Inherent Risk

Lecturer:

Introduction

Inherent risk refers to the risk that rises as a result of material misstatement in accounting transaction and financial statements due to omission and errors arising from other factors apart from failure of controls. Inherent risk is a risk of misstatement arising from a fraud or an error in a financial statement based on external auditor’s assessment regardless of the awareness of the management internal control systems[ CITATION Bra13 l 1033 ]. The inherent risks generally reflected in higher levels where there is high degree of estimation and judgment embraces in accounting decision making as well as where transactions involves is entirely highly complex. Complex transaction becomes difficult for the accountant to report accurate financial information except for the use of the work on an expert thus leading to higher chances of Inherent risk. The factors that enhance increases assessment of inherent risk includes:

  1. Lack of management well-vastness and competence

One. Tel communication describes a less significant managerial skills which work on the managerial emphasize to competently enhance accuracy in the financial transaction reported in annual reports[ CITATION Bra13 l 1033 ]. One. Tel communication company limited experience accentuates the high assessment of inherent risk of misstatement of financial transactions in the financial statements. The cash flow financial statement describes the negative cash and cash items from operating activities where the negative amounts should reflect positive amount due to cash receipts from the customers among other transactions. The negative balance however, show the changes of material misstatement arising from limited management experience thus leading to high assessment of inherent risk[ CITATION Edw10 l 1033 ]. The negative earnings of $ (282.0) available for appropriation indicates higher changes o material misstatement which arises from the factor of management limited experiences thus enhancing to higher degree of assessment of inherent risk in financial transactions.

  1. Unusual transactions with competitors such as Telstra’s Market share

One. Tel Company accentuates unusual transaction with the competitors such as Telstra’s in the market share. The unusual transaction such as irrelevant growth rates arising from the management practices of growth rate describes the higher chances of material misstatement and higher assessment of risk[ CITATION Sad16 l 1033 ]. The poor earning before amortization and tax of (230.4) accentuates less significant budgeted transaction thus raising high assessment of inherent risk. Furthermore. One. Tel Company describes a less significant financial entries as supposed to be disclose in detail in the financial reports thus describing higher changes of material misstatement and assessment of inherent risk.

  1. Complex business arrangements serving fully digitized networks

One. Tel Company serve in dynamic and competitive environments where the giant firms set pragmatic operational framework and industry accounting policies that suppresses the accounting arrangement of One Tel Company. The deregulation of the telecommunication industry heightens complex operational strategy which describe the low return as well as poor growth that raises high assessment risk offer the company annual reports transactions[ CITATION Pet10 l 1033 ]. The negative cash and cash items from operating and investing activities of (169.7) and (614.9) respectively accentuates poor growth significance due to the strategic compels business arrangement enhance by the deregulation bodies. Thus, the adverse earnings and cash retained in the business due to complex opportunities describes higher changes of misstatement due to complex arrangement and high level of inherent risk assessment.

  1. Discrepancies in business accounting records

One. Tel Company recognizes the availability of depreciation in the statement of comprehensive income statements which is ought to be added back in the cash flow statement since it is none cash items[ CITATION Hur13 l 1033 ]. One. Tel cross examination of the financial report (income and cash flow) statements describes the financial discrepancies that may have resulted as a result of the misstatement of transaction which rises the need of inherent risk assessment.

  1. Accounting methods which appears in favor form over substance

One. Tel Communication Company accentuates the high assessment of inherent risk of misstatement of financial statement as described in the reveals most of transactions are negative in income and cash flow statement[ CITATION Cip16 l 1033 ]. The cash flow financial statement describes the negative cash and cash items from operating activities thus reflecting the need of favoring the business over the competitive and earnings ratio to satisfy the users.

Auditing Standard No. 12 accentuates the assessment strategic business risk under several risk factors and procedures. Paragraph 4-58 of the stand gives ideal analysis of the auditor responsibilities based on the strategic risk assessment procedures. Some of the factors that an auditor should identify at initial stages includes,

  1. Accounting methods which appears in favor form over substance

The auditor’s engagement letter supposes the full responsibility in assessing for compliance as well as presentation of financial statement without any limitation. However, based on the pragmatic auditor responsivities, the accounting records with are presented in favor of substance identified at the strategic business risk assessment as required by the Auditing Standard 12 paragraph (46-48) through obtaining the analytical procedures.

  1. Lack of management well-vastness and competence

The less managerial competence is inherent risk assessment factor which provides significance offer the regulation on the misstatement of transition as a result of inherent risk. The audit assessment of the company’s policies should have a highlight of the current management competency in limiting the chances of misstatement in financial statements.

