1.1 - Understanding the Entity

Question 1

Why do auditors need an understanding of the nature of the business and of the context in which it operates?

Answer 1

In order to be able to identify problem areas which might cause difficulties in collecting evidence or drawing assurance conclusions

Question 1

What are the three reasons as to WHY we obtain an understanding of the entity and its environment?

Answer 1

• to identify and assess the risk of material misstatements in the financial statements
• to enable the auditor to design and perform further audit procedures
• to provide a frame or reference for exercising audit judgement e.g when setting audit materiality

Question 2

WHAT are the first 2 things we obtain by understanding the entity and its environment?

Answer 2

• industry, regulatory and other external factors, including the reporting framework
• nature of the entity, including selection and application of accounting policies

Question 3

WHAT are the other 3 things we obtain by understanding the entity and its environment?

Answer 3

• objectives and strategies and relating business risks that might cause material misstatement in the financial statements
• measurement and review of the entity’s financial performance
• internal control

Question 4

What are the first 3 ways as to how we obtain an understanding of the entity and its environment?

Answer 4

• inquiries of management and others within the entity
• analytical procedures
• observation and inspection

Question 5

What are the final 2 ways as to how we obtain an understanding of the entity and its environment?

Answer 5

• prior period knowledge
• discussion of the susceptibility of the financial statements to material misstatement among the engagement team