Why is it important for the auditor to obtain an understanding of the clients industry?
In an audit it is important for an auditor to acquire sufficient knowledge about the client's business this will not only help him/her express an opinion as to the truth and fairness of assertions in the financial statements but also help him/her safeguard against any form of pitfalls or being misled. This article is an attempt to briefly highlight those points which auditors keep in mind and adopt in practice. The following points/matters about which the auditor is to be knowledgeable: 1. About ownership, organisation & capital structure. 2. Management objectives, strategy and philosophy, Management Information System (MIS). 3. Internal control environment 4. Products, markets, suppliers and business operations. 5. Inventories (location, quantity and costing) 6. Financial performance, trends & past financial reports/statements. 7. Regulatory environment and requirements Sources for Obtaining Knowledge: * Previous experience with the industry. * Discussion with the people in the organization. *Discussion with past/other auditors and professionals. * Industry profile and publications * Entity-industry visits. *Promotion literature, case studies, budgets, office manual, survey reports etc. The knowledge of the business is a frame of reference within which the auditor exercises his/her professional judgement. The auditor benefits if he/she could use the information with him/her in: 1. Assessing risks and problems. 2. Audit planning and performance. 3. Audit evidences evaluation. 4. Client service. Auditors knowledge of the client's business would help him/her in the following areas: * Developing and formulating audit plan and programme. * Assessing audit evidences. * Identifying special audit areas where attention is required. * Assessing inherent and control risks in the entity. * Identifying related party transactions. * Evaluating accounting and management representation. * Considering the fraud risk factors. The auditor should draft a plan to obtain right and sufficient knowledge of the business and the same should be communicated to his/her audit staff. Any additional or new information should be carefully assessed and the audit staff should take note of it. The knowledge of the business should form the back drop of auditor's judgement. Thank you readers. Ashish Sharma. Tags Audit One of the principles underlying auditing standards notes that the auditor obtains an understanding of the entity and its environment to provide a basis for identifying and assessing the risks of material misstatements in the financial statements. Auditors need an understanding of the client's business and industry because the nature of the business and industry affect business risk and the risk of material misstatements in the financial
statements. Auditors use the knowledge of these risks to determine the appropriate extent of further audit procedures. 1. Industry and External Environment - Read industry trade publications, AICPA Industry Audit Guides, and regulatory requirements. During the course of the plant tour, the CPA will obtain a perspective of the client's business, which will contribute to the auditor's understanding of the entity and its environment.
Remember that an important aspect of the audit will be an effective analysis of the inventory cost system. Therefore, the auditor will observe the nature of the company's products, the manufacturing facilities and processes, and the flow of materials so that the information obtained can later be related to the functions of the cost system. The three categories of client objectives are (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with laws and regulations. Each of these objectives affects the auditor's assessment of inherent risk and evidence accumulation as follows: 1. Reliability of financial reporting - The financial reporting framework selected by management may affect the reliability of financial reporting. For example, management's selection of the cash basis of accounting may affect the risks of material misstatement differently than the risks of material misstatement that might be present if management selects U.S. GAAP or IFRS as the framework for financial reporting. Furthermore, recent changes in those standards by the standards-setting bodies may impact the complexity of the underlying accounting for transactions, accounts, and disclosures, which increases inherent
risks. If management sees the reliability of financial reporting as an important objective, and if the auditor can determine that the financial reporting system is accurate and reliable, then the auditor can often reduce his or her assessment of inherent risk and planned evidence accumulation for material accounts. In contrast, if management has little regard for the reliability of management's financial reporting, the auditor must increase inherent risk assessments and gather more appropriate
evidence during the audit. |