(Understanding the entity and its environment) You have just been assigned as in

Question

(Understanding the entity and its environment) You have just been assigned as in-charge accountant on HipStar, Inc. a new audit client in the recording industry. HipStar is an emerging growth company that finds new recording artists, records their music, and distributes the music directly to consumers exclusively over the Internet. The company does not produce CDs or tapes and does not distribute the artist's music through traditional distribution channels. In order to better understand HipStar, you have set out to understand the following:

1. Industry conditions

2. The regulatory environment

3. Other external factors affecting the business

4. The entity's business operations

5. The entity's investing activities and financing activities

6. The entity's financial reporting activities

7. The entity's objectives, strategies, and related business risks

8. How the entity measures and reviews its financial performance.

Required

For each of these eight categories (1) describe the knowledge and understanding you want to obtain about HipStar to develop a knowledgeable perspective about the entity and (2) identify how this knowledge might assist in assessing the risk of material misstatement. Use the following format:

1. Industry conditions

2. Regulatory environment

3. Other external factors affecting the business

4. The client's business operations

5. The client's investing activities and financing activities

6. The client's financial reporting activities

7. The client's objectives, strategies, and related business risks

8. How the client measures and reviews the entity's financial performance

Key Categories Describe the knowledge used to develop a knowledgeable perspective about HipStar Identify how this knowledge might assist in assessing the risk of material misstatement

1. Industry conditions

2. Regulatory environment

3. Other external factors affecting the business

4. The client's business operations

5. The client's investing activities and financing activities

6. The client's financial reporting activities

7. The client's objectives, strategies, and related business risks

8. How the client measures and reviews the entity's financial performance

Explanation / Answer

The table is given below:

Key Categories Describe the knowledge used to develop a knowledgeable perspective about HipStar Identify how this knowledge might assist in assessing the risk of material misstatement Industry conditions Knowledge about the markets, technology acceptance and competitive environment. Acceptance of company's technology in the market is essential for company's survival and growth. Ability to face competitive pressure and quick response to market requirements is critical for generation of revenue and earning reasonable profits. Regulatory environment Knowledge on legal and copyright issues that may be faced by the company. Identification of regulatory risks faced by the firm and measures that can/have been taken by the company to deal with them. Other external factors affecting the business Knowledge of demand for products/services in the industry. Information on actual demand position for company's products will help in understanding the pricing strategies as against the competitors, methods used to increase sales and application of cost control methods. The client's business operations Knowledge of different forms of costs and revenues, sources and usage of cash flow. Additionally knowledge on how the rights over music are acquired. Use of correct methodologies for reporting revenues, costs and cash flows will reduce the risk of material statements. The client's investing activities and financing activities Knowledge about the technology requirements of the company. Additionally knowledge on how to finance/raise funds for investment purposes. Sources and uses of cash flows with respect to investing and financing activities is important for understanding the actual cash position of the company. Excess borrowings or significant investment in new technology can result in severe cash shortage. The client's financial reporting activities Knowledge of various accounting rules, principles, procedures and accounting standards relevant to the company. Correct application of accounting rules, regulations and standards is important for ensuring defect/error free financial reporting. The client's objectives, strategies, and related business risks Knowledge of company's current business strategies, its growth and expansion plans. Additionally plans for contigencies that may be faced by the company in the future. Conduct of business operations in accordance with established objectives and strategies is essential to minimize business risks. How the client measures and reviews the entity's financial performance Knowledge of company's procedures for monitoring and appraising performance. Additionally knowledge of key financial ratios used in the performance evaluation and comparison with other companies in the industry. Comparison of actual versus expected ratios can help in identifying significant deviations and accounts with high level of risks.

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