32The auditor shall obtain an understanding of the nature of the entity.

32 The auditor shall obtain an understanding of the nature of the entity.

33 The nature of an entity refers to the entity’s operations, its ownership and governance, the types of investments that it is making and plans to make, the way that the entity is structured and how it is financed. An understanding of the nature of an entity enables the auditor to understand the classes of transactions, account balances, and disclosures to be expected in the financial report.

34 The entity may have a complex structure with subsidiaries or other components in multiple locations. In addition to the difficulties of consolidation in such cases, other issues with complex structures that may give rise to risks of material misstatement include: the allocation of goodwill to business segments, and its impairment; whether investments are joint ventures, subsidiaries, or investments accounted for using the equity method; and whether special-purpose entities are accounted for appropriately.

35 An understanding of the ownership and relations between owners and other people or entities is also important in determining whether related party transactions have been identified and accounted for appropriately. ASA 550 Related Parties, provides additional explanatory guidance on the auditor’s considerations relevant to related parties.

36 The auditor shall 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.

37 The understanding encompasses the methods the entity uses to account for significant and unusual transactions; the effect of significant accounting policies in controversial or emerging areas for which there is a lack of authoritative guidance or consensus; and changes in the entity’s accounting policies. Ordinarily, the auditor:

(a) identifies financial reporting standards and regulations that are new to the entity and considers when and how the entity will adopt such requirements; and

(b) considers the reasons for the change and whether it is appropriate and consistent with the requirements of the applicable financial reporting framework, where the entity has changed its selection of or method of applying a significant accounting policy.

38 The presentation of a financial report in conformity with the applicable financial reporting framework includes adequate disclosure of material matters. These matters relate to the form, arrangement, and content of the financial report and its appended notes, including, for example, the terminology used, the amount of detail given, the classification of items in the report, and the basis of amounts set forth. Ordinarily, the auditor considers whether the entity has disclosed a particular matter appropriately in light of the circumstances and facts of which the auditor is aware at the time.