Factors Contributing to Inherent Risk Assessment
Due to the presence of strong competition betwixt businesses, they become vulnerable to many risks. Out of these risks, the inherent risk is that risk that will be present even if strong control measures are implemented by the business management. In simple words, because of the very presence of a business, inherent risks automatically arise. Besides, audit processes and other strategies even fail to identify such risks and as a result, businesses face immense difficulties in conducting their normal routine activities (Matthew, 2015). In relation to this, it can be observed that OneTel being an international telecommunication company had also suffered a major downfall due to the prevalence of inherent risks.
OneTel had business affairs all around the world and it was primarily based on technology and innovation. Furthermore, the company offered a broad variety of integrated goods and services to its subscribers or consumers that assisted it to procure the leadership position in this segment in the whole of Australia. In the starting phase, the company was primarily a market player that offered a variety of services to its customers, but with the due passage of time, many companies endeavored to occupy the leadership position in the same line of business. Since many companies joined the race of offering telecommunication services to the consumers, competition became very strong, and as a result, the prices of call rates and other services had to be deteriorated in order to implement a strong impact on the customers. In simple words, competitive prices were ruling in the telecommunication industry (Parker et. al, 2011). Besides, stricter competition betwixt major market players resulted in enhanced competitive prices in relation to telephony services, and other call related services. Since OneTel was the oldest player in this segment; it had already captured most of the share of the market and had procured a huge base of customers as well. However, with many other competitors arising in the business, the market share of the company started to deteriorate (Gaylord, 2001). The factors that would have resulted in the evaluation of inherent risks at the level of financial reporting are as follows:
- It could be observed from the financial statements of the company that its shares had been issued in an open market wherein from $355.6 million in the year 1999, it reported at $1225.6 million in the year 2000 (Gaylord, 2001). This gives rise to the fact that massive quantum of involved investments in a business provides a path for inherent risks to occur. In addition, complexities in a transaction also result in the generation of inherent risks in a business. Moreover, even though dematerialization of shares has assisted in creating a flexible level of control in the event of complex and huge transactions, yet inherent risks may tend to arise because there are billions of transactions and effective control procedures may not be able to mitigate every risk. Therefore, in relation to this, an effective process of inherent risk evaluation is the need of the hour.
- It could be observed from the cash flow statement of the company that there was a purchase of license transaction in the year 2000. Furthermore, transactions like purchase of license, amortization, capitalization, registration, and maintenance of such accounts is a very complicated procedure. These necessitate effective and uniform financial planning so that complications in future could be avoided. Moreover, evaluation of inherent risks in relation to such transactions is also of crucial importance. Computations like valuation of intangibles require effective interference from the management as well. Thus, an affixed quantum of care and risk assessment is the need of the hour in relation to such transactions as these can play a key role in generating various risks (Kedia & Philippon, 2007). Besides, such transactions are also vulnerable to frauds and misstatements. In addition to the above, the company has also procured huge borrowings and advances that range from short term to medium term to long term. Besides, this is evident from the financial statements of the company that the company has undertaken such transactions and as a result, these are very vulnerable to frauds and misstatements. Such misstatements or mistakes can be effectively taken into due consideration with the assistance of proper control measures (Matthew, 2015). Nevertheless, if not for frauds, such transactions possess ample amount of risks that may pave a path for inherent risks to arise. Hence, proper inherent risk assessment measures are also vital so that the risks associated with the transactions can be mitigated effectively.
- Abnormal items often form part of the financial statements of the company. These items necessitate proper risk evaluation mechanisms in order to mitigate the risks before it can hamper the affairs of the company (Kruger, 2009). Furthermore, there are massive garnered losses for the year at both the consolidated level of financial statements and at the entity level as a whole. Besides, the maintenance, calculation, writing off, etc of such garnered losses of the company is surely a complicated transaction wherein the interference on the part of the management and proper assessment of inherent risk processes is vital in nature. Moreover, in relation to the company, it could be observed that the value of its plant and machinery had been enhanced. However, it could be attributed to the fact that the company had purchased plant and machinery (Kruger, 2009). In relation to the same, purchase of such assets depends upon the management’s decision wherein their discretion is the only key towards the success of the transaction and vice-versa. In other words, what assets to purchase, how to purchase the assets, from where to purchase the assets, etc kinds of decision is to be made by the management and that necessitates proper inherent risk evaluation processes in place.
Strategic risks are the types of risks that are very important for the successful continuation of a business enterprise, and that necessitates prior caution and care. Moreover, loopholes can be generated if such risks are not properly assessed and mitigated by the management. These risks prevail at the superior level of the management and are subject to inefficient decision-making. In other words, these risks exist as the management may fail to make a proper decision or may not be capable of executing efficient plans and strategies (Jones & Hensher, 2007). Nonetheless, all the planning risks identified in the previous section like the purchase of a license, amortization, etc are recognized at the stage of strategic risk evaluation.
Inherent Risk Assessment at the Financial Report Level
Inherent risks primarily depend upon the judgment of individuals that is directly related to the measure of such risks. Moreover, control and detection risks can be mitigated but inherent risks necessitate prior caution and measures on the part of the management. Besides, even there are effective risks management measures implemented within a company, the likelihood of the presence of inherent risks would still not decline (Roach, 2010). The influence of such risks relies on many factors that are as follows:
- Taking into account the nature of the business, the most relevant factor that plays a key role in contributing towards the creation of inherent risk is the prevalence of a vast network of companies. All the network of companies including partnerships, joint ventures, etc contributes towards an enhancement in inherent risks. Besides, the broader is the network, the more possibility of an increase in inherent risks (Messier & Emby, 2005). There may be other entities as well that the company must sustain off its balance sheet. Nevertheless, the ability of the management to mitigate inherent risks deteriorates with enhancement of complexities within the management.