Question Two

Sale transactions are routine for many enterprises and do not represent a high risk that is abnormal. Sales for many organization are controlled through the use of cash registers and procedures that are detailed to reconcile the daily sales that have been recorded in the cash registry with deposits at the bank which is done on a regular basis. However, some entities may not have routine sales, or the company management may make a decision that overrides the normal processing to achieve a given sales or profitability goal[ CITATION Hur13 l 1033 ]. A significant percentage of fraud take place when revenue is recognized improperly. Hence for many entities, the sale transactions are considered to be a high inherent risk. The standard rule for recognition of revenue accentuates that it should be recognized when it is realized or if the income is realized and received. The auditor will seek to understand;

The principal operations of the entity which is the business that the entity engages. For example, One Tel was involved in the selling of mobile phones and One Net internet services. Their sale strategy heightened the provision of telecommunication services that were innovative and quality at prices below what the competitors were charging the customer[ CITATION Bra13 l 1033 ]. The company, for example, might enter into a one-off agreement to purchase communication equipment from one supplier and subsequently sell it to another supplier. The auditor thus needs to question whether the activity is above board. The process of earnings and the nature of commitments that seem to extend beyond the regular delivery of goods.

Complex sales transactions are often complicated to determine when the sale took place. The transaction might, for example, be structured in a way that the title passes to the buyer only when some contingent situation have been met. Some of the difficult audit issues encompass the determination on

  1. The point in time when the recognition of revenue is done

  2. The impact of items that are unusual and whether the title was passed to the purchaser.

  3. All the goods that have been recorded as sales have been shipped and that they were new goods.

The auditor can thus identify many of the risks when coming up with an adequate understanding of the risks of the business and the client control environment and the transaction types that were entered into by the client.

Receivables

The key risk associated with receivables heightens that the net amount shown in the financial statement is not collectible. The reason for this perspective may either be that the recorded receivables does not represent a solid reflection of the sums or there exists an allowance that is insufficient for the amounts that are uncollectible[ CITATION Hur13 l 1033 ]. Alternatively, the enterprise might be shipping goods that are of low quality hence pose a high risk of return. Moreover, the entity may elect to sell their products to new customers who have credit paying capacity that is questionable. Other risks may directly be linked to the sales contract nature which was written by the customer. Some of the risks that affect receivables;

  1. The trade of receivables was made with a remedy but documented as sales of the receivable rather than a transaction that is financial.

  2. The receivables are guaranteed as surety against particular loans. The disclosure of such restriction is needed.

  3. The classification of the receivable is incorrectly done as existing when the possibility of the collection in the next financial year is low.

  4. The collection of receivables is conditional on measures that are definite which currently is difficult to estimate.

  5. The requirement of payment is only when the purchaser sells the product to the final consumer in the chain of supply

The company may accept payment by use of cash in settlement of the transactions. For example, One Tel transactions for the purchase of mobile phones and internet services were settled using cash. It is predictable that a material percentage of the transactions were settled using this manner[ CITATION Pet10 l 1033 ]. Cash by its nature is considered to be a looked-for asset which is a focus to temptations. For this cause, there is a moderately high risk that money that is expected from the customers is embezzled by employees who are dishonest or other individuals. To reduce the prospect of the misdemeanors being noticed, the related individuals would try to find ways that douse the traces of such dealings from the records of the company.

Borrowings

The company seeks additional funds in the form of loans and which is paid back as principal and an interest rate that is predetermined. Borrowings are a key risk because the amount seeks to describe the solvency of the entity. An increase will heighten that the firm solvency increases. Additionally, the funds borrowed should highlight the intended use and an assessment given on the anticipated returns. Due diligence is important to be carried out with the aim of assessing the objectivity of seeking debt. The debt requires detailed plan since their relevance is on a continuous basis for many years in the financial statement. It is also important to assess the authority of issue for the debt as a measure to assess the inherent risk.

Question three

Going concern is an assumption that assumes that the business will remain in operation for the next foreseeable future without the purpose of liquidating. The assumption of going concern provides the benchmark to which the business will not be close after each financial period such that the financial transactions can be treated as carried down within the foreseeable year[ CITATION Edw10 l 1033 ]. The chances to which the business will remaining in operation is rated to base on the going concern assumption of high/low or medium. Determination of the rate of extend to which going concern assumption can be rated is based on two factors such as operating and financial indicators.

  1. Financial Indicators

The going concern is ascertained by the fact the business financial assets overshadow the business liabilities within the financial year. Furthermore, the financial liability of long-term borrowings are failing due for payment and the current assets are less significant to settle the liability the going concern risk is low while average rate of meeting the liability the assumption is rated medium and if the business is able to settle repayment then the risk is rated high[ CITATION Pet10 l 1033 ]. Based on the One. Tel Company experience insignificant financial ability to meet the repayments this this is rates low.

  1. Operational Indicators

The operational incentives heightens by the management efficiency to substantially enhancing regulation procedures as well as enhancing suppliers concern will determine the low chances of liquidation thus high rate of going concern.

Bibliography

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