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Just What is Conversational Auditing?
Conversational auditing happens when an auditor accepts a verbal comment (usually made by the client) as audit evidence. This can happen directly (e.g., in a formal interview) or indirectly (the auditor overhears two employees talking in an adjacent cubicle).

Is this evidence good or bad? It depends. Sometimes the best evidence is gathered from conversations. Scuttlebutt heard at a water cooler. Or the "straight scoop" shared by a lower level employee.

One thing is for sure. For years, good auditors have uncovered issues, adjustments, and problems by listening to verbal comments made by clients. Oh sure, confirmations and vouching are important, but listening can be even more effective. This is why "inquiry" is an acceptable audit procedure recognized in our professional standards.

So then what is the big debate about? Well, auditors are sometimes too quick to rely on client representations. In other words, it is critical that an auditor evaluates conversations with professional skepticism. You see, all conversations are not created equal. Some verbal representations are valuable gems, but others are worthless, or even incorrect. As a result, a smart auditor does not blindly rely on conversations for evidence.

This article provides guidance on when to rely on verbal evidence. Always begin by asking yourself the following two questions.

Question One: Does the client know what he or she is talking about?
Some clients love to talk. They are eager to offer opinions on a wide range of topics. Unfortunately, they do not always know what they are talking about.

While some clients are reluctant to talk with auditors, other folks are quite willing to share information, even when they may be inadvertently supplying incorrect information.

Why would a client speak without being absolutely sure of the facts?

• Talking is more fun than actually doing work.
• The client has an inflated sense of importance (e.g., the mid-level manager who thinks he should be running the company).
• The client does not know all the facts.

On this last example, a low-level clerk might confidently mention that nobody checks the accuracy of reconciliations performed in the accounting department. In reality however, the supervisors may examine the recs on a spot basis (without the knowledge of the clerk).

Also, remember that even an intelligent client may not be informed about everything that is happening in the company.

Question Two: Does the person have any reason to manipulate the truth?
Let us assume that a client is knowledgeable about a particular topic. Do not shut off your professional skepticism yet! You must also answer Question Two.

Sadly, some clients mislead and even lie to auditors. Why? To cover up a fraud. Or, perhaps more common, a slight alteration of the truth can make the person look better. Or save the individual from needing to perform additional work for the auditors.

For example, suppose an auditor asked the client, "Do you regularly review inventory for obsolete items?" and "Do you take this review seriously?"

How many times is a client going to answer "no?" Hardly ever! First of all, the client knows that a "no" answer may lead to a management letter comment. By asking vague questions, the auditor has made it quite tempting to shade the truth without lying. After all, "regularly" and "seriously" are works that can be interpreted differently.

Better questions might be "How often do you review inventory for obsolete items?" and "How detailed is this review?" Follow-up questions should then arise from the client's answers to make sure misunderstandings don't exist.

How Much Reliance Can be Placed?
We now know that some verbal comments are more reliable than others. In general, rely more heavily on comments from knowledgeable individuals who are telling the truth rather than uninformed liars!

In any scenario, always consider whether it is appropriate to corroborate a client's verbal comment. Ask somebody else the same question. Examine supporting documents to verify the representation.

Pretend that you confirmed accounts receivable at an interim date. At year-end, you analyze gross profit margins as part of your rollforward procedures. The controller explains that the healthy increase in margins is due to price increases in the fourth quarter.

Should you accept this explanation or dig further? It depends on how much evidence you need.

How much do you need? For starters, it depends on materiality, internal controls, and risk. For example, if you have adequately tested controls in the sales cycle (reducing control risk to "low"), you might feel comfortable with the controller's explanation, especially if he is honest and knowledgeable. In a different situation, you might want more evidence to obtain the "warm, fuzzy feeling" about the balances.

Also, do not forget about other procedures that you have conducted. For example, suppose that you did not test controls, but you did vouch a sample of fourth quarter shipments and performed extensive cut-off testing. Again, you may be satisfied with the controller's explanation.

Alternatively, let us say this analysis is your main enchilada. Plus, the controller earns an incentive bonus based on net income. Then it probably makes sense to dig deeper, right? Perhaps verify these price increases with somebody in marketing, or corporate sales agreements before and after the alleged price increases.

Good friends, there is no "cookbook" answer concerning how much reliance can be placed on verbal comments. You must use professional judgment while considering factors such as risk, materiality, internal controls, and other testwork performed. This may be difficult for less experienced auditors, so it is crucial that your audits are adequately planned, supervised, and reviewed. If done properly, efficiency and quality should improve.