What does inherent risk assess?

Inherent risk refers to the potential for fraud or error in the absence of any internal controls. This concept recognizes that certain activities or transactions may carry risks due to their nature, regardless of how robust the internal controls are. For instance, complex financial transactions or operations in volatile markets might inherently possess a higher level of risk.

When assessing inherent risk, the focus is on identifying what could go wrong based purely on the characteristics of the processes or transactions themselves. This allows auditors to gauge how much risk exists before any mitigating controls are applied. By clearly understanding inherent risk, auditors can better evaluate the level of concern that should be addressed through robust internal controls and can tailor their audit approaches accordingly.

The other options, while related to the broader framework of risk assessment, do not accurately define inherent risk. The likelihood of internal control failure speaks to the effectiveness and reliability of existing controls rather than the risks posed by activities themselves. Evaluating the effectiveness of controls is a separate analysis following the understanding of inherent risks. Similarly, the impact of external factors on operations is concerned with external risks that may affect a credit union but does not focus on the intrinsic characteristics of the operations in question.