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What is Inherent Risk in Audit?

The inherent risk with the control risk is the risk which is sued by the auditor for the purposes of assessing the risk of the material misstatements which is connected with any particular financial statement line item or the area of the audit. The CPE firms uses this assessed level of the risk of the material misstatement in order to design in the various different procedures of an audit so that the same could be applied to the accounts that are associated with these (Accounting simplified, 2017).

The inherent risk is considered to the level of the susceptibility of making any material misstatement which would exist in case there are no controls in place. This is the risk which is assessed by the knowledge of the auditor and also the judgement with regard to the industry, the types of the transactions that have been entered into and this occurs for one particular company. This applies to the assets of the company. The auditor will assess each area of the audit as being low when compared with the other inherent risks (Anao, 2017).

  • Integrity of the management: in case, the management lack some integrity, then there are more of the poor reputation of the business in the community. The auditor would have a limited access to the people and also to the information in case there is a lack of integrity of the management. This cannot be identified during the strategic business risk assessment.
  • Experience of the management and changes during the period of reporting: in case, the management is not experienced enough and if it lacks the knowledge that affects the preparation of the financial statements, then there would be an issue. In case, there is an increased turnover of employees in the company, then the inherent risk for the audit would be increased and the main reason behind the same would be the fact that the individuals or the employees who are honest would resign from their positions in case the management ask them to commit a fraud. This can be identified during the strategic business risk assessment.
  • Unusual presence of the management: the management could have the intentions of misstating the financial statements. This would lead to facing the cash flow problems, poor liquidity, poor operating results of the management. Also, the management compensation schemes are connected and depends upon the earnings or the prices of the shares of the company. In such a case, there would be an incentive for the management to misstate the results so as to obtain a bonus amount. This cannot be takes into account when the assessment of the business risk is being considered. This cannot be identified during the strategic business risk assessment (Legislation, 2017).
  • Nature of entity’s business: when there is a new economy or in case, there is a new internet company, then that would have the potential advantages unless and until there has been a reputation along with some reliable revenue source, till then they would be considered to be risky. In case, the business has a complex capital structure, then that would increase the inherent risk. This includes the existence of the related party transactions that would increase the inherent risk. This mainly because the transactions are not entered into with an independent party and hence, the conditions of sale could have been affected. This can be identified during the strategic business risk assessment.

There are many of the issues that are connected with the nature of the business. In case the company has a higher capital structure, then it would be exposed to an increased inherent risk.

  • There is also a chance that the misstatement has been found in the audit of the previous year. This would mean that the misstatement would be found this year as well. This cannot be identified during the strategic business risk assessment (Student VIP, 2017).
  • In case, an auditor does not have good experience, then it is quite likely that he would not be able to find the errors and that would mean that the inherent level of the risks would be assessed at high. This cannot be identified during the strategic business risk assessment.
  • If the company has entered into the non-routine transactions, then the audit risk would be assessed as high. This cannot be identified during the strategic business risk assessment (HKIAAT, 2017).
  • Experience of the management and changes during the period of reporting: in case, the management is not experienced enough and if it lacks the knowledge that affects the preparation of the financial statements, then there would be an issue. In case, there is an increased turnover of employees in the company, then the inherent risk for the audit would be increased and the main reason behind the same would be the fact that the individuals or the employees who are honest would resign from their positions in case the management ask them to commit a fraud.
  • Nature of entity’s business: when there is a new economy or in case, there is a new internet company, then that would have the potential advantages unless and until there has been a reputation along with some reliable revenue source, till then they would be considered to be risky. In case, the business has a complex capital structure, then that would increase the inherent risk. This includes the existence of the related party transactions that would increase the inherent risk. This mainly because the transactions are not entered into with an independent party and hence, the conditions of sale could have been affected.

The nature of the business entity is also of an utmost importance. In case, the entity has a quite big capital structure, then the assessed inherent risk would be high. When the transactions are entered into with the unrelated party, then the inherent risk would increase.

  • There is also a chance that the misstatement has been found in the audit of the previous year. This would mean that the misstatement would be found this year as well.
  • In case, an auditor does not have good experience, then it is quite likely that he would not be able to find the errors and that would mean that the inherent level of the risks would be assessed at high.
  • If the company has entered into the non-routine transactions, then the audit risk would be assessed as high.
  • A higher amount of the judgement is required in the situations wherein the management of the clients entity would need to exercise a great deal of the judgement when it comes to the estimating and recording the transactions. The examples of the same includes the certain investments to be recorded at fair value, allowances for the uncollectible trade receivables, writing off the obsolete inventory etc.
  • An increased amount of judgement is required when there is a great likelihood of the misstatements. Hence, the auditor is more likely to assess the inherent risk as being high.
  • From the point of view of the auditor, he would always set in the higher inherent risk for the questionable items such as the trade receivables when they have become overdue, inventories that have a lower turnover, transactions that have bene entered into with the related parties, amounts that are due from the officers along with the cash disbursements.

