Page 174 - COSO Guidance Book

Factors to consider when obtaining

an understanding of the entity and

its environment

Many in the control community — and those familiar with the Sarbanes-Oxley Act of 2002 (SOX), which
focuses on internal control over financial reporting — are knowledgeable about various types of internal
controls. However, most control stakeholders are unfamiliar with the factors, other than internal control,
that should be considered when obtaining an understanding of the entity and its environment.

GAAS stresses that auditors consider these factors when conducting a financial statement audit.

These factors include the following:
 Industry, regulatory, and other external factors
 The nature of the entity
 The entity’s selection and application of accounting policies
 Objectives and strategies and related business risks
 Measurement and review of the entity’s financial performance

To enhance the reader’s familiarity with these factors, some examples are shown in exhibit 1-1.

Exhibit 1-1: Factors to consider when obtaining an understanding of the entity
1
and its environment
Industry factors
 The market and competition, including demand, capacity, and price competition
 Cyclical or seasonal activity
 Product technology relating to the entity’s products
 Supply availability and cost

Regulatory factors
 Accounting principles and industry-specific practices
 Regulatory framework for a regulated industry
 Legislation and regulation that significantly affect the entity’s operations
– Regulatory requirements
– Direct supervisory activities
 Taxation (corporate and other)

1
AU-C section 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement
(AICPA, Professional Standards), appendix A lists these as examples. Not all examples will be applicable for every
engagement.

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