26The auditor’s understanding of the entity and its environment consists of an understanding of the following aspects:

26 The auditor’s understanding of the entity and its environment consists of an understanding of the following aspects:

• Industry, regulatory, and other external factors, including the applicable financial reporting framework.
• Nature of the entity, including the entity’s selection and application of accounting policies.
• Objectives and strategies and the related business risks that may result in a material misstatement of the financial report.
• Measurement and review of the entity’s financial performance.
• Internal control.

Appendix 1 contains examples of matters that the auditor may consider in obtaining an understanding of the entity and its environment relating to the above categories. Appendix 2 contains a detailed explanation of the internal control components.

27 The nature, timing, and extent of the risk assessment procedures performed depend on the circumstances of the engagement such as the size and complexity of the entity and the auditor’s experience with it. In addition, identifying significant changes in any of the above aspects of the entity from prior periods is particularly important in gaining a sufficient understanding of the entity to identify and assess risks of material misstatement.

Industry, Regulatory and Other External Industry, Regulatory and Other External Factors, Including the Applicable Financial Reporting Framework

Industry, Regulatory and Other External Factors, Including the Applicable Financial Reporting Framework

28 The auditor shall obtain an understanding of relevant industry, regulatory, and other external factors including the applicable financial reporting framework.

29 These factors include industry conditions such as the competitive environment, supplier and customer relationships, and technological developments; the regulatory environment encompassing, among other matters, the applicable financial reporting framework, the legal and political environment, and environmental requirements affecting the industry and the entity; and other external factors such as general economic conditions. See ASA 250 Consideration of Laws and Regulations in an Audit of a Financial Report, for additional mandatory requirements related to the legal and regulatory framework applicable to the entity and the industry.

30 The industry in which the entity operates may give rise to specific risks of material misstatement arising from the nature of the business or the degree of regulation. For example, long-term contracts may involve significant estimates of revenues and costs that give rise to risks of material misstatement. In such cases, under ASA 220 Quality Control for Audits of Historical Financial Information, the auditor needs to consider whether the engagement team includes members with sufficient relevant knowledge and experience.