Understanding the Firm's Environment

One of the considerations in audit planning is obtaining a knowledge of the client’s business. An auditor obtains knowledge about a new client’s business and its industry to

• Make constructive suggestions concerning improvements to the client’s internal control.

• Develop an attitude of professional skepticism concerning management’s financial statement assertions.

• Evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated.

• Understand the events and transactions that may have an effect on the client’s financial statements.

When the continuing auditor intends to use information about the entity and its environment obtained in prior periods, the auditor should

• Seek permission with the client in using the prior period information obtained by the auditor.

• Determine whether to equitably reduce the audit fee due to lower audit effort expended during the engagement.

• Determine whether changes have occurred that may affect the relevance of such information in the current audit.

• Assess control risk as “high” for the assertions affected by the prior-period information.

Which of the following mattes is not included under “regulatory environment”?

• Accounting principles and industry specific practices.

• Legislation and regulation that significantly affect the entity’s operations.

• Government policies currently affecting the conduct of the entity’s business

• General level of economic activity (for example, recession, growth)

These are the operational approaches by which management intends to achieve its objectives

• Strategies

• Planning methods

• Business risk approaches

• Operational plans

S1 Business risk is broader in scope than the risk of material misstatement

S2 Most business risks have financial consequences and they may have an effect on the financial statements of an entity.

• True, False

• False, True

• True, True

• False, False

Examples of matters an auditor may consider under measurement and review of the entity’s financial performance include the following (select the exception)

• Key ratios and operating statistics

• Use of information technology

• Competitor analysis

• Employee performance measures and incentive compensation policies

Which of the following is most correct concerning the understanding of internal control needed by auditors to plan the audit?

• The auditors must understand the control environment, but not the accounting system or the control procedures

• The auditors must understand the control environment, the accounting system and not the control procedures.

• The auditors must understand the control environment, the accounting system and must use judgment as to the control procedures which must be considered.

• The auditor must understand the control environment, the accounting system, and all control procedures

The auditor should obtain an understanding of the entity and its environment, including its internal control, sufficient to identify and assess the risk of material misstatement of the F/S, due to:

• Fraud

• Error

• Fraud and error

• None of these

The following statements relate to business risk. Select the incorrect statement:

• Business risk is narrower in scope than the risk of material misstatement

• Most Business risks have financial consequences, though they may have an effect on the F/S on an entity.

• Usually, management identifies business risks and develops approaches to address them.

• Smaller entities often do not set their objectives, strategies, or manage the related business risks, through formal plans or processes.

In an audit of F/S, an auditor’s primary consideration regarding a control is whether it:

• Enhances management’s decision-making processes

• Reflects management’s philosophy and operating style

• Affects management’s F/S assertions

• Provides adequate safeguards over access to assets.