In the field of financial and management accounting, the inherent risk is defined as the possibility of incorrect or misleading information in the financial statements result in something other than a failure of management. Examples of inherent risk are the most common, where the accountants have to use more than normal amount of judgments and approximations, or where we are talking about complex financial instruments.
Types of audit risk
In order to understand inherent risk, this allows you to place it in the context of risk analysis audit. Audit risk is the risk of errors during the audit, and it is traditionally divided into three different types.
The first type is risk management. Risk management occurs when the results of the financial audit due to the lack of proper control of accounting in the firm. It is likely to surface in the form of fraud or lazy accounting practices.
It’s also possible that the auditors simply will not be able to detect, otherwise it is easy to notice mistakes in financial statements. This is known as detection risk. As a rule, the risk of detection is countered by increasing the number of discrete operations during the test.
Inherent risk is the third main types of audit risk. Is considered the most harmful of the main components of audit risk, inherent risk can be easily avoided by increasing the auditor or the establishment of controls in the audit process.
Typical examples of risk
Inherent risk is common in the financial services sector. The main reasons for this are the complexity and dynamism in the regulation of financial institutions, large companies and the development of derivatives and other complex instruments.
Financial institutions often have long and complex relationships with multiple parties. A holding company may be involved in several things at the same time, each controlling machinery and other off-balance sheet entities. each level of the organizational structure can have a large number of investors and customer relationships. Related parties are notoriously less transparent than private companies.
Business relationships include those with auditors, both initial and repeated meetings with the auditors to create some risk. The initial auditors can be overwhelmed by complexity or new topics. Repeat interactions can result in overconfidence and lack of discipline due to personal relations.
Custom accounts or transactions can be risky. For example, considering damage from the fire or the acquisition of another company quite often, auditors run the risk of too much or too little focusing on a unique event.
Inherent risk-this is especially common among the accounts that require a lot of estimates, approximations or estimates by the management. Estimation of fair values in accounting for financial instruments are difficult to make, and the nature of the process, the Fair value must be disclosed in the financial statements. Auditors can investigate and interview managers of the company methods, to minimize error. This risk is increased when it occurs rarely or for the first time.