Final answer:
An auditor obtains an understanding of an entity and its environment to assess the risk of material misstatement in the financial statements and design an effective audit strategy tailored to the entity's specific context and audience.
Step-by-step explanation:
The primary purpose for an auditor to obtain an understanding of the entity and its environment is to assess the risk of material misstatement in the financial statements. This understanding helps the auditor to identify and assess the risks of material misstatement, whether due to fraud or error, and to design and implement responses to the assessed risks.
It includes gaining insights into the entity's operations, its financial reporting, and the industry in which it operates, which are essential for the auditor to plan and perform an effective audit. By knowing the entity's priorities and the organizational culture, auditors can better anticipate potential issues and areas of focus during the audit process.
For instance, by understanding the audience of the company's financial information and their knowledge level, auditors can tailor their audit approach accordingly. Questions an auditor may consider include: 'What does my audience know about this subject?' and 'What does my audience need to know to understand the financial statements?'. Such questions ensure that the auditor's report is comprehensible and informative.