Obtaining an understanding of the entity and its environment is an essential aspect of performing an audit in accordance with Nepal Standard on Auditing. In particular, that understanding establishes a frame of reference within which the auditor plans the audit and exercises professional judgment about assessing risks of material misstatement of the financial statements and responding to those risks throughout the audit, for example when:
Establishing materiality and evaluating whether the judgment about materiality remains appropriate as the audit progresses;
Considering the appropriateness of the selection and application of accounting policies, and the adequacy of financial statement disclosures;
Identifying areas where special audit consideration may be necessary, for example, related party transactions, the appropriateness of management‟s use of the going concern assumption, or considering the business purpose of transactions;
Developing expectations for use when performing analytical procedures;
Designing and performing further audit procedures to reduce audit risk to an acceptably low level; and
Evaluating the sufficiency and appropriateness of audit evidence obtained, such as the appropriateness of assumptions and of management‟s oral and written representations.
The auditor uses professional judgment to determine the extent of the understanding required of the entity and its environment, including its internal control. The auditor‟s primary consideration is whether the understanding that has been obtained is sufficient to assess the risks of material misstatement of the financial statements and to design and perform further audit procedures. The depth of the overall understanding that is required by the auditor in performing the audit is less than that possessed by management in managing the entity.