Introduction

Auditing standards are a collection of criteria and concepts that auditors follow when performing an audit. These criteria promote uniformity, quality, and dependability in the audit process. They are created by professional accounting groups, such as the American Institute of Certified Public Accountants (AICPA), to protect the integrity and credibility of financial accounts. Auditing standards have developed to keep up with changes in company operations, regulatory needs, and technological advances (Gao & Zhang, 2019). These principles serve as the framework upon which auditors plan, carry out, and report on audit engagements.

SAS No. 145, titled ‘Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement,” is an auditing standard recently introduced by AICPA. It advises auditors to thoroughly understand the entity being audited and assess the risks of substantial misstatement. The standard highlights the need for auditors to be well-versed in the entity’s activities, industry, internal controls, and risk factors (Appelbaum et al., 2023). It also emphasizes the importance of assessing the risks of material misstatement, which assists auditors in determining the nature, time, and scope of audit procedures to be done. SAS No. 145 is a notable advancement in auditing standards since it focuses on improving audit effectiveness and efficiency by adopting a risk-based approach. Auditors can deliver more meaningful and relevant audit opinions if auditing methods are aligned with the SAS No. 145 outlines the essential principles and requirements (Appelbaum et al., 2023). Its goal is to provide a thorough understanding of the entity and its surroundings, as well as the process of assessing the risks of material misstatement.

The fundamental concepts, methodology, and practical implications of SAS No. 145 in the context of auditing practices will be examined in this study. It will go over the importance of understanding the entity and analyzing risks and auditors’ responsibility in efficiently executing these principles. Furthermore, the study paper will examine real-world examples and case studies to demonstrate how SAS No. 145 can be used. It will also assess the advantages and disadvantages of this auditing standard and potential future advances in the auditing industry.

The Entity

In auditing, the entity refers to the organization or business being audited. A corporation, partnership, government agency, or nonprofit organization could be involved. Raximova, Abdulxayeva & Pirimkulov (2020) explain that understanding the entity is essential during the audit process since it allows auditors to get insights into its operations, financial situation, and performance.

Importance of Understanding the Entity

Effective risk assessment: Auditors can detect and assess the risks of significant misstatement with a detailed understanding of the entity. It enables them to adjust audit procedures to the entity’s circumstances and manage resources effectively.

Planning the audit: Understanding the entity helps auditors design an effective audit strategy, determine the nature, timing, and scope of audit processes, and select the appropriate audit team (Raximova et al., 2020).

Evaluating internal controls: Understanding the entity’s internal control environment allows auditors to evaluate the design and efficacy of controls, identify control vulnerabilities, and determine how much reliance should be placed on those controls.

Assessing financial statement presentation: Understanding the entity assists auditors in evaluating the fairness and accuracy of financial statement presentation, including transaction and event recognition, measurement, and disclosure (Raximova et al., 2020).

Factors Considered When Understanding the Entity

Auditors must understand the industry in which the business operates, including its particular characteristics, risks, rules, and competitive landscape. This knowledge aids in analyzing industry-specific risks that may influence the entity’s financial statements.

Governance structure: The entity’s governance structure, which includes its board of directors, management team, and oversight processes, influences its control environment and financial reporting integrity (Raximova et al., 2020). Auditors should comprehend the entity’s organizational structure, including its subsidiaries, branches, and divisions. This knowledge aids in the identification of relevant reporting relationships, business lines, and geographic areas for the audit.

Business operations: Auditors must gather knowledge of the entity’s primary business activities, products, services, and inco