Inherent risk is a term used in the field of auditing to describe the risk that a company’s financial statements may be misstated due to errors or fraud, regardless of the effectiveness of the company’s internal controls. In other words, inherent risk is the risk that exists independently of the company’s internal controls and is not mitigated by those controls.
There are several factors that contribute to inherent risk, including the complexity of the company’s operations, the level of judgment involved in preparing the financial statements, and the degree of subjectivity in the estimates and assumptions used in the financial statements.
Inherent risk is a concern for auditors because it can affect the accuracy and reliability of a company’s financial statements. As a result, auditors must consider inherent risk when planning and performing an audit, and must design their audit procedures to appropriately address the inherent risk of misstatement.
To mitigate inherent risk, auditors may use a variety of techniques, including testing transactions and account balances, reviewing documents and records, and performing substantive procedures. Auditors may also use analytical procedures, which involve comparing financial data to industry benchmarks or to the company’s prior financial statements, to identify unusual or unexpected transactions or trends that may indicate inherent risk.
Overall, inherent risk is an important consideration for auditors, as it can have a significant impact on the accuracy and reliability of a company’s financial statements.