• Definition of Inherent Risk:
Inherent risk refers to the risk of material misstatement in financial statements or other reports due
to the nature of the subject matter, without considering any controls in place. It arises from the
complexity, judgment, or uncertainty involved in the underlying transactions or calculations.
• Why This Is Inherent Risk:
The Federal Credit Reform Act requires complex calculations to estimate loan subsidies, interest
rates, and cash flows. These calculations inherently involve significant judgment and estimation,
making them prone to errors. This is a classic example of inherent risk because the complexity exists
regardless of controls.
• Why Other Options Are Incorrect:
A . Audit Risk: This refers to the overall risk that the auditor may issue an incorrect opinion. In this
case, the issue is about the inherent complexity of the calculations, not the auditor’s procedures.
B . Control Risk: This is the risk that errors will not be prevented or detected due to weak internal
controls. While control risk could contribute to misstatements, it is not the primary issue in this
example.
C . Detection Risk: This is the risk that auditors will not detect a misstatement. This risk relates to
audit procedures, not the inherent complexity of the calculations.
• Reference and Documents:
GAO Yellow Book on Risk Assessment: Explains inherent risk in the context of government financial
reporting.
AICPA Standards on Audit Risk (AU-C 315): Highlights inherent risk as arising from the nature of
transactions or subject matter.
