Question

Professional auditing standards provide guidance on the auditor's consideration of an entity's business risks. What is the auditor's objective for understanding an entity's business risks? Why does an auditor not have responsibility to identify or assess all business risks? Provide some examples of business risks associated with an entity that an auditor should consider when performing an audit.

Answer 1

Auditor's objectives for understanding entity's business risk are to assess the risk of material mismanagement through nature of the entity, its environment including internal controls and analysis of organization's financial soundness by interpreting entity financial statements, taking necessary actions, feedback & measures to implement appropriate responses. Few objectives of understanding business risk are mentioned in the below table from the viewpoint of the auditors.

Assessment of entity's finance performance by checking all relevant records and documents of transactions.

Gathering various sources of information regarding business activities and operations including internal controls & policies

To facilitate in better communication between the entity's management and all stakeholders of the entity

In order to assess several internal and external factors which can impact entity financial performance

Evaluating several business strategies to mitigate business risks from material mismanagement

Reviewing entity policies and procedure to tackle to the organizational change and taking measures to adapt to changes due to restructuring

Only certain business risks results in the risk of material mismanagement whether due to error or fraud.due to this reason auditors have responsibility to assess and review only those business risks that involves material mismanagement risks at the financial statement and assertion levels. Therefore auditors are not responsible for identification and assessment of all the business risks.

Examples of entity's business risks that are considered by auditors while performing an audit are mentioned below.

Organization who are expanding their business operations in new location/ geographical areas to reach more customers

2. Organization who are launching new products & services or doing modification in the product category or line of business

3. Material Mismanagement risks will arise if there are changes in the Industry/ Sector which the business firm operates or make changes in their distribution channels / supply chains

4. If the entity is operating in the economically unstable regions then material mismanagement risks increases due to highly inflationary economies of such region or there is significant changes in the value of its currency.