Question

1. What is the primary objective of obtaining an understanding of the company's objectives, strategies, and related business risks in a financial statement audit?

a. Determine whether sufficient objectives have been created.

b. Identify suggestions for addressing the risks.

c. Provide a basis for issuing an opinion the financial statements.

d. Identify risks that may result in material misstatement of financial statements.

Answer 1

The objective of the auditor is to identify and appropriately assess the risks of material misstatement, thereby providing a basis for designing and implementing responses to the risks of material misstatement.

The auditor should obtain an understanding of the company and its environment ("understanding of the company") to understand the events, conditions, and company activities that might reasonably be expected to have a significant effect on the risks of material misstatement. Obtaining an understanding of the company includes understanding:

1. Relevant industry, regulatory, and other external factors;
2. The nature of the company;
3. The company's selection and application of accounting principles, including related disclosures;
4. The company's objectives and strategies and those related business risks that might reasonably be expected to result in risks of material misstatement; and
5. The company's measurement and analysis of its financial performance.

In obtaining an understanding of the company, the auditor should evaluate whether significant changes in the company from prior periods, including changes in its internal control over financial reporting, affect the risks of material misstatement.

Company Objectives, Strategies, and Related Business Risks

The purpose of obtaining an understanding of the company's objectives, strategies, and related business risks is to identify business risks that could reasonably be expected to result in material misstatement of the financial statements.

Note: Some relevant business risks might be identified through other risk assessment procedures, such as obtaining an understanding of the nature of the company and understanding industry, regulatory, and other external factors.

  

• Industry developments (a potential related business risk might be, e.g., that the company does not have the personnel or expertise to deal with the changes in the industry.)
• New products and services (a potential related business risk might be, e.g., that the new product or service will not be successful.)
• Use of information technology ("IT") (a potential related business risk might be, e.g., that systems and processes are incompatible.)
• New accounting requirements (a potential related business risk might be, e.g., incomplete or improper implementation of a new accounting requirement.)
• Expansion of the business (a potential related business risk might be, e.g., that the demand for the company's products or services has not been accurately estimated.)
• The effects of implementing a strategy, particularly any effects that will lead to new accounting requirements (a potential related business risk might be, e.g., incomplete or improper implementation of the strategy.)
• Current and prospective financing requirements (a potential related business risk might be, e.g., the loss of financing due to the company's inability to meet financing requirements.)
• Regulatory requirements (a potential related business risk might be, e.g., that there is increased legal exposure.)

  Note: Business risks could affect risks of material misstatement at the financial statement level, which would affect many accounts and disclosures in the financial statements. For example, a company's loss of financing or declining conditions affecting the company's industry could affect its ability to settle its obligations when due. This, in turn, could affect the risks of material misstatement related to, e.g., the classification of long-term liabilities or valuation of long-term assets, or it could result in substantial doubt about the company's ability to continue as a going concern. Other business risks could affect the risks of material misstatement for particular accounts, disclosures, or assertions. For example, an unsuccessful new product or service or failed business expansion might affect the risks of material misstatement related to the valuation of inventory and other related assets.