What Is a Residual Security?
Residual risk refers to those risks that remain after the application of all control and risk management technologies and are not managed, that is, risks that are not effectively controlled by the enterprise (including strategic risks and process risks). Residual risk is the root cause of realistic business problems and accounting problems. It may lead to adverse business results, and in severe cases, it may also lead to the failure or bankruptcy of the business. In the face of strict market supervision and pressure from various parties in the society, the management of the audited unit is likely to have incentives to use financial reporting fraud to cover up unfavorable operations.
Residual risk
Right!
- Remaining
- Correct
- For strategic risks and process risks for each business process,
- Significance for registered accounting audit
- Affecting CPA expectations
- A certified public accountant's perception of a certain risk will affect his expectations of the financial consequences of this risk. For example, when it is understood that a competitor has caused a price war, if a client company takes measures to reduce prices as a countermeasure, the CPA will expect the audited unit to slow down its revenue growth, and its profit margin and inventory turnover rate may decline. If the company does not compete by means of price reduction but by means of improving service level, the CPA will form the expectation that the service cost of the audited unit will increase and the profit will decline.
- Affect the survival of the audited unit
- If a certain threat is serious, it may indicate that under the conditions of the current business plan and target market, the audited unit may not be able to survive. If this issue is critical, CPAs should consider the possibility of the company going bankrupt in the short term. Even if the company does not go bankrupt in the short term, CPAs need to consider whether this situation has been fully disclosed in the financial report.
- