Audit Risk Model and Professional Standards
Inherent risk refers to the propensity of asserting a material misstatement. The misstatement can occur either individually or as an aggregate. Inherent risk varies depending on the classes of transactions, account balances, and disclosure. Therefore, the risk can be greater in some assertions compared to others. For example, “the degree of misstatement is likely to be high in complex calculations compared to simple calculations.”
Moreover, cash is more vulnerable to being stolen compared to inventory. Accounts that are made from various accounting estimates are likely to be characterized by a high degree of uncertainty compared to those that are made from factual data. Inherent risks also arise due to external circumstances. For example, the high rate of technological innovation is likely to affect some businesses by making some products obsolete. Some of the products that are considered obsolete are likely to be overstated. Inherent risk can also be due to internal factors.
In the course of executing their duties, auditors should not decrease the audit risk to zero. Additionally, the auditor cannot be 100% sure that the financial statements he or she is relying on are free from relevant misstatements due to errors or fraud. This aspect underscores the inherent limitations of auditing, which makes most evidence and conclusions made by auditors persuasive rather than conclusive. The inherent limitations associated with a specific audit also arise from audit procedures and the financial reporting systems adopted by an organization. The existence of inherent risk in auditing underscores the importance of ensuring that audits are conducted at a reasonable cost and period. In summary, inherent risk cannot be zero.