Which procedure is part of assessing risks of material misstatement?

Obtaining an understanding of the entity and its environment is a crucial step in assessing risks of material misstatement. This procedure enables auditors to gain insights into the entity's operations, industry practices, and internal control environment. By comprehensively understanding these aspects, auditors can identify potential areas where material misstatements may occur, whether due to fraud or error.

This understanding also aids in risk assessment by highlighting significant risks specific to the entity, such as regulatory risks or those arising from complex transactions. Furthermore, it allows auditors to tailor their audit approach more effectively by focusing efforts on areas deemed higher risk, ultimately enhancing the effectiveness of the audit process.

In contrast, testing controls, substantive testing exclusively, or merely engaging in discussions with management do not encompass the breadth of understanding required to adequately assess risks of material misstatements. While these actions may be part of the overall audit strategy, they do not substitute for a comprehensive understanding of the entity and its environment, which is foundational in the risk assessment process.