Background Information about the Client

Background Information about the Client

Prior to acceptance of an engagement, the auditors should obtain a preliminary knowledge of the industry and ownership, management and operations of the prospective client, sufficient to enable them consider their ability and willingness to undertake the audit.

Following acceptance of an engagement, the auditors should obtain more detailed knowledge and information sufficient to enable them plan the audit, develop effective audit approach and understand the events and practices that have significant effect on the financial statement or their audit work.




What should be known about the client company include:

• general economic factors and industry conditions affecting the entity’s business
• important characteristics of the entity, its business, its financial performance, and its reporting requirements; including changes since the date of the last audit exercise
• the general level of competence of management and recent management changes
• the accounting policies adopted by the entity and changes in those policies
• the effect of new legislation, accounting or auditing pronouncements
• the regulatory framework, if any
• the auditors‟ cumulative knowledge of the accounting and internal control systems and any expected changes.

In succeeding periods, the auditors should consider the information gathered previously and should perform procedures designed to identify significant changes that have taken place since the last audit.

Sources of Knowledge

Auditor should obtain an understanding of the supply chain information system, including the related business processes, relevant to procurement reporting. In performing an audit on procurement records, the auditor should have or obtain knowledge of client’s business sufficient to enable him identify and understand events, transactions and practices that in the auditor’s judgment may have significant effect on the procurement records or the audit report. Prior to accepting an engagement, the auditor should obtain a preliminary knowledge of the industry and of ownership, management and operations of the entity to be audited. After accepting to act as the company’s auditor, further and more detailed information would be obtained. Obtaining the required knowledge of the business is a continuous and cumulative process. The following may be used as sources for that information. The auditors can obtain knowledge of the industry and the entity from a number of sources, for example

• previous experience with the entity and of its industry
• discussion with people within the entity (for example the junior and senior managers)
• discussion with internal audit personnel and review of internal audit reports
• discussion with auditors (including predecessor auditors) and with legal and other advisors who have provided services for the entity or within the industry
• discussion with knowledgeable people outside the entity, (for example industry economists, industry regulators, customers, suppliers, competitors)
• publications related to the industry (from government, banks and regulators, financial newspapers)
• legislations and regulations that significantly affect the entity
• visits to the entity’s premises and plant facilities
• internal documents produced by the entity (for example minutes of meetings, materials sent to shareholders, promotional literature, prior- years’ annual and financial reports, budgets, management reports, interim financial reports, management policies, accounts, job descriptions, marketing and sales plans
• Industry-specific guidance.

Using the Knowledge

Understanding the business and using this information appropriately assist the auditors in;

• Assessing risks and identifying problems
• Planning and performing the audit effectively and efficiently
• Evaluation audit evidence
• The auditors make judgements about many matters throughout the course of the audit where knowledge of the business is important, for example:
• Assessing inherent and control risks
• Considering business risks and management’s response thereto
• Developing the overall audit plan and the audit programme
• Determining a materiality level and assessing whether the materiality level chosen remains appropriate
• Assessing audit evidence to establish its appropriateness and the validity of the related financial statement assertions
• Evaluating accounting estimates and management representations
• Identifying areas where special audit considerations and skill may be necessary
• Identifying related parties and related party transactions
• Recognizing conflicting    information     (for     example     contradictory representations)
• Making informed inquiries and assessing the reasonableness of answers
• Considering the appropriateness of accounting policies and financial statement disclosure

The audit engagement partner should ensure that assistants assigned to an audit engagement obtain sufficient knowledge of the business of the entity being audited to enable them to carry out audit work delegated to them. Such knowledge may be passed to assistants initially by means of the audit planning memorandum or an audit-briefing meeting and subsequently during the course of the audit. In addition, the audit engagement partner must ensure that audit assistants understand the need to be aware of and to share additional information.

Factors to consider in relation to knowledge of the client’s business

The following matters are to be considered in relation to knowledge of the client’s business.

a) General Economic Factors

• General level of economic activity (for example growth, recession )
• Interest rate and availability of financing
• Inflation
• Government’s monetary, fiscal, taxation and trade restriction policies
• Foreign currency rates and control

b) The Industrial Conditions Affecting the Clients’ Business

• The market and competition
• Cyclical and seasonal activity
• Changes in product technology
• Business risk (for example high technology, high fashion, ease of entry for competition)
• Declining or expanding operations
• Adverse conditions (for example declining demand, excess capacity, serious price competition)
• Key ratios and operating statistics
• Specific accounting practices and problems
• Environmental requirements and problems
• Regulatory framework
• Energy supply and cost
• Specific or unique practices (for example reacting to labour contracts, financing methods, accounting methods)
• Management and Ownership of the Entity
• Corporate structure – private, public, government
• Beneficial owners and related parties (local, foreign, business reputation and experience)
• The relationship between owners, directors and management
• Capital structure (including any recent or planned changes)
• Organization structure
• Management objectives, philosophy and strategic plans
• Acquisitions, mergers or disposals of business activities planned or recently executed
• Sources of methods of financing (current, historical)
• Board of directors (composition, business reputation and experience, independence from and control over operating management, frequency of meetings, existence of audit committee and scope of its activities, existence of policy on corporate conduct, changes in professional advisors)
• Operating management (experience and reputation, turnover, key financial personnel and other status in the organization, staffing of accounting department, incentive or bonus plans as part of remuneration, use of forecasts and budgets, pressures on management, management information systems)
• Internal Audit function (existence, quality )
• Attitude to internal control environment

c) The Entity’s Business

• Nature of business (for example manufacturer, wholesaler, financial services, imports/exports)
• Location of production facilities, warehouses, offices
• Employment (for example by location, supply, wage levels, union contracts, pension commitments, government regulations)
• Products or services and markets (for example major customers and contracts, terms of payments, profit margins, reputation of products warranties, order book, trends, marketing strategy and objectives, manufacturing processes)
• Important suppliers of goods and services (for example long term contracts, stability of supply, terms of payment, imports, methods of delivery)
• Inventories (for example location, quantities)
• Franchises, licenses, patents
• Important expense categories
• Research and development
• Foreign currency assets, liabilities and transactions by currency, hedging
• Legislation and regulations that significantly affect the entity
• Information systems (including computerized information systems) – current plans to change
• Debt structure, including covenants and restrictions.

d) Financial Performance

Factors concerning the entity’s financial conditions and profitability

• Accounting policies
• Earnings and cash-flow trends
• Leasing and other financial commitments
• Availability of lines of credit
• Off balance sheet finance issues
• Foreign exchange and interest rate exposures
• Comparison with industrial trends

e) Reporting Environment

External influences which affect the directors in the preparation of the financial statements

• Legislation
• Regulatory environment and requirements
• Taxation
• Accounting requirements
• Measurement and disclosure issues peculiar to the business
• Audit reporting requirements
• Users of the financial statements
• Communication of Knowledge about the Business

Knowledge of the client’s business becomes useful to the auditors if it is made known to the audit team members. The audit engagement partner should therefore ensure that the audit team obtains such knowledge of the business of the entity being audited as may reasonably be expected to be sufficient to enable it to carry out the audit work effectively.