what is inherent risk in auditing

Inherent risk in auditing refers to the risk of a material misstatement in financial statements due to factors other than a failure of internal control. It is one of the three types of audit risks that auditors and analysts must consider when reviewing financial statements, along with control risk and detection risk. Inherent risk is most likely to occur when transactions are complex or require a high degree of judgment in regard to financial estimates. It is also common in the financial services sector due to complex regulations and the use of difficult-to-assess financial instruments. Inherent risk is related to the company, its environment, and its internal control, and auditors assess it using information obtained from performing risk assessment procedures and considering the characteristics of the accounts and disclosures in the financial statements. Inherent risk is highest when management has to use a substantial amount of judgment and approximation in recording a transaction, or where complex financial instruments are involved. Examples of inherent risk include transactions among related parties, which are often fraught with inherent risk due to the potential for conflicts of interest and increased risk of misstatement in financial transactions or other regulatory compliance violations.