Auditing – Study Notes Chapter 11 Understanding of Entity and Inherent Risk Assessment

LO: BUSINESS RISKS AND RELATED AUDIT RISKS:

Category: Market Risk

Business Risk Related Audit Risk

Decline in market demand for a product.
Decreased consumer interest or increased competition Risk of overstatement in revenue and inventory valuation
leading to reduced sales. due to potential slow-moving or obsolete inventory.

Technological advancements by competitors.

Competitors introducing superior technology, leading Over-valuation of existing technology based inventory,
to loss of market share. impairment of assets.

Category: Credit Risk

Business Risk Related Audit Risk

High level of customer credit defaults.

Economic downturn leading to customers failing to Overstatement of accounts receivable and understatement of
settle their debts, increasing the likelihood of bad debts. provision for doubtful debts.

Changes in credit policy.

Lenient credit policies leading to increased credit sales Increased likelihood of bad debts, affecting the accuracy of
to customers with poor creditworthiness. revenue and receivables.

Category: Liquidity Risk

Business Risk Related Audit Risk

Inability to refinance short-term debt.

Challenges in renewing or obtaining new financing, Potential going concern issues and misstatement in the
impacting the company’s ability to meet short-term classification of debt.
obligations.

Category: Operational Risk

Business Risk Related Audit Risk

Supply chain disruptions.

Interruptions in the supply chain, affecting the Misstatement in cost of goods sold, inventory levels, and
production and delivery of goods. potential impairment of assets.

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Auditing – Study Notes Chapter 11 Understanding of Entity and Inherent Risk Assessment

Category: Compliance Risk

Business Risk Related Audit Risk

Non-compliance with new regulations.

Failure to adapt to new regulatory requirements, Misstatement due to fines and contingencies not accounted
leading to potential legal and financial penalties. for, and non-compliance with financial standards.

Violation of environmental laws.

Non-compliance with environmental regulations, Failure to recognize environmental liabilities and related
resulting in fines and remediation costs. expenses.

Category: Strategic Risk

Business Risk Related Audit Risk

Poor acquisition decisions.

Investing in acquisitions that do not align with the Overvaluation of intangible assets, goodwill impairment, and
company's strategic objectives or are overvalued. misstatement in long-term investment accounts.

Category: Reputation Risk

Business Risk Related Audit Risk

Negative publicity due to a scandal.

A scandal or negative event impacting the company’s Over/understatement of brand value and goodwill, and
reputation, potentially affecting customer trust and potential contingent liabilities.
business prospects.

Product safety issues. Liabilities related to product recalls and customer

Recalls or safety concerns about products damaging the compensation, and impairment of brand value.
company's reputation. Write-down of inventory to NRV.

Category: Technology Risk

Business Risk Related Audit Risk

Cybersecurity breach.
Unauthorized access to the company’s digital assets, Misstatement due to compromised financial data, potential
leading to data loss or theft. liabilities related to the breach.

Obsolescence of technology.
Rapid technological changes rendering current Risk of impairment of technology-based assets.
technology obsolete.

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 Auditing – Study Notes Chapter 11 Understanding of Entity and Inherent Risk Assessment

Category: Environmental Risk

Business Risk Related Audit Risk

Failure to meet environmental standards.

Non-compliance with environmental regulations, Misstatement due to unrecognized environmental liabilities
leading to fines and reputation damage. and potential impairment of assets.

Category: Political/Economic Risk

Business Risk Related Audit Risk

Changes in government policy or taxation.

New policies or tax laws that affect the entity’s Misstatement in tax liabilities, deferred tax assets, and
operations and financial position. potential fines for non-compliance with new policies.

Category: Closure of a factory/ Business Unit:

Business Risk Related Audit Risk

There is a business risk that the investment might not be The closure of the unit result that the plant may be
recovered if the demand is not generated in coming years. impaired and its impairment testing is not done properly.

Restructuring provision may not be appropriately

recorded.

Category: Manufacturing Risk:

Business Risk Related Audit Risk

In case, any injury occurs due to the fault in manufacturing There is a risk that an injury incident might have occurred
process, there is a risk that customers might stop or reduce its due to a fault of a product produced, which needs to be
orders. disclosed as a contingency or a provision might need to be
recorded.

Category: Foreign Currency Translation:

Business Risk Related Audit Risk

There is also a risk that the closing receivables in foreign There is also a risk that the closing receivables in foreign
currency may not be re-translated using the exchange rate of currency may not be re-translated using the exchange
the year-end date. rate of the year-end date. Similarly, the same effect also
needs to be taken in the foreign exchange gain or loss.

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