Question

Why must the auditor obtain an understanding of internal control?

please write a reasonable opinion. 15-20 sentences, may be more

Answer 1

First of all let's understand what we mean by an "internal control". Internal controls refers to the plan, policies & procedures that a company has in place to prevent, detect and correct fraud, error and potential misstatements. It is very important for an auditor to obtain a detailed understanding of the internal control to be able to design test of control procedures, ascertain the risk of material misstatement in each financial statement line item and decide on the level of substnative testing required with repect to a particular financial statement line item.

Audit standards in almost every country require an auditor to first obtain an understanding of the entity and environement which includes obtaining understanding of the internal controls, perform test of control procedures which includes testing both design and operating effectiveness of the internal controls in order to be able to identify whether the controls have been designed properly and whether they have been operating effectively throughout the year or not and then based on the reliance obtained from the test of control procedures, the auditor is required to set the level of substantive testing required to be obtain comfort over the transactions and account balances.

Hence internal controls form an important part of the audit plan. It is also to be noted that most regulatory authorities also require the auditor to provide an opinion on the internal financial controls including whether they have been designed properly and whether they have been operating effetively throughout the year. Hence understanding the internal controls is one of the initial exercises of audit which is highly important and must be performed properly.