Read the business characteristics indicative of high inherent risk on page 145* of your text and think of a company that you would consider to be a risky audit. Go to the company's website and review their annual report and/or 10-K and read Management's Discussion and Analysis. What information concerning risk is in this discussion and what would the auditor need to consider in determining the audit risk and controlling it?
Financial statement assertions are important to auditors because they should consider audit risk at the assertion level for all significant account balances, transaction classes, and disclosures. Audit risk consists of (1) the risk of material misstatement of a relevant assertion related to an account balance, class of transaction, or disclosure and (2) the risk that the auditors will not detect such misstatement. The Risk of Material Misstatement (Inherent Risk and Control Risk) The risk of material misstatement may be separated into two components—inherent risk and control risk. Inherent risk is the possibility of material misstatement of an assertion before considering the client’s internal control. Factors that affect inherent risk relate to either the nature of the client and its environment or the nature of the particular financial statement element. Business characteristics of the client and its environment affect the inherent risk of the audit as a whole. Therefore, these characteristics affect the assertions about a number of financial statement accounts. For example, business characteristics such as the following are indicative of high inherent risk:
• Inconsistent profitability of the client relative to other firms in the industry.
• Operating results that are highly sensitive to economic factors.
• Going concern problems.
• Large known and likely misstatements detected in prior audits.
• Substantial turnover, questionable reputation, or inadequate accounting skills of management.
Your answer must be in your own words.
Approximate length: 1 to 2 double-spaced pages.