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Why is Business Understanding Important for the Auditor?

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For decades, the auditor’s understanding of a business and its environment has provided the basis for risk assessment and the design of auditing procedures that respond to identified risks. Conducting an efficient audit requires knowledge of how a client’s business operates and understanding the environment in which it competes. The international standards on auditing are more detailed and demand that an auditor be aware of the company’s goals and strategy. They must also be aware of any associated business risks that could be anticipated to increase the chances of significant misstatement. It is crucial to note that the process of identifying risks should begin with gaining knowledge of the nature, characteristics, dynamics, ad environment of the. The risk assessment of the potential effect should come next. The risks include misstatement on the financial statements, as opposed to going in the opposite direction and starting to assess risk by reading the financial statements. This could result in missing relevant and pervasive risks relating to the entity’s industry or its specific circumstances. If the auditor thoroughly understands the client’s business, many issues can be avoided. We frequently come across audit engagements where the auditor does not complete the proper procedures or overlooks audit procedures relating to a particular transaction because the auditor does not have a thorough grasp of the business. When this happens, it’s frequently because the team thought every transaction in an account would go through the same procedure. Don’t carry over old planning work documents from the previous year; instead, take a fresh look at the business side of the organization you are inspecting this year. To re-verify the client, it should include:

  • Business model
  • Products and services
  • Customer base
  • Competitors, and
  • Industry,
  • Control Environment Understanding

The auditor should gain knowledge about the client’s system of internal controls when the engagement team has gained a thorough understanding of the client’s operations. Fundamentally, this obligation is not changing because of new standards; it is still a part of conventional audit procedures. However, the new guidelines give clear instructions on how to go about getting this understanding. Consider including documentation of the following areas this year for the following benefits.

Benefits of auditing to the business

  • Organizational Control Environment: Understand what processes are in place within the organization beyond the work performed by the engagement team for external audits. What are the ongoing tasks, activities, and processes in place at the company that support achieving financial reporting objectives?
  • Corporate Risk Assessment Process: How does your company develop its risk assessment? Compare this audit’s risk assessment to your risk assessment. Supporting the request helps clarify the engagement team’s understanding of the organization’s risk assessment process.
  • Company process for monitoring internal control system: Consider what the company does to ensure that financial reporting is controlled in the absence of external assurance.
  • Enables the Pursuit of Business Objectives: An effective audit structure helps a business pursue and attain its various corporate objectives. Multiple forms of internal control are required in the business for regulating, monitoring, and detecting regular, irregular transactions.
  • Understanding of information systems and communication:The surveyed companies are modernizing their strategies and investing in technology improvements to stay competitive. Audits must be adapted to provide investors relevant information and maintain market confidence.

Tips for Auditors to understand Business Process

  • At the beginning of planning, take time to review the company’s business model.
  • Use data analytics to understand business transactions better.
  • Create flowcharts that you can use to reconcile business transactions with annual financial statements. This allows the entire audit team to understand better how transactions are reflected in the financial statements.
  • Make sure the industry, technology challenges, and business align with the expertise of your engagement team.
  • Don’t think information arrives magically in financial accounts; instead, ask straightforward questions and maintain your curiosity.

All of these aspects of understanding an assurance client require teams to take the time to revisit their understanding of the entity being audited. Consider talking to people at work you don’t see regularly. Discover new company documents and information and keep up with the latest developments in the industry.

Written by –  Luv Jain

At MAS, we assist our clients in dealing with internal audits; government audits of various corporate matters (company incorporation), statutory audits, ROC compliance, and company winding-up) in India by providing them adequate support and guidance from our end. If you have any questions or wish to know more about Why is Business Understanding Important for the Auditor, kindly contact us.


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