Final answer:
The procedures to understand an entity and its environment, including its internal controls, are termed as 'risk assessment procedures.' These are part of the initial steps an auditor takes to identify risks of material misstatement in the financial statements. The correct answer is option 2 ) Risk assessment procedures.
Step-by-step explanation:
The procedures performed to obtain an understanding of the entity and its environment, including internal controls, are known as audit procedures. However, more specifically, these procedures are termed risk assessment procedures. An auditor carries out risk assessment procedures at the beginning of an audit to identify and assess the risks of material misstatement in the financial statements, whether due to fraud or error. Understanding the entity involves evaluating the industry, regulatory, and other external factors, including the entity's objectives and strategies, and its associated business risks that may result in a material misstatement of the financial statements. It involves understanding the entity's internal control as well to establish the design and implementation of relevant controls that prevent or detect and correct material misstatements at a timely basis.
Control procedures, on the other hand, are the policies and procedures that an entity implements to address the risks identified during the risk assessment process. Sampling procedures are used to select a representative subset of the entire population for testing, in order to draw conclusions about that population.
The correct answer to the student's question is 2 ) Risk assessment procedures. Performing these procedures helps the auditor decide the nature, timing, and extent of further audit procedures to be performed during the audit.