Assessing the Inherent Risk of Selling Goods and Services
When performing an audit, you look at revenue transactions. As the auditor you need to factor in any inherently risky circumstances that affect the revenue accounts. Generally, you look at four inherent risk factors for revenue:
Industry-related factors: You consider any external events that have an effect on revenue and cash flow. Two examples are an increase in market share by the competition (meaning the competition is stealing your client’s customers) and a lessening of demand for the goods or services the company provides.
Complexity of revenue recognition: This risk factor means that the client uses detailed calculations to determine its revenue recognition. A good example is long-term contracts that span several accounting periods.
Difficulty of auditing the transactions: This factor shows up when revenue accounts include accounts that are difficult to audit because estimates or other revenue accounting theories are in use. Allowance for uncollectible customer accounts is an example.
You can find out the approach typically used in your audit client’s industry from internal research on the topic or by asking the client.
Misstatements in prior audits: Any account that reflects mistakes in prior audits is always deemed to be inherently risky.
If a company has never been audited, you do have some inherent risk, because your beginning balances in the financial statement account haven’t been verified as material correct by an audit. Follow your CPA firm policy in this arena, and query your audit team leader for guidance on treatment of beginning balances.