Why is an Understanding of the Company and Its Environment, and the Applicable Financial Reporting Framework required in independent audit of financial statements?

 

An understanding of the company and its environment, and the applicable financial reporting framework helps the auditor to understand the events and conditions that are relevant to the company. This is necessary to conduct an effective independent audit in accordance with a risk-based approach. This activity is aimed at collecting and analyzing information that allows identifying the client's business risks and assessing their impact on the financial statements.

Usually, an auditor performs risk assessment procedures to obtain an understanding of:

(a) The following aspects of the company and its environment:

· The company’s organizational structure, ownership and governance, and its business model, including the extent to which the business model integrates the use of IT.

· Industry, regulatory and other external factors.

· The measures used, internally and externally, to assess the company’s financial performance

(b) The applicable financial reporting framework, and the entity’s accounting policies and the reasons for any changes.

(c) The appropriateness and consistency of the company’s accounting policies with the applicable financial reporting framework.

The nature and extent of the required understanding is a matter of the auditor’s professional judgment and varies from company to company based on the nature and circumstances of the company, including:

● The size and complexity of the entity, including its IT environment.

● The auditor’s previous experience with the company.

● The nature of the entity’s systems and processes, including whether they are formalized or not; and

● The nature and form of the company’s documentation.


ISA 315

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