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Auditing and Assurance Standard (AAS) 20 Knowledge of the Business The following is the text of the Statement on Standard Auditing Practices (SAP) 20, "Knowledge of the Business", issued by the Council of the Institute of Chartered Accountants of India. This Statement should be read in conjunction with the "Preface to the Statements on Standard Auditing Practices", issued by the Institute. Introduction 1. The purpose of this Statement is to establish standards on what is knowledge of the business, why it is important to the auditor and to members of the audit staff working on an engagement, why it is relevant to all phases of an audit, and how the auditor obtains and uses that knowledge. 2.In performing an audit of financial statements, the auditor should have or obtain knowledge of the business sufficient to enable the auditor to identify and understand the events, transactions and practices that, in the auditor's judgment, may have a significant effect on the financial statements or on the examination or audit report. Such knowledge is used by the auditor in assessing inherent and control risks and in determining the nature, timing and extent of audit procedures. 3. The auditor's level of knowledge for an engagement would include a general knowledge of the economy and the industry within which the entity operates, and a more particular knowledge of how the entity operates. The level of knowledge required by the auditor would, however, ordinarily be less than that possessed by management. A list of matters to be considered in a specific engagement is set out in the Appendix. Obtaining the Knowledge 4. Prior to accepting an engagement, the auditor would obtain a preliminary knowledge of the industry and of the nature of ownership, management and operations of the entity to be audited, and would consider whether a level of knowledge of the business adequate to perform the audit can be obtained. 5. Following acceptance of the engagement, further and more detailed information would be obtained. To the extent practicable, the auditor would obtain the required knowledge at the start of the engagement. As the audit progresses, that information would be assessed and updated and more information would be obtained. Obtaining the required knowledge of the business is a continuous and cumulative process of gathering and assessing the information and relating the resulting knowledge to audit evidence and information at all stages of the audit. For example, although information is gathered at the planning stage, it is ordinarily refined and added to in later stages of the audit as the auditor and the members of his audit staff learn more about the business. 7. For continuing engagements, the auditor would update and re-evaluate information gathered previously, including information in the prior year's working papers. The auditor would also perform procedures designed to identify significant changes that have taken place since the last audit. 8. The auditor can obtain knowledge of the industry and the entity from a number of sources. For example:
Using the Knowledge 9. Knowledge of the business is a frame of reference within which the auditor exercises professional judgment. Understanding the business and using this information appropriately assists the auditor in:
10. The auditor makes judgments about many matters throughout the course of the audit where knowledge of the business is important. For example:
11. The auditor should ensure that the audit staff assigned to an audit engagement obtain sufficient knowledge of the business to enable them to carry out the audit work delegated to them. The auditor would also ensure that the audit staff understand the need to be alert for additional information and the need to share that information with the auditor and other audit staff. 12. To make effective use of knowledge about the business, the auditor should consider how it affects the financial statements taken as a whole and whether the assertions in the financial statements are consistent with the auditor's knowledge of the business. Effective Date 13. This Statement on Standard Auditing Practices becomes operative for all audits commencing on or after 1st April, 2000. APPENDIX Knowledge of the Business - Matters to Consider This list covers a broad range of matters applicable to many engagements; however, not all matters will be relevant to every engagement and the listing is only illustrative. A. General economic factors General level of economic activity (for example, recession, growth)
B. The industry - important conditions affecting the client's business
C The entity 1. Management and ownership - important characteristics
2. The entity's business - products, markets, suppliers, expenses, operations.
3. Financial performance - factors concerning the entity's financial condition and profitability
4. Reporting environment - external influences which affect management in the preparation of the financial statements 5. Legislation
With the formation of the Auditing Practices Committee in 1982, the Council of the Institute has been issuing a series of Statements on Standard Auditing Practices (SAPs). Statements on Standard Auditing Practices lay down the principles governing an audit. These principles apply whenever an independent audit is carried out. Statements on Standard Auditing Practices become mandatory on the dates specified in the respective SAPs. Their mandatory status implies that, while discharging their attest function, it will be the duty of the members of the Institute to ensure that the SAPs are followed in the audit of financial information covered by their audit reports. If, for any reason, a member has not been able to perform an sudit in accordance with the SAPs, his report should draw attention to the material departures therefrom.
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