CPA Exam — AUDAssessing Risk and Developing a Planned ResponseEasy
A public company client frequently engages in complex, non-routine transactions, such as business combinations and divestitures. These transactions often involve significant judgment and specialized accounting treatment. How would these types of transactions typically impact the auditor's assessment of inherent risk?
- AThey would primarily impact control risk, as management's controls over these transactions are critical.
- BThey would decrease inherent risk because they are typically reviewed by legal counsel.
- CThey would have no impact on inherent risk, as inherent risk only relates to routine transactions.
- DThey would increase inherent risk due to their complexity, judgment required, and infrequent nature.
Show answer & explanationAnswer & explanation
Correct answer: D. They would increase inherent risk due to their complexity, judgment required, and infrequent nature.
Complex, non-routine transactions inherently carry a higher risk of material misstatement because they often involve significant judgment, specialized accounting principles, and are less frequently encountered, meaning standard controls may not be adequate or well-established. This directly increases inherent risk.
Why the other options are wrong
- A. While control risk is also relevant, the nature of the transactions themselves, before considering controls, makes them more susceptible to misstatement, which is the definition of inherent risk.
- B. While legal review is important, the inherent complexity and judgment involved in these transactions still elevate inherent risk.
- C. Inherent risk applies to all transactions and balances, and is often higher for non-routine or complex ones.
Inherent Risk - Non-Routine Transactions
Non-routine transactions are those that occur only occasionally or are outside the normal course of business. They often involve significant management judgment and calculation, increasing their susceptibility to material misstatement.
- Often involve complex accounting principles.
- Less subject to established, routine internal controls.
- Require significant management judgment and estimation.
Memory trick: Unusual and Tricky = High Risk.