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UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT-3

UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT
AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT

 

d) Measurement and Review of the Entity’s Financial Performance


The auditor should obtain an understanding of the measurement and review of the entity’s financial
performance. Performance measures, internal and external, some times create pressures on the
entity and motivate management to misstate the financial statements.
Internally generated information may highlight entity’s position vis--vis, its competitors and
reports from credit rating agencies and analysts may provide information useful to the auditors
understanding of the entity and its environments.
Examples of matters an auditor may consider include the following:
Key ratios and operating statistics
Key performance indicators
Employee performance measures and incentive compensation policies.
Trends
Use of forecasts, budgets and variance analysis
Analyst reports and credit rating reports
Competitor analysis
Period –on-period financial performance (revenue growth, profitability leverage)

e) Internal Control


Understanding of Internal Control is used by the auditor to identify types of potential
misstatements and to consider factors that affect the risks of material misstatements and design the
nature, timing and extent of further audit procedures.

Definition of internal control


Internal controls is the process designed and effected by those charged with governance,
management, and other personnel to provide reasonable assurance about the achievement of the
entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of
operations and compliance with applicable laws and regulations. It follows that internal control is
designed and implemented to address identified business risks that threaten the achievement of any
of these objectives.

Components of internal control


(a) The control environment
(b) The entity’s risk assessment process
(c) The information system, including the related business processes relevant to financial
reporting and communication.
(d) Control activities
(e) Monitoring of controls

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