WXY Biotech Ltd. is engaged in manufacturing specialised pharmaceutical products. During the financial year 2024–25, the company: Introduced a new…

Inherent risk is the susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements before consideration of any related controls as described in SA 200. There is always a risk that before considering any existence of internal control in an entity, a particular transaction, balance of an account or a disclosure required to be made in the financial statements of an entity has a chance of being misstated and such misstatement can be material. This risk is known as inherent risk. Inherent risk is higher for some assertions and related classes of transactions, account balances, and disclosures than for others. For example, it may be higher for complex calculations. In the given case, revenue-sharing agreements with foreign distributors and application of a newly issued Accounting Standard involving multiple performance obligations require complex judgment and calculations, thereby increasing inherent risk in revenue recognition assertions. Inherent risk factors are considered while designing tests of controls and substantive procedures. Category of auditor's assessment lower or higher, each category covers a range of degrees of inherent risk. Auditor may assess the inherent risk of two different assertions as lower while recognizing that one assertion has less inherent risk than the other, although both have been assessed as lower. It is important to consider the reason for each identified inherent risk even if the risk is lower, when auditor designs tests of controls and substantive procedures. For example, even if inventory valuation risk is assessed as lower, the auditor must understand why such assessment is appropriate in light of biotechnology products which may become obsolete quickly. External circumstances giving rise to business risks may also influence inherent risk. For example, technological developments might make a particular product obsolete. In the present case, rapid technological advancements in the pharmaceutical industry and recent insolvencies in the sector increase inherent risk relating to inventory valuation, going concern, and impairment of assets. Factors in the entity and its environment may also influence the inherent risk related to a specific assertion. Few examples of inherent risks could include: An accounting standard provides guidance on some complex issue which might not be understood by the management. Therefore, recording of this issue in financial statements carries inherent risk of being misstated. In the given case, adoption of a new revenue standard increases such risk.There are large number of business failures in an industry. Therefore, assertions in financial statements of an entity operating in such an industry carry an inherent risk of being misstated. Here, recent insolvencies in the pharmaceutical sector increase inherent risk relating to recoverability of receivables and going concern assumptions. Inherent risk exists independently of internal controls and represents the susceptibility of assertions to material misstatement. In the given case, complex revenue arrangements, adoption of a new Accounting Standard, technological changes, and industry instability significantly increase inherent risk. Accordingly, the auditor must carefully assess inherent risk for each relevant assertion and design appropriate tests of controls and substantive procedures to obtain sufficient and appropriate audit evidence.