- Secondly, any abnormal activities or transactions also play a role in enhancing the inherent risks because such activities necessitate adjustments and speculations that give rise to inherent risks. Further, any activity that consists of forecasts and ideas of the management are also vulnerable to inherent risks because of the situation’s subjectivity (Livne, 2015). On a whole, there is always a risk whether it depends upon management ideas or estimates, or other abnormal transactions as a whole.
- The third factor that contributes towards an increase in inherent risks is the prevalence of related party transactions in a business. This is because of the existence of an emotional phase of the management towards any transaction. Therefore, related party transactions play a key role in increasing the inherent risks (Makela & Nasi, 2009). In addition, contraventions of potential debt covenants are also another factor that results in an enhancement of inherent risks. This can be proved in the case of OneTel wherein the company had borrowed massive loans and no borrowings can come without the presence of covenants. Therefore, contravention of such covenants can result in problematic scenarios. Nevertheless, repayment of loans, as well as their interests through other covenants, is not an absurdly easy task (Cook, 2001). This is because a risk of contravention of management is always prevalent in such scenario. In simple words, if the management attempts to exaggerate the performance, the risk may never be safeguarded or even identified as a whole (Gay & Simnet, 2015). Moreover, the efficacy of audit team can also assist in depleting the prevalent risks. However, it must also be noted that inherent risks can also be derived from the inability of the audit personnel, and this can be proved in the case of OneTel. Therefore, on a whole, an incapable audit team also plays a role in contributing towards the creation of inherent risks (Livne, 2015). In relation to this, proper training and education of audit personnel are the need of the hour that can assist in safeguarding and identifying the risks.
In relation to the going concern concept, it must be noted that a company is started with an aim to continue its operations for an indefinite period. Therefore, any affair like a decision, transaction, or event that can hamper this thought must be immediately looked after. Besides, every investor and stakeholder have expectations with the company that it will run forever and allow them to procure profits as well (Douglas et. al, 2015). Therefore, every small activity must be taken due care of so that the expectations of the investors and stakeholders are not hampered.
Hence, it is acceptable that every activity in opposition to the going concern concept measured and reported as low, medium, or high. Furthermore, it is significant for the directors and auditors to coordinate at their best possible ways in order to identify any issues that can influence the company’s going concern evaluation. Besides, unspecific or immediate financial crisis may be beyond reach but every controlled decision can assist in safeguarding such situation. There are various factors that can affect the going concern concept assumption of companies (Gay & Simnet, 2015). For instance, non-fulfillment of the covenants of creditors, significant failure of debt repayment, the inability of the company to tackle competition, regular losses, signs of withdrawal of credit assistance, etc. All these factors can result in significant losses of finance and the goodwill of the company as a whole, thereby affecting its going concern principle. Therefore, in order to safeguard such scenario, it is the responsibility of the management to exert a special interest so that there are minimal possibilities for frauds or errors. However, it is not guaranteed that every factor may be under the control of the management. It may happen that some factors are beyond the management’s control (Douglas et. al, 2015). For instance, the introduction of new products in the market that makes the company incapable of coping up with, natural disasters, etc are some of the factors that can not only affect the going concern assumption but are also beyond the management’s control.
Thus, in relation to the above-mentioned discussion, it is notable that development of an effective parameter is the need of the hour so that it can assist in depicting the management the intensity of the situation, and how rapidly it must be looked after. Hence, a reflector of low, medium, and high scenario, in order to judge how worse the scenario is and how manageable is the situation, can be implemented by many companies so that the upcoming problems can be avoided. Moreover, this can also assist in understanding the overall situation of a company, thereby ultimately resulting in an effective course of action.
References
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Gaylord, B 2001, Liquidation of One.Tel of Australia Is Outlined, viewed 14 May 2017 https://www.nytimes.com/2001/06/06/business/liquidation-of-onetel-of-australia-is-outlined.html?_r=0
Jones, S. & Hensher, D. 2007, ‘Modelling Corporate Failure: A Multinomial Nested Logit Analysis for Unordered Outcomes’, The British Accounting Review, vol. 39, no. 1, pp. 89-107. Kedia, S. & Philippon, T. 2006, The Economics of Fraudulent Accounting, Rutgers University, USA.
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Cook, T 2001, Collapse of Australia’s fourth largest telco adds to growing list of corporate failures viewed 14 May 2017, https://www.wsws.org/en/articles/2001/06/onte-j08.html
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Makela, H & Nasi, S 2009, ‘Social Responsibilities of MNCs in Downsizing Operations: A Finnish Forest Sector Case Analysed from the Stakeholder, Social Contract and Legitimacy Theory Point of View’, Accounting, Auditing & Accountability Journal, vol. 23, no. 2, pp. 149-74.
Messier, W & Emby, C 2005, Auditing & Assurance Services: A systematic approach, McGraw-Hill.
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Roach, L 2010, Auditor Liability: Liability Limitation Agreements, Pearson.
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