Auditing Standards and Practices Council

Philippine Standard on Auditing 310

KNOWLEDGE OF BUSINESS
 PSA 310

PHILIPPINE STANDARD ON AUDITING 310

KNOWLEDGE OF THE BUSINESS

CONTENTS

Paragraphs

Introduction 1-3

Obtaining the Knowledge 4-8

Using the Knowledge 9-12

Effective Date 13

Acknowledgment 14-15

Appendix: Knowledge of the Business – Matters to Consider

Philippine Standards on Auditing (PSAs) are to be applied in the audit of financial statements.
PSAs are also to be applied, adapted as necessary, to the audit of other information and to
related services.

PSAs contain the basic principles and essential procedures (identified in bold type black
lettering) together with related guidance in the form of explanatory and other material. The
basic principles and essential procedures are to be interpreted in the context of the explanatory
and other material that provide guidance for their application.

To understand and apply the basic principles and essential procedures together with the related
guidance, it is necessary to consider the whole text of the PSA including explanatory and other
material contained in the PSA not just that text which is black lettered.

In exceptional circumstances, an auditor may judge it necessary to depart from a PSA in order
to more effectively achieve the objective of an audit. When such a situation arises, the auditor
should be prepared to justify the departure.

PSAs need only be applied to material matters.

 PSA 310

The PSAs issued by the Auditing Standards Practices Council (Council) are based on
International Standards on Auditing (ISAs) issued by the International Auditing Practices
Committee of the International Federation of Accountants.

The ISAs on which the PSAs are based are generally applicable to the public sector, including
government business enterprises. However, the applicability of the equivalent PSAs on
Philippine public sector entities has not been addressed by the Council. It is the understanding
of the Council that this matter will be addressed by the Commission on Audit itself in due
course. Accordingly, the Public Sector Perspective set out at the end of an ISA has not been
adopted into the PSAs.
 PSA 310

Introduction

1. The purpose of this Philippine Standard on Auditing (PSA) is to establish

standards and provide guidance on what is meant by a knowledge of the business,
why it is important to the auditor and to members of the audit staff working on an
engagement, why it is relevant to all phases of an audit, and how the auditor
obtains and uses that knowledge.

2. In performing an audit of financial statements, the auditor should have or

obtain a knowledge of the business sufficient to enable the auditor to identify
and understand the events, transactions and practices that, in the auditor’s
judgment, may have a significant effect on the financial statements or on the
examination or audit report. For example, such knowledge is used by the
auditor in assessing inherent and control risks and in determining the nature, timing
and extent of audit procedures.

3. The auditor’s level of knowledge for an engagement would include a general

knowledge of the economy and the industry within which the entity operates, and a
more particular knowledge of how the entity operates. The level of knowledge
required by the auditor would, however, ordinarily be less than that possessed by
management. A list of matters to consider in a specific engagement is set out in the
Appendix to this PSA.

Obtaining the Knowledge

4. Prior to accepting an engagement, the auditor would obtain a preliminary

knowledge of the industry and of the ownership, management and operations of
the entity to be audited, and would consider whether a level of knowledge of the
business adequate to perform the audit can be obtained.

5. Following acceptance of the engagement, further and more detailed information

would be obtained. To the extent practicable, the auditor would obtain the
required knowledge at the start of the engagement. As the audit progresses, that
information would be assessed and updated and more information would be
obtained.

6. Obtaining the required knowledge of the business is a continuous and cumulative

process of gathering and assessing the information and relating the resulting
knowledge to audit evidence and information at all stages of the audit. For
example, although information is gathered at the planning stage, it is ordinarily
refined and added to in later stages of the audit as the auditor and assistants learn
more about the business.
 PSA 310

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7. For continuing engagements, the auditor would update and reevaluate information
gathered previously, including information in the prior year’s working papers. The
auditor would also perform procedures designed to identify significant changes
that have taken place since the last audit.

8. The auditor can obtain a knowledge of the industry and the entity from a number
of sources. For example:

•1Previous experience with the entity and its industry.

