FUNDAMENTALS OF AUDITING ACC 311 Lec 14
Lesson 14
UNDERSTANDING THE ENTITY
AND ITS ENVIRONMENT
AND ASSESSING THE RISKS
OF MATERIAL MISSTATEMENT
Risk
assessment
procedures
Understanding
consists of:
Inquiries
Analytical procedures
Observation &
Inspection
External Factors
Nature of entity
Objectives and
strategies and the related business risks
Assessing the risk of
material
misstatement
Communication
Documentation
Measurement & review
of financial performance
Internal Control
d) Measurement and
Review of the Entity’s Financial Performance
The auditor should
obtain an understanding of the measurement and review of the entity’s financial
performance. Performance
measures, internal and external, some times create pressures on the
entity and motivate
management to misstate the financial statements.
Internally generated
information may highlight entity’s position vis-à-vis, its competitors and
reports from credit
rating agencies and analysts may provide information useful to the auditors
understanding of the
entity and its environments.
Examples of
matters an auditor may consider include the following:
• Key ratios and
operating statistics
• Key performance
indicators
• Employee performance
measures and incentive compensation policies.
• Trends
• Use of forecasts,
budgets and variance analysis
• Analyst reports and
credit rating reports
• Competitor
analysis
• Period –on-period
financial performance (revenue growth, profitability leverage)
e) Internal Control
Understanding of
Internal Control is used by the auditor to identify types of potential
misstatements and to
consider factors that affect the risks of material misstatements and design the
nature, timing and
extent of further audit procedures.
50
Definition of
internal control
Internal controls is the
process designed and effected by those charged with governance,
management, and other
personnel to provide reasonable assurance about the achievement of the
entity’s objectives with
regard to reliability of financial reporting, effectiveness and efficiency of
operations and
compliance with applicable laws and regulations. It follows that internal
control is
designed and implemented
to address identified business risks that threaten the achievement of any
of these
objectives.
Components of
internal control
(a) The control
environment
(b) The entity’s risk
assessment process
(c) The information
system, including the related business processes relevant to financial
reporting and
communication.
(d) Control activities
(e) Monitoring of
controls
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