My Vision Electronics Limited, a company engaged in the manufacture of consumer electronic products, was undergoing statutory audit for the year…

CA Intermediate · Auditing and Ethics · MTP · September 2026
My Vision Electronics Limited, a company engaged in the manufacture of consumer electronic products, was undergoing statutory audit for the year ended 31st March, 2026. During the planning stage, the audit team identified that the company had introduced a new range of technologically advanced products involving complex revenue recognition and valuation issues. The industry was also experiencing rapid technological changes, resulting in frequent product obsolescence. During the discussion on audit planning and risk assessment, an audit assistant stated that since the company had implemented a robust internal control system over financial reporting, there was no need to assess the possibility of material misstatements before evaluating those controls. He further stated that the same level of inherent risk should be assigned to all account balances and disclosures. The audit team was required to consider whether these views were consistent with the concept of inherent risk and its assessment under the Standards on Auditing. With reference to above facts, explain the concept of inherent risk. Also explain why inherent risk may vary across different assertions, how it is considered while designing audit procedures and illustrate your answer with suitable examples. Comment on the correctness of the audit assistant's views.

Suggested Answer and Working Notes:

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 have 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. 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. External circumstances giving rise to business risks may also influence inherent risk. For example, technological developments might make a particular product obsolete. 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: - i 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. ii 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. From the facts of the case, it can be concluded that the audit assistant's views are not correct. Inherent risk exists before considering the related internal controls and may differ from one assertion to another depending upon its nature and complexity. Further, factors such as complex accounting issues and rapid technological changes in the industry increase the inherent risk of material misstatement.

Topics: Risk Assessment and Internal Control

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