•2
•3Discussion with people with the entity (for example, directors and senior
operating personnel).
•4
•5Discussion with internal audit personnel and review of internal audit reports.
•6
•7Discussion with other auditors and with legal and other advisors who have
provided services to the entity or within the industry.
•8
•9Discussion with knowledgeable people outside the entity (for example, industry
economists, industry regulators, customers, suppliers, competitors).
•10
•11Publications related to the industry (for example, government statistics,
surveys, texts, trade journals, reports prepared by banks and securities dealers,
financial newspapers).
•12
•13Legislation and regulations that significantly affect the entity.
•14
•15Visits to the entity’s premises and plant facilities.
•16
•17Documents produced by the entity (for example, minutes of meetings, material
sent to shareholders or filed with regulatory authorities, promotional literature,
prior years’ annual and financial reports, budgets, internal management reports,
interim financial reports, management policy manual, manuals of accounting and
internal control systems, chart of accounts, job descriptions, marketing and sales
plans).
 PSA 310

•18
•19-3-
•20
•21
Using the Knowledge

9. A knowledge of the business is a frame of reference within which the auditor

exercises professional judgment. Understanding the business and using this
information appropriately assists the auditor in:

•22Assessing risks and identifying problems.

•23
•24Planning and performing the audit effectively and efficiently.
•25
•26Evaluating audit evidence.
•27
•28Providing better service to the client.
•29
10. The auditor makes judgments about many matters throughout the course of the
audit where knowledge of the business is important. For example:

•30Assessing inherent risk and control risk.

•31
•32Considering business risks and management’s response thereto.
•33
•34Developing the overall audit plan and the audit program.
•35
•36Determining a materiality level and assessing whether the materiality level
chosen remains appropriate.
•37
•38Assessing audit evidence to establish its appropriateness and the validity of the
related financial statement assertions.
•39
•40Evaluating accounting estimates and management representations.
•41
•42Identifying areas where special audit consideration and skills may be necessary.
•43
•44Identifying related parties and related party transactions.
•45
•46Recognizing conflicting information (for example, contradictory
representations).
 PSA 310

•47
•48-4-
•49
•50
•51Recognizing unusual circumstances (for example, fraud and noncompliance
with laws and regulations, unexpected relationships of statistical operating data
with reported financial results).
•52
•53Making informed inquiries and assessing the reasonableness of answers.
•54
•55Considering the appropriateness of accounting policies and financial statement
disclosures.
•56
11. The auditor should ensure that assistants assigned to an audit engagement
obtain sufficient knowledge of the business to enable them to carry out the
audit work delegated to them. The auditor would also ensure they understand
the need to be alert for additional information and the need to share that
information with the auditor and other assistants.

12. To make effective use of knowledge about the business, the auditor should
consider how it affects the financial statements taken as a whole and
whether the assertions in the financial statements are consistent with the
auditor’s knowledge of the business.

Effective Date

13. This PSA shall be effective for audits of financial statements for periods ending on
or after June 30, 2003.

Acknowledgment

14. This PSA, Knowledge of the Business, is based on International Standard on

Auditing (ISA) 310 of the same title issued by the International Auditing Practices
Committee of the International Federation of Accountants.

15. There are no significant differences between this PSA and ISA 310.
 PSA 310

-5-

This Philippine Standard on Auditing 310 was unanimously approved on January 28, 2002
by the members of the Auditing Standards and Practices Council:

Benjamin R. Punongbayan, Chairman Antonio P. Acyatan, Vice Chairman

Felicidad A. Abad David L. Balangue

Eliseo A. Fernandez Nestorio C. Roraldo

Editha O. Tuason Joaquin P. Tolentino

Joycelyn J. Villaflores Carlito B. Dimar

Froilan G. Ampil Erwin Vincent G. Alcala

Horace F. Dumlao Isagani O. Santiago

Eugene T. Mateo Emma M. Espina

Edijer A. Martinez
 PSA 310

Appendix

Knowledge of the Business – Matters to Consider

This list covers a broad range of matters applicable to many engagements; however, not all
matters will be relevant to every engagement and the listing is not necessarily complete.

