S3: Understanding the Business

Session objective To explain why understanding of the business of the entity is important for the auditor To explain why understanding of the business of the entity is important for the auditor To outline the steps involved in understanding the entity to be audited To outline the steps involved in understanding the entity to be audited

Process of understanding the business of the entity Understanding of accounting system Understanding of accounting system Assessing the control environment especially internal controls Assessing the control environment especially internal controls Assessing risk Assessing risk Determining Materiality level Determining Materiality level Designing audit procedures Designing audit procedures Understanding substance of transactions Understanding substance of transactions Identifying the nature and source of audit evidence Identifying the nature and source of audit evidence Evaluating financial statements keeping in mind the interest of stakeholders Evaluating financial statements keeping in mind the interest of stakeholders

Why understand the business? Auditors should have/obtain a knowledge of the business of the entity to be audited Auditors should have/obtain a knowledge of the business of the entity to be audited which is sufficient to enable them to identify and understand the events, transactions and practices which is sufficient to enable them to identify and understand the events, transactions and practices that may have a significant effect on the financial statements or the audit thereof that may have a significant effect on the financial statements or the audit thereof Such knowledge of the business of the auditee should be obtained so as to be sufficient to enable the auditor to carry out the audit work effectively Such knowledge of the business of the auditee should be obtained so as to be sufficient to enable the auditor to carry out the audit work effectively

Why understand the business? (contd.) Understanding the business helps us to design an approach that is Understanding the business helps us to design an approach that is Effective Effective Efficient Efficient Adds value Adds value Develops the team Develops the team Without a very good understanding of the business audit will not be able to satisfy the above mentioned criteria. Without a very good understanding of the business audit will not be able to satisfy the above mentioned criteria. It is a key component also for maximising the impact of our audit. It is a key component also for maximising the impact of our audit.

Why understand the business? (contd.) The business activity and regularity framework drive the financial statements. The business activity and regularity framework drive the financial statements. We should form an expectation of what the financial statements contain based on our understanding of these. We should form an expectation of what the financial statements contain based on our understanding of these.

External factors Authorising Legislation Authorising Legislation Regulations issued under Authorising Legislation Regulations issued under Authorising Legislation Parliamentary Authority Parliamentary Authority Political Environment Political Environment Business Environment Business Environment Financial and Performance Reporting requirements Financial and Performance Reporting requirements Future Events Future Events Other Factors Other Factors

Internal factors These are factors that look inside the business. e.g. These are factors that look inside the business. e.g. Corporate Plans Corporate Plans Business Plans Business Plans Management Reports Management Reports Board Minutes Board Minutes The structure of the organisation, and The structure of the organisation, and Audit committees Audit committees

Overall control environment The effectiveness of the top management of the auditee organisation The effectiveness of the top management of the auditee organisation The effectiveness of the finance wing of the auditee organisation The effectiveness of the finance wing of the auditee organisation Organisational structure, roles and responsibilities – the efficacy of the organisational structure, in terms of flow of information, staff training and supervision etc Organisational structure, roles and responsibilities – the efficacy of the organisational structure, in terms of flow of information, staff training and supervision etc

Overall control environment Human resources policies and procedures – the effectiveness of the HR policies and procedures, in terms of ensuring appropriate recruitment, induction, training, management, retention and promotion Human resources policies and procedures – the effectiveness of the HR policies and procedures, in terms of ensuring appropriate recruitment, induction, training, management, retention and promotion Management’s risk assessment process – the effectiveness of risk identification, promulgation, management, ownership, monitoring and reporting Management’s risk assessment process – the effectiveness of risk identification, promulgation, management, ownership, monitoring and reporting Reliability of overall financial reporting and budgetary control Reliability of overall financial reporting and budgetary control

Overall control environment Effectiveness of the Audit Committee – the effectiveness of the audit committee in terms of ensuring appropriate challenge of and support to the Accounting Officer Effectiveness of the Audit Committee – the effectiveness of the audit committee in terms of ensuring appropriate challenge of and support to the Accounting Officer Effectiveness of Internal Audit – the effectiveness of internal audit in terms of providing adequate levels of appropriate internal audit provision, and of reporting back Effectiveness of Internal Audit – the effectiveness of internal audit in terms of providing adequate levels of appropriate internal audit provision, and of reporting back