ISA-310 Obtaining background knowledge about the client and industry
Prior to accepting the appointment, the auditor should obtain preliminary knowledge of the entity and its environment.
After accepting the appointment, the auditor should gather more detailed information about the entity; the industry and the economy sufficient to enable him identify and understand events and circumstances that significantly affect the financial statement and the audit report.
Gathering the required knowledge about the entity is a continuous and a cumulative process throughout the audit.
Nature of background knowledge that the auditor should obtain
a) Entity its business
1) Ownership of the entity.
2) Nature of the entity.
3) Management of the company.
4) Frequency of the Board meetings.
5) Organizational structure, capital structure etc.
6) Nature of the business i.e. manufactures importers etc.
7) Location of the production facilities, warehouses and offices.
8) The products and services of the firm.
9) Manufacturing processes.
10) Key financial personnel and their status.
11) Important supplies of goods and services.
12) Financial performance of the entity in the past.
b) Industry
1) Market and competition
2) Seasonal activities it the industry.
3) Changes in product technology.
4) Adverse conditions in the industry such as declining demand.
5) Specific accounting problems and practices in the industry.
6) Specific regulations and legislations in the industry.
c) General economic conditions
1) Interest rates and availability of financing.
2) Inflation levels.
3) Taxation levels.
4) Foreign exchange rates.
5) Monetary and fiscal policies.
6) Trade restrictions etc.
d) Laws and legislations affecting the entity
1) Regulatory environment and requirements.
2) Important laws and legislations affecting the firm.
3) Audit reporting requirements.
Sources of Background knowledge
1) Previous experience with the entity or industry.
2) Discussion with the people in the entity such as directors and other senior personnel.
3) Discussion with the internal audit personnel and review of the internal audit reports.
4) Discussion with other auditors with legal and other advisors who have provided services to the entity or within the industry.
5) Discussion with knowledgeable people outside the entity such as economists, suppliers, customers etc.
6) Reading publications related to the industry such as government statistics, trade journals, financial newspapers etc.
7) A physical visit to the entities premises and plant facilities.
8) Reading documents produced by the entity such as minutes, materials sent to shareholders, marketing plans, promotional literature, prior year’s annual reports etc.
Use of the background knowledge to the auditor
1) Planning and performing the audit efficiently and effectively.
2) It helps the auditor to provide a better audit service to the client.
3) It helps the auditor in assessing risks and identifying problems.
4) It helps the auditor to determine the materiality levels.
5) It helps the auditor in evaluating audit evidence.
6) It helps the auditor in identifying related parties and related party transactions.
7) It helps the auditor to recognize conflicting information.
8) It helps the auditor to recognize unusual circumstances such as fraud and non-compliance with the laws.
9) It helps the auditor to make informed enquiries and to assess the reasonableness of the answers.
10) It helps the auditor in assessing the appropriateness of the accounting policies used and the financial statements disclosures.