Yellow is a junior auditor assigned to audit Rainbow Company who is engaged in providing internet service to its customers. During the

planning meeting of the external audit team, they were discussing their strategy in terms of understanding their client. Not having any

previous audit experience, Yellow asked the audit manager as to what level of knowledge and understanding they need to acquire in

the engagement. What should be the response of the audit manager to Yellow?

Gaining an understanding of the entity and its environment varies from one engagement to another. The level of

understanding required from the external auditors will depend on what the client requires.

Understanding the entity and its environment entails obtaining knowledge at the client$-$level, industry$-$level and general

business environment level since all these levels influence inherent risk.

We should focus our efforts on obtaining knowledge at the client$-$level. In this way, we will not be wasting time and effort in

understanding the industry in which it operates which is unnecessary.

It is enough that we understand at the client$-$level only so long as we identify both entity$-$level risks and transaction$-$level

risks. These two can compensate for our lack of understanding at the industry$-$level.