Inherent Risk Assessment in an Audit to Assess the Susceptibility

Question: Discus about the Inherent Risk Assessment. Answer: It is the responsibility of the auditor to determine the risk attached to audit while he is working with the clients. There are several kinds of risk; one of them is inherent risk. For the purpose of assessing this risk, auditor ignores whether the client has internal controls so that inherent risk can be mitigated (Internal control are the controls like financial statements secondary review).Strength of clients internal control is assessed when assessment is made about the control risk of the client. Auditors job for the purpose of assessing the inherent risk is to assess the susceptibility of the financial stamen assertions to material mistaken depending on the clients business nature. Below are the factors that may increase the inherent risk:- External and Environmental factors: - Below are few examples of external and environmental factors which may result in inherent risk. Rapid Change: Nature of business wherein inventory becomes quickly obsolete has higher inherent risk. Expiring Patents: Any business relating to industry like pharma also has risky external and environmental factors. Patents of drug expire ultimately and hence Pharma Company has to enter into competition with other manufacturers who are marketing the similar drug. Sate of the economy : Economic growth levels also impacts the external factors and hence impacts the business Availability of financing : Interest rates and other financial availability also impacts the external factor .If client faces issues in fulfilling the short term cash payments , availability of loans at low interest rate may result in client staying in business or shutting the same. Prior Period misstatements Any mistakes in previous years which were not material and if these mistakes exist in financial statements. Auditor has to collate current year and prior year misstatements to observed and analyze whether to adjust the books with total mistaken post clients approval Susceptibility to theft or fraud: If assets are prone to fraud or theft, the balance or account is expected to be risky inherently. For Ex- If most of the payments of client receive in cash from its customer, then this cash is more prone to fraud or theft as compared to credit card or payment by cheque. Similarly, small inventory items are riskier. (Loughran, 2017) In the given case, One Tel is a Telecom Company; the company has been established in the year 1995. The company engaged in offering a fully integrated product list including low-cost international and national calls, Internet services, prepaid and post paid calling cards plus GSM mobile phone services. The company works on the strategy of providing better and quality services to the clients at reduced cost. From the last annual report of the company i.e. for the year 2000, it was evident that out of the total sales that have been made in by the company, 64% of the sales come in from Australia. From the perspective of inherent risk assessment several factors that would have contributed to an increased inherent risk assessment at the financial report level for the company. One among them is the stiff competition that is already there in Australia in relation to the telecom industry. In the telecom industry, as per the US department of state, Telstras market share is around 57 per cent, Optus 31 per cent and Vodafone 11 per cent. (Source: US Department of State FY2001 Country Commercial Guide). The telecommunication infrastructure in Australia is very sophisticated in the world. In this situation, it is difficult for the management of Tel One Company to penetrate the existing market. As already provided, the Australian market meets out 64% of the total sales of the company. In this situation if by any means, there has been a decrease in the market share of the company in the country, the same will have a great impact on the sales of the company on a larger scale. This big inh erent risk for the company and in long run may impact the going concern of the company as well. This dependency of the management on Australian geography may act as an inherent risk. Further in the year 2000, the management of the company has made considerable expenditures in acquiring licenses worth more than $500 million. This is big expenditure from the standpoint of the company and the company has issued additional shares in this regard to meet out the payment requirements for the licenses. Being it has been just 5 years for the company and making such a huge investment in such a stage at times when the company has been incurring losses; it is a big inherent risk for the management and for the company. Further the company has been incurring huge losses in the year 2000. The operating loss of the company in the year 2000 was around $282 million which is relatively on a higher side increasing the risk for the company. During the strategic business risk assessment, the risk related to the dependency of the management on Australian geography exists. The management should admit the same and should take adequate steps to mitigate the same in long run. The management in this case should work on identifying new markets all across the globe and even work on increasing the sales volume in the existing market as well. In this situation, the management should work on looking in for developing nations for expansions. There are several inherent risk factors that would have contributed to an increased inherent risk assessment at the account balance level. In the year 2000, the management of the company has made considerable expenditures in acquiring licenses worth more than $500 million. The company at the same time has made considerable expenditure on the plant and equipments. This expenditure has been made by the management with an intention to increase the revenue and profit of the company. In spite of the losses the company has incurred huge losses. The operating loss of the company in the year 2000 was around $282 million which is relatively on a higher side increasing the risk for the company. This is big expenditure from the standpoint of the company and the company has issued additional shares in this regard to meet out the payment requirements for the licenses. Being it has been just 5 years for the company and making such a huge investment in such a stage at times when the company has bee n incurring losses; it is a big inherent risk for the management and for the company. In order to meet of the increasing capital expenditure, the management has issued additional shares and made borrowing from outside sources. This has turned out to be an additional risk for company at an account level as the same would put an additional interest cost charge on the profit and loss account of the company putting extra pressure and trued out to be an inherent risk for the company. Going concern has been regarded as a basic accounting assumption that needs to be adhered by the management of all companies. As per the concept all the transactions that have been entered into by the company should have been entered with an intention that the company will carry on business for longer period of time. At times of entering into the transaction it has been assumed that the company will carry on business for a longer period with an objective that the business will continue for the period till the business will not be able to meet out its commitments and objectives. In the case of One Tel, the area of going concern should be assessed as high. The business that needs to be carried out by the company should be done with the intention that the same should in no case hamper the going concern of the company. In the given case, the company faces stiff competition in Australia. In the telecom industry, as per the US department of state, Telstras market share is around 57 per cent, Optus 31 per cent and Vodafone 11 per cent. The telecommunication infrastructure in Australia is very sophisticated in the world. In this situation, it is difficult for the management of Tel One Company to penetrate the existing market. As already provided, the Australian market meets out 64% of the total sales of the company. In this situation if by any means, there has been a decrease in the market share of the company in the country, the same will have a great impact on the sales of the company on a larger scale. This in long run will affect the going concern ability of th e company, being if the sales fall, the management will not be in a position to meet out the basic needs of the company. The company in order to grow has made considerable investment in acquiring licenses and plant machinery and the management has to bear all related cost. This will affect the going concern of the company and thus, the company should be prioritizing the same and considering the going concern part on high mode. Conclusion Considering the overall position of the company and analyzing the financial health of the company by reviewing the balance sheet and profit and loss account of the company, it has been concluded that the financial health of the company is not very sound. The company has made considerable capital expenditure in increasing the sales and profit numbers but all turned out negative for the company and ultimately the company has to incur huge losses. The company in the year 2000 has ended up in making an operating loss of $282 million which is huge considering the capital expenditure that they have made in licenses and machineries. IN this situation, it is advisable for the management to look in for new market and should work on reducing their dependency on Australian market. The Australian telecom market is too condensed where the existing players have their fixed market share and it is very difficult to penetrate their existing share. The management in this case should work on identifyin g new markets all across the globe and even work on increasing the sales volume in the existing market as well. In this situation, the management should work on looking in for developing nations for expansions. References Loughran M, 2017, HOW TO ASSESS INHERENT RISK IN AN AUDIT, Viewed on 22nd May 2017, reterived from https://www.dummies.com/business/accounting/auditing/how-to-assess-inherent-risk-in-an-audit/