The assumption of going concern merely states that the business would continue in the future and it would operate indefinitely or at least long enough when it comes to the fulfilment of the objectives of the company or the objectives with which it was formed. The assumption assumes that the business would have a longer life and would not close or would not be sold in the immediate future. The companies that are said to be going concern would contribute in the near future but the companies that are not expected to carry on its operations would not be considered to be a going concern company.

This is the concept which is most important to the different principles of generally accepted accounting principles. This concept is very important since it assesses the ability of the company to prepay and accrue the expenses. In case, the company expects to be shut done in the near future, then it would not repay or accrue anything. The company might not even be there in case the company is not expected to function long enough to realise is future expenses (Accounting course, 2017). One of the most major contributions that the assumption of going concern makes is the fact of the area of the assets. The whole concept of deprecation and the amortization of the assets is somewhat based on the fact that the businesses would continue well in the future. The assets are also reported on the balance sheet at the historical costs due to the assumption of going concern. In case, there is an assessment that the business would be closed won within the period of one year, then the estimation of the asset based on the liquidating values is considered to be more appropriate. All of the assets would be recorded at the net realisable vales and all of these assets would be considered as the current assets and the current liabilities and then there would be a reason to segregate the assets into current and long term categories. There are many of the businesses that closes don and would go bankrupt. In case the financial position of the company indicates that its hindering the assumption of the going concern, then the stated assumption cannot be followed. Hence, these financial statements would have more issues and could also go bankrupt. And also, the financial statements prepared would still have to disclose in all of the assumptions. Hence e, the inherent risk for this assumption would be assessed at high due to the complexity in ethics and assumption (Accounting tools, 2017).

In the nutshell, when there is a new economy or in case, there is a new internet company, then that would have the potential advantages unless and until there has been a reputation along with some reliable revenue source, till then they would be considered to be risky. In case, the business has a complex capital structure, then that would increase the inherent risk. This includes the existence of the related party transactions that would increase the inherent risk. This mainly because the transactions are not entered into with an independent party and hence, the conditions of sale could have been affected. This can be identified during the strategic business risk assessment.

This is the concept which is most important to the different principles of generally accepted accounting principles. This concept is very important since it assesses the ability of the company to prepay and accrue the expenses. In case, the company expects to be shut done in the near future, then it would not repay or accrue anything. The company might not even be there in case the company is not expected to function long enough to realise is future expenses. From the point of view of the auditor, he would always set in the higher inherent risk for the questionable items such as the trade receivables when they have become overdue, inventories that have a lower turnover, transactions that have bene entered into with the related parties, amounts that are due from the officers along with the cash disbursements.

References

Accounting-simplified.com. (2017). Audit Risk Model | Inherent Risk, Control Risk & Detection Risk. [online] Available at: https://accounting-simplified.com/audit/risk-assessment/audit-risk.html [Accessed 25 May 2017].

Legislation.gov.au. (2017). ASA 315 - Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment - October 2009. [online] Available at: https://www.legislation.gov.au/Details/F2011C00629 [Accessed 25 May 2017].

My Accounting Course. (2017). Going Concern Concept | Examples | My Accounting Course. [online] Available at: https://www.myaccountingcourse.com/accounting-principles/going-concern-concept [Accessed 25 May 2017].

studentvip-notes.s3.amazonaws.com. (2017). Factors affecting inherent risks. [online] Available at: https://studentvip-notes.s3.amazonaws.com/5501-sample.pdf [Accessed 25 May 2017].

ww.hkiaat.org. (2017). Risk in Auditing – Inherent Risk. [online] Available at: https://www.hkiaat.org/images/uploads/articles/PBEPIII_inherent_risk.pdf [Accessed 25 May 2017].

www.accountingtools.com. (2017). Going concern. [online] Available at: https://www.accountingtools.com/going-concern-principle [Accessed 25 May 2017].

www.anao.gov.au. (2017). Example financial statements risk analysis. [online] Available at: https://www.anao.gov.au/sites/g/files/net616/f/BPG-PSFS-toolkit-item-05.pdf [Accessed 25 May 2017].

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