Factors That Auditors Evaluate When Assessing Inherent Risk.

2. Describe typical factors that auditors evaluate when assessing inherent risk.

Inherent risk is the measure of the likelihood that there may be material misstatement assuming the absence of internal controls, i.e. before considering the effectiveness of the internal controls. It is basically when the effectiveness or efficiency of internal controls are not considered when assessing risk. So if there is a high likelihood of misstatement, inherent risk is high. It requires a high level of professional judgment.

Some factors that auditors evaluate when assessing inherent risk include:

The nature of a client’s business: The more susceptible the client is to changes in the competitive market place the higher the inherent risk. For example in the Smartphone and software industry, technology changes are volatile and firms are constantly trying to improve on their technology in order to move with the latest trends and stay competitive. Also, the product life cycles are short due to these fast-paced changes thereby increasing the risk of inventory obsolescence.

New engagements: Whenever auditors are dealing with a new client, the inherent risk is always high due to lack of familiarity.

The integrity of management: Management integrity must be evaluated. An unethical and dishonest management team increases risks of fictitious transactions and therefore fraudulent misrepresentations of the financial statements. This is a huge factor to consider, as it is one of the most common causes of fraud. If the management is honest, the inherent risk is lower.

The nature of the client’s data processing systems: If the data processing system is not managed and maintained properly, the inherent risk would be greater. It essentially means that the method of the programming of the system affects its quality. Also, the complexity of a system or program increases the risk of error and thereby affects inherent risk i.e. the more complex the system is, the higher the...