It is one of the important principles in developing an overall audit plan. Infact without adequate knowledge of client’s business, a proper audit is not possible. AAS-20 on “Knowledge of the Business” deals in detail about the significance of such knowledge on the part of the auditor.
The auditor needs to obtain a level of knowledge of the client’s business that will enable him to identify the events, transactions and practices that, in his judgment, may have significant effect on the financial information. Among other things, the auditor can obtain such knowledge from :
- The client’s annual reports to shareholders.
- Minutes of meetings of shareholders, board of directors and important committees.
- Internal financial management reports for current and previous periods, including budgets, if any.
- The previous year’s audit working papers, and other relevant files.
- Firm personnel responsible for non-audit services to the client who may be able to provide information on matters that may affect the audit.
- Discussions with client.
- The client’s policy and procedures manual.
- Relevant publications of the Institute of Chartered Accountants of India and other professional bodies, industry publications, trade journals, magazines, newspapers or text books.
- Consideration of the state of the economy and its effect on the client’s business.
- Visits to the client’s premises and plant facilities.
With respect to the previous year’s audit working papers and other relevant files, the auditor should pay particular attention to matters that requires special consideration and decide whether they might affect the work to be done in the current year. Discussions with the client might include such subjects as :
- Changes in management, organisational structure and activities of the client.
- Current Government legislation, rules, regulations and directives affecting the client.
- Current business developments affecting the client.
- Current or impending financial difficulties or accounting problems.
- Existence of parties in whom directors or persons who are substantial owners of the entity are interested and with whom transactions are likely.
- New or closed premises and plant facilities.
- Recent or impending changes in technology, type of products or services and production or distribution methods.
- Significant matters arising from previous year’s financial statements, audit report and management letters, if any.
- Changes in the accounting practices and procedures and in the system of internal control.
- Scope and timing of the examination.
- Assistance of client personnel in data preparation.
- Relevance of any work to be carried out by the client’s internal auditors.
In addition to the importance of knowledge of the client’s business in establishing the overall audit plan, such knowledge helps the auditor to identify areas of special audit consideration, to evaluate the reasonableness both of accounting estimates and management representations, and to make judgments regarding the appropriateness of accounting policies and disclosures.