing. The authors’ comment was “The speeds with which this equipment can process coded information are so great that the effects on record-keeping cannot be foreseen at present.”

Although this 1957 edition was substantially revised with respect to accounting principles and other professional matters, it did not contain any changes in auditing methods, which generally accepted auditing standards had begun to codify. A questionnaire in the appendix suggested some changes that presaged the radical changes in focus and organization of the audit that were to occur in the next edition, for example, control questions on sales, operating revenue, and receivables were brought together in a single section.

1975: The Computer Age

The ninth edition of Montgomery’s Auditing (1975) was by Defliese, Johnson and MacLeod, three partners of Coopers & Ly-brand, the multinational firm formed by the combination of Montgomery’s U.S. firm with United Kingdom and Canadian firms. Coupled with the growth in the scope and size of firms (both client and audit) there was the virtual takeover of the bookkeeping functions by the computer. The computer brought speed and efficiency in data handling, and the ability to generate many new reports which previously would have cost more than companies were willing to spend.

There was thus a major rethinking of the whole audit process. Generally Accepted Auditing Standards began to be published by the AICPA in 1954; they had appeared seven years before with “Tentative” in the title. By the 1975 edition, these Standards had received widespread recognition and acceptance, and they re-ceived major consideration in the early chapters of this edition. The field work standards for evaluating internal control and obtaining competent evidence might be said to form a basis for what followed with respect to auditing methods. The discussion of the use of the methods was sharpened and the organization for applying them substantially altered in this edition.

The new organization was tied to the newly recognized theory revolving around the term “competent evidential matter.” The underlying evidence consisted of compliance tests of the transactions to learn of compliance with a previously approved system of internal control. Together these led to the concept of “sufficient competent evidential matter” as required by the generally accepted auditing standards. Corroborative evidence consisted of various evaluation procedures and analytical reviews. Basic tests of compliance involved transactions, and the ninth edition grouped the transactions into segments: revenue, buying, production, property, income tax, cash, and financing. For each segment the auditor must set forth objectives for the system to achieve, determine what controls the client used, and whether or not they would be effective if in use, and then test to see if the controls actually were in use. Auditors must see that the results are in accord with the “things themselves,” by going outside the books to seek corroborative evidence, as summarized on the diagram on page 108 of the book. Common procedures for gaining such evidence are confirming accounts receivable by correspondence with debtors, seeing documents, and observing inventory.

The new bookkeeping tool, the computer, has brought with it the need for radically increased controls, very different from those used previously. The organization of these controls is according to integrated transaction cycles. The auditor must learn the controls the client has planned and confirm that they are operating. There is extensive discussion of the various tests of disciplinary controls, application controls and error controls (“Controls are useless unless errors detected are themselves controlled, examined and properly disposed of.”43) In the audit of computer data, the auditor may use generalized audit programs (often prepared by the audit firm), specialized programs written for the specific audit purpose of the particular client, or even the client’s programs “but only after he has thoroughly reviewed the program logic so that he has the requisite assurance that the program [will] perform the procedures he has specified.”44 To the extent that items selected for examination by these programs were selected at random, statistical inferences can be made about the whole with mathematically defined risk and materiality levels. Although there is a major section headed “Limited Role of Statistical Inference in Auditing,” a twenty-one page appendix describes Statistical Sampling Procedures. Nevertheless, the auditor’s intuition and judgment are still important. Now they are used to set specific standards of materiality and risk.

Recapitulation

From this account of successive editions of Montgomery’s Auditing it can he seen that the auditor has responded to the changes of society with changes in concepts and methods.

Early in the century, auditors began to realize that financial statement figures must relate to things themselves; merely chasing transactions through books was not enough. The movement to verify the balance sheet amounts grew so strong that tracing transactions became an unimportant audit step. At some point in the century a swing started toward internal control and systems auditing. The emerging theory of auditing lists transaction auditing as primary audit evidence and account balance as corroborative audit evidence

Throughout all of this evolution of auditing, the basic methods of auditing have stayed the same. Emphasis in applying them swung from transactions to balances and then back to transactions. Auditors, however, did not leave transactions for balances and then move back to transactions. They verified balances and did the transactions work in increasingly sophisticated ways. This I call “spiraling upward.”

APPENDIX A Note on Sources and Historical Research

My source for this study was a complete set of Montgomery’s Auditing including: (1) Dicksee’s Auditing, Authorized American Version by Montgomery, 1905 and a revision in 1909, (2) Auditing by Montgomery (1912, through seven editions to 1949) and (3) two editions of Montgomery’s Auditing by certain partners of Lybrand, Ross Bros. &. Montgomery (now Coopers & Lybrand).

Some researchers, such as E. Peragallo and W. E. Stone have used original account books, and have drawn observations and generalizations from their contents. They have used primary sources. Other researchers use secondary sources, as I have done. Users of secondary sources base their thoughts and generalizations on observations of others.

In this research I have confined myself to the writings of Mont-gomery, to be sure, a limited set of observations, lt does have an advantage other than economy of effort. Changes in Montgomery’s statements from one edition to another can probably be more truly ascribed to changes in circumstances than to changes in the observer. Montgomery, though subject to human frailties and to personal growth, was one person, and, therefore, inconsistencies of observation can be excluded.

