Why is there a need for the auditor to obtain a preliminary understanding of the client and its environment?

Obtaining an understanding of the client’s business is key to an effective and efficient audit. It enables us not only to tailor our work to meet the individual facts and circumstances of each client, but also to carry out that work and to evaluate our findings in an informed manner. Our knowledge of the client’s business also helps us to develop and maintain a positive professional relationship with the client.

International Standards on Auditing (ISA) 315 states that the auditor should obtain an understanding of the entity and its environment, including its internal control, sufficient to identify and assess the risks of material misstatement of the financial statements whether due to fraud or error, and sufficient to design and perform further audit procedures.

Understanding the entity is an iterative process, continuing throughout the entire duration of the audit.

Prior the accepting an audit engagement, we should obtain a preliminary knowledge of the industry and of the ownership, management and operations of the entity to be audited.

Detailed information is required at the planning stage of our audit to enable us to plan our work adequately. We need to understand the nature of client’s business, its organization, its method of operation and the industry in which it is involved. This understanding enables us to appreciate which events and transactions are likely to have a significant effect on the financial statements.

Specifically, such an understanding helps us to :

• Identify the areas of high risk where we should concentrate our audit effort
• Maximize efficiency in other areas of audit significance
• Assess the potential for use of analytical procedures, by enabling us to identify the information which we can use to make predictions and comparisons
• Obtain an understanding of the internal control structure
• Assess the inherent and control risks in the key areas of audit significance
• Develop an audit strategy enabling us to obtain the necessary audit evidence in the most effective and efficient manner possible.

Knowing the client’s business helps us in a number of ways both during the conduct of the audit, and when we come to complete our work.

This includes, for example, helping us in :

• Recognising errors in the financial statements
• Asking the right questions and evaluating the reasonableness of the answers we receive
• Making judgements about the appropriateness of the client’s accounting principles, policies and procedures
• Identifying unusual or unexpected transactions and related party transactions
• Interpreting the results of audit tests and evaluating their effect
• Carrying out appropriate procedures to review events occurring after the balance sheet date
• Carrying out an overall review of the financial statements.

Knowledge of the client’s business and the industry in which it operates is essential also to the development of a positive relationship and it helps us as follows :

• In understanding the management’s philosophy and aspirations for the business
• Understanding the business strategy and plans
• Providing relevant and practical business advice to the client
• Identifying areas in which the client might benefit from other professional services which we provide.

ISA 315 states that :

• the auditor should obtain an understanding of relevant industry, regulatory, and other external factors including the applicable financial reporting framework
• the auditor should obtain an understanding of the nature of the entity
• the auditor should obtain an understanding of the entity's selection and application of accounting policies and consider whether they are appropriate for its business and consistent with the applicable financial reporting framework and accounting policies used in the relevant industry
• the auditor should obtain an understanding of the entity's objectives and strategies, and the related business risks that may result in material misstatement of the financial statements
• the auditor should obtain an understanding of the measurement and review of the entity's financial performance.

Each year, the auditor's understanding of the entity should be updated and details of significant changes documented (Hrd) ***

The number of American households that were unbanked last year dropped to its lowest level since 2009, a dip due in part to people opening accounts to receive financial assistance during the pandemic, a new report says.  

Roughly 4.5% of U.S. households – or 5.9 million – didn't have a checking or savings account with a bank or credit union in 2021, a record low, according to the Federal Deposit Insurance Corporation's most recent survey of unbanked and underbanked households. 

Roughly 45% of households that received a stimulus payment, jobless benefits or other government assistance after the start of the pandemic in March, 2020 said those funds helped compel them to open an account, according to the biennial report which has been conducted since 2009.

"Safe and affordable bank accounts provide a way to bring more Americans into the banking system and will continue to play an important role in advancing economic inclusion for all Americans,'' FDIC acting chairman Martin J. Gruenberg said in a statement.  

A lack of banking options delayed some households from getting federal payments aimed at helping the country weather the economic fallout from the COVID-19 health crisis.

Battle against predatory lending:Mississippi social justice firm fights payday 'predatory lending' in low-income communities

Checks arrived late for some of the unbanked:For 'unbanked' Americans, pandemic stimulus checks arrived slowly and with higher fees. But that could change.

The FDIC initiated an educational campaign to get more Americans to open an account to enable the direct deposit of those funds. And banks such as Capital One and Ally Financial ended  overdraft and other fees that have been a key barrier to some Americans accessing the banking system. 

What does it mean to be unbanked?

A household is deemed unbanked when no one in the home has an account with a bank or credit union. That share of households has dropped by nearly half since 2009. And since 2011, when 8% of U.S. households were unbanked, the highest since the start of the survey, and the record low reached in 2021, roughly half of the drop was due to a shift in the financial circumstances of American households the FDIC says.

Who are the underbanked?

Those who have a checking or savings account, but also use financial alternatives like check cashing services are considered underbanked. The underbanked represented 14% of U.S. households, or 18.7 million, last year.   

Why are people unbanked or underbanked?

Many of those who are unbanked say they can't afford to have an account because of the fees for insufficient funds and overdrafts that are tacked on when account balances fall short. Roughly 29% said fees or not having the required minimum balance were the primary reasons they didn't have a checking or savings account, as compared to 38% who cited those obstacles in 2019.

Are some groups more likely to be unbanked? 

The numbers of the unbanked were greater among households that included those who were working age and disabled, lower income, included a single mother, or were Black or Hispanic. Among white households for instance, 2% didn't have a bank account last year as compared to 11% and 9% of their Black and Hispanic counterparts.

Meanwhile, nearly 15% of households with a working age member who had a disability were unbanked compared to almost 4% of other households. And  nearly 16% of households with a single mother were unbanked as compared to about 2% of married couples who lacked an account. 

 "These gaps attest there's still a lot of opportunity to expand participation across the population in the banking system,'' Keith Ernst, Associate Director of Consumer Research and Examination Analytics at the FDIC, said during a media call about the report.            

Will the number of unbanked rise if the U.S. has a recession? 

Perhaps.

"During the last recession unbanked rates did indeed go up,'' Karyen Chu, chief of the Banking Research Section at the Center for Financial Research, said during the call. 

Additionally, last year, homes where the head of household was out of work were nearly five times more likely to not have a bank account as compared to those where the household head was employed.

Recession predictions 2023:Is a recession inevitable in 2023? Here's what experts are saying.

"To the extent that income goes down ... that has generally been associated with increases in unbanked rates,’’ Chu said. 

How does the auditor obtain an understanding of the client and its environment?

Why an auditor should have an understanding of the client's business and its environment when developing an overall audit plan?

Why must auditors obtain an understanding of the client's accounting system?

For what primary purpose does the auditor obtain an understanding of the entity and its environment?