Inherent Risk
Candlefocus EditorInherent risk can also be associated with the use of estimates and assumptions, such as the value of inventory or the provisioning of expected losses. These estimates and assumptions are based on managements best judgement, and can be vulnerable to change given changes in the external environment. Errors and omissions in the risk assessment process can directly increase this inherent risk.
In general, inherent risk is considered higher in volatile industries, such as technology and financial services, where firms must rely heavily on staying up to date with regulations, standards and the competitive environment.
In assessing inherent risk, it is important to identify, define and document the risks inherent in the company’s activities, operations, and transactions. Expected risks can be analyzed, evaluated, and assessed to identify where further risk assessments and enhancements to internal controls may be appropriate.
Auditors and analysts must be aware of inherent risk when evaluating financial statements. Not only does it affect the quality of the assessment, but it can also affect the control environment within an entity. By taking into account the inherent risk, organizations can determine how to create and maintain effective processes and internal controls to ensure the quality of financial statements and the accuracy of financial reports.
Overall, inherent risk is a key element in a financial audit or analysis, and must be assessed by auditors and analysts for detecting errors in financial statements that could lead to misstated or inaccurate financial reporting. With a robust assessment of inherent risks, organizations can reduce their vulnerability to these errors and thereby protect the assets and financial security of the company.