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what is inherrent risk in audit risk

What is Inherrent Risk in Audit Risk?

Inherrent risk is the risk of misstatement that exists in an entity’s financial statements before considering the effectiveness of internal control. It is the risk that an auditor will not detect a material misstatement without considering the effectiveness of internal control. In other words, it is the risk that errors or fraud may exist in the financial statements which the auditor must be aware of and take into consideration when formulating the audit risk assessment.

Definition of Inherrent Risk

Inherrent risk is the risk that material misstatements exist in an entity’s financial statements before considering the effectiveness of internal control. It is the risk that an auditor will not detect a material misstatement without considering the effectiveness of internal control. In other words, it is the risk that errors or fraud may exist in the financial statements which the auditor must be aware of and take into consideration when formulating the audit risk assessment.

How is Inherrent Risk Determined?

Inherrent risk is determined through analysis of the nature of the entity’s business, its financial reporting and internal control systems. It is also determined through an assessment of the risks of material misstatement. The auditor must also consider the nature and extent of evidence available to support the financial statements.

Implications of Inherrent Risk

The presence of inherrent risk indicates the need for the auditor to perform additional audit procedures to evaluate the risk of material misstatement in the financial statements. This is because the auditor must consider the possibility that material misstatements may exist in the financial statements before considering the effectiveness of internal control.

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The Jaguar Bank of Indianapolis (JBI) starts operations on January 1, 2022 issuing equity amounting $100. JBI advertises an annual interest of 4% for its savings deposits, paid annually, and free checking accounts (i.e., no maintenance fee). On the first day of operations, JBI receives a total of $150 as checking deposits and $750 as savings deposits. The bank lends $700 for an annual interest rate of 8%. It purchases treasury bonds worth $150 which earns 5% per annum. JBI maintains $100 at the Fed and keeps the remaining liquidity in cash reserves. Federal Reserve pays 4.5% interest on JBI’s reserve account. However, JBI does not pay interest on checking accounts of its customers. JBI’s operational expenses during its first year of operations is $18 and the corporate tax rate is 25%. Shareholders of JBI receive 10% dividends. A customer withdraws $170 from her savings account. To pay that amount back, the Bank sells its Bonds portfolio for $120 making a loss of $30 and withdraw another $50 from the account at Fed. Find the following. Find total liabilities

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inter-quartile