I had considered reviewing old working papers of some of the audit firms. I have had some interesting conversations about doing so and some pledges of help. But I ran into problems, primarily of record retention; many of the firms have a policy of destruction on a planned scheduIe. The older papers are just not available. Again, it is the successful firms that have remained in business and whose records might be available (except for the planned destruction). What the unsuccessful firms did would not be available in any case.

Old audit manuals may exist. One firm approached could not come up with any of its old ones. If ever these get into a library open to the public, I did not find any. Even if I had the audit manuals, they would show me what the auditors should have done, not what they did do.

After reviewing possible sources of material other than the set of Montgomery’s Auditing I am convinced that there remains very little evidence of what auditors do and that other hortatory works, outlining what the auditors should do, were similar to Montgomery’s but lacked the consistency of the single author.

FOOTNOTES

1American Institute of Accountants, pp. 28-29. 2Dicksee, 1905, p. 8. 3Dicksee, 1905, p. 23. 4Dicksee, 1905, p. 19. 5Dicksee, 1905, p. 24. 6Montgomery, 1912, p. 9. Montgomery, 1912, p. 80. Montgomery, 1912, pp. 82-84, emphasis his. Montgomery, 1912, p. 87, emphasis his. 10 Montgomery, 1912, p. 100. 11Montgomery, 1912, p. 107. 12Montgomery, 1912, p. 110. 13Montgomery, 1912, p. 110. 14Montgomery, 1912, p. 149. 15Montgomery, 1912, p. 247. 16Montgomery, 1912, p. 248. 17Montgomery, 1912, p. 263. 18Montgomery, 1916, p. viii. 19Montgomery, 1921, p. iii. 20Montgomery, 1921, p. iv. 21 Montgomery, 1921, p. 78. 22Montgomery, 1921, p. 68.

Myers: Spiraling Upward: Auditing Methods 71
23Montgomery, 1921, p. 78.
24Montgomery, 1921, p. 73, emphasis his.
25Montgomery, 1921, p. 162.
26Montgomery, 1921, p. 168.
27Montgomery, 1927, p. 115.
28Montgomery, 1927, p. 115.
29Montgomery, 1927, p. 153.
30Montgomery, 1927, p. 523.
31 Montgomery, 1927, p. 523.
32Montgomery, 1934, p. 281.
33Montgomery, 1934, p. iv.
34Dicksee, 1905, p. 166.
35Montgomery, 1934, p. 180.
36Montgomery, 1934, p. 161.
37Montgomery, 1934, p. 153.
38Montgomery, 1940, p. iii.
39Montgomery, 1940, p. 8.
40Montgomery, 1940, p. 134.
41Montgomery, Lenhart and Jennings, 1949, p. 39.
42Lenhart and Defliese, 1957, p. 560.
43Defliese, Johnson, MacLeod, p. 170.
44Defliese, Johnson, MacLeod, p. 173.

BIBLIOGRAPHY

Major Sources:

(arranged chronologically) Dicksee, Lawrence, Auditing, Authorized American Edition, Robert H. Montgomery,
editor, New York, 1905. Dicksee, Lawrence, Auditing, Authorized American Edition, Revised and Enlarged,
Robert H. Montgomery, editor, New York: Ronald Press Co., 1909. Montgomery, Robert H., Auditing Theory and Practice, New York: The Ronald Press
Company, 1912. Montgomery, Robert H., Auditing Theory and Practice, Second Edition, Revised
and Enlarged, New York: The Ronald Press Company, 1916. Montgomery, Robert H., Auditing Theory and Practice, Third Edition, Revised and
Enlarged, New York: The Ronald Press Company, 1921. Montgomery, Robert H., Auditing Theory and Practice, Fourth Edition, Revised and
Enlarged, New York: The Ronald Press Company, 1927. Montgomery, Robert H., Auditing Theory and Practice, Fifth Edition, New York:
The Ronald Press Company, 1934. Montgomery, Robert H., Auditing Theory and Practice, Sixth Edition, New York:
The Ronald Press Company, 1940. Montgomery, Robert H., Norman J. Lenhart, and Alvin R. Jennings, Montgomery’s
Auditing, Seventh Edition, 1949. Lenhart, Norman J., and Philip L. Defliese, Montgomery’s Auditing, Eighth Edition,
New York: The Ronald Press Company, 1957. Defliese, Philip L., Kenneth P. Johnson, and Roderick K. MacLeod, Montgomery’s
Auditing, Ninth Edition, New York: The Ronald Press Company, 1975. Minor Sources: American Institute of Accountants, Audits by Certified Public Accountants, New
York: American Institute of Accountants, 1950.
Brown, R. Gene, “Changing Audit Objectives and Techniques,” Accounting Review, October 1962, pp. 696-703.
Mautz, R. K. and Hussein A. Sharaf, The Philosophy of Auditing, American Accounting Association, 1961.
Peragallo, Edward, “Development of the Compound Entry in the 15th Century Ledger of Jachomo Badoer, A Venetian Merchant,” Accounting Review, January 1983, pp. 98-104.
Stone, Williard E., “1794 Middleton, Delaware—From Accounting Records,” The Accounting Historians Journal, Spring 1979, pp.