Which of the following is an example of an 'Inherent Risk' factor?

Answer options:

The entity lacks a formal code of conduct.

The entity holds complex financial derivatives that are difficult to value.

The auditor fails to detect a material misstatement.

Bank reconciliations are not performed timely.

How to approach this question

Audit Risk Model: Inherent (Nature of account), Control (Internal systems), Detection (Auditor work). Complexity is Inherent.

Full Answer

B.The entity holds complex financial derivatives that are difficult to value.✓ Correct

Inherent risk is the susceptibility of an assertion to a misstatement that could be material, assuming that there are no related controls. Complex derivatives are inherently risky due to valuation difficulty.

Common mistakes

Confusing Control Risk (lack of checks) with Inherent Risk (nature of item).

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