Understanding the entity and its environment and assessing the risks of material misstatement

This chapter provides guidance for the auditor to identify and assess the risks of material misstatements. The auditor does this by achieving an understanding the entity and its environment, including internal control. AU-C 315 describes how the auditor should identify and assess the risk of material misstatement, which, in turn, provides a basis for designing further audit procedures. These further audit procedures (which consist of tests of controls and substantive tests) must be clearly linked and responsive to assessed risks. AU-C 315 also includes the concept of significant risks, which are risks that require special audit consideration.AU-C 330 provides guidance on the design and performance of further audit procedures. In all audits, the auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or to fraud, and to design the nature, timing, and extent of further audit procedures. The auditor should perform risk assessment procedures to provide a basis for the identification and assessment of material misstatement at the financial statement and relevant assertion level.The auditor's risk assessment procedures provide the audit evidence necessary to support the auditor's risk assessments, which in turn support the determination of the nature, timing, and extent of further audit procedures. Thus, the results of the auditor's risk assessment procedures are an integral part of the audit evidence obtained to support the opinion on the financial statements.