Inherent Risk in Auditing

Inherent risk is the susceptibility of an account balance or class of transactions to misstatement that could be material either individually or when aggregated with misstatement in other balances or classes assuming that there were no related internal controls. This risk mainly arises at the level of management and the risk factor generally being high. Factors Affecting Inherent Risk:

At the level of financial statement
Integrity of management;
Management’s experience and knowledge;
Unusual pressure on management;
Nature of entity’s business;
Factors affecting industry;

At the level of Account Balance & Transaction
Quality of Accounting System;
Accounts prone to misstatement;
Complex transaction;
Judgement involved in determining balance;
Assets prone to misappropriation;
Unusual transaction at or near the period end;
Transaction not subjected to ordinary processing;

As per SA 315 “Identifying and assessing the risk of material misstatement through understanding the entity and its environment” the auditor shall Identifying risks throughout the process of obtaining an understanding of the entity and its environment, including relevant controls that relate to risk and by considering the classes of transaction, account balance and disclosure in the financial statement. Assess the identified risks and evaluate whether they relate more pervasively to the financial statement as a whole and potentially affect many assertions. Relate the identified risks to what can go wrong at the assertion level, taking account of relevant controls that the auditors intend to test Consider the likelihood of misstatement including the possibility of multiple misstatements and whether the potential misstatement is of a magnitude that could result in a material misstatement. As per SA 330 “The Auditor’s Response to Assessed Risk” while designing the future audit procedures to be performed, the auditor shall consider the reason for the assessment given to the risk of material misstatement at the assertion level for the likelihood of material misstatement due to the particular characteristics of the class of the transaction, account balance or disclosure and obtain more persuasive audit evidence the higher the auditor’s assessment of risk.