Final answer:
An auditor must understand a client's business to evaluate how transactions impact financial statements, provide professional scepticism, assess material misstatement risks, and suggest internal control improvements. This knowledge ensures a comprehensive and reliable audit process.
Step-by-step explanation:
An auditor gathers information about a new client's business operations and the industry they belong to for several reasons. The primary purpose is to gain an understanding of the client's business, which is necessary to evaluate how different events and transactions might impact the financial statements. This in-depth knowledge is crucial for the auditor to provide professional scepticism and to assess the risk of material misstatement due to error or fraud.
Gaining detailed knowledge about the client's business allows the auditor to make informed judgments regarding the client's internal controls and the aggregation of known misstatements. This enables them to evaluate whether these misstatements cause the financial reports to be materially incorrect. Furthermore, familiarity with the client’s business helps the auditor in making constructive suggestions for improvements in the client's internal control system.
Therefore, understanding the client's business sector and specific operations is integral to a comprehensive audit process, ensuring the reliability of financial information presented to users such as investors and creditors. This understanding facilitates a more effective and efficient audit.