iTunes does in fact download the complete update package but does not wipe the device clean. It will replace files and parts of the OS with updated versions while retaining the non updated or modified files, and all user data.
The only time iTunes wipes the device, is when you restore the device to factory condition. It will then remove everything from the device, and install a clean OS version.
If done directly on the device(without itunes), it will remove the relevant updated files and sections of the OS, and replaces them with the updated versions.
It does not as suggested "lay" the update on top of the old OS. It modifies the existing OS with the new and updated files from the update. As such it may use a bit more storage space, if the new parts are a bit bigger than the old one, but generally it takes over the space used by old files.
With that said, I do not believe Apple has any documentation regarding the exact operation of iOS updates. But it is the general operation of updates on any platform.