A. General economic factors

•57General level of economic activity (for example, recession, growth)

•58
•59Interest rates and availability of financing
•60
•61Inflation, currency revaluation
•62
•63Government policies
•64
–1Monetary
–2
–3Fiscal
–4
–5Taxation – corporate and other
–6
–7financial incentives (for example, government aid programs)
–8
–9tariffs, trade restrictions
–10
•65Foreign currency rates and controls
•66
B. The industry—important conditions affecting the client’s business

•67The market and competition

•68
•69Cyclical or seasonal activity
•70
•71Changes in product technology
•72
•73Business risk (for example, high technology, high fashion, ease of entry for
competition)
•74
•75Declining or expanding operations
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Appendix

•76-2-
•77
•78
•79Adverse conditions (for example, declining demand, excess capacity, serious
price competition)
•80
•81Key ratios and operating statistics
•82
•83Specific accounting practices and problems
•84
•85Environmental requirements and problems
•86
•87Regulatory framework
•88
•89Energy supply and cost
•90
•91Specific or unique practices (for example, relating to labor contracts, financing
methods, accounting methods)
•92
C. The entity

1. Management and ownership—important characteristics

· Corporate structure—private, public, government (including any recent or

planned changes)

•93Beneficial owners and related parties (local, foreign, business reputation

and experience)
•94
•95Capital structure (including any recent or planned changes)
•96
•97Organizational structure
•98
•99Management objectives, philosophy, strategic plans
•100
•101Acquisitions, mergers or disposals of business activities (planned or
recently executed)
•102
•103Sources and methods of financing (current, historical)
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Appendix

•104-3-
•105
•106Board of directors
•107
–11Composition
–12
–13business reputation and experience of individuals
–14
–15independence from and control over operating management
–16
–17frequency of meetings
–18
–19existence of audit committee and scope of its activities
–20
–21existence of policy on corporate conduct
–22
–23changes in professional advisors (for example, lawyers)
–24
•108Operating Management
•109
–25experience and reputation
–26
–27turnover
–28
–29key financial personnel and their status in the organization
–30
–31staffing of accounting department
–32
–33incentive or bonus plans as part of remuneration (for example, based on
profit)
–34
–35use of forecasts and budgets
–36
–37pressures on management (for example, overextended, dominance by
one individual, support for share price, unreasonable deadlines for
announcing results)
–38
–39management information systems
–40
•110Internal audit function (existence, quality)
•111
•112Attitude to internal control environment
 PSA 310

Appendix

•113-4-
•114
•115
2. The entity’s business—products, markets, suppliers, expenses, operations

•116Nature of business(es) (for example, manufacturer, wholesaler, financial

services, import/export)
•117
•118Location of production facilities, warehouses, offices
•119
•120Employment (for example, by location, supply, wage levels, union
contracts, pension commitments, government regulation)
•121
•122Products or services and markets (for example, major customers and
contracts, terms of payment, profit margins, market share, competitors,
exports, pricing policies, reputation of products, warranties, order book,
trends, marketing strategy and objectives, manufacturing processes)
•123
•124Important suppliers of goods and services (for example, long-term
contracts, stability of supply, terms of payment, imports, methods of delivery
such as “just-in-time”)
•125
•126Inventories (for example, locations, quantities)
•127
•128Franchises, licenses, patents
•129
•130Important expense categories
•131
•132Research and development
•133
•134Foreign currency assets, liabilities and transactions—by currency, hedging
•135
•136Legislation and regulation that significantly affect the entity
•137
•138Information systems—current, plans to change
•139
•140Debt structure, including covenants and restrictions
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Appendix

•141-5-
•142
•143
3. Financial performance—factors concerning the entity’s financial condition and
profitability

•144Key ratios and operating statistics

•145
•146Trends
•147
4. Reporting environment—external influences which affect management in the
preparation of the financial statements

5. Legislation

•148Regulatory environment and requirements

•149
•150Taxation
•151
•152Measurement and disclosure issues peculiar to the business
•153
•154Audit reporting requirements
•155
•156Users of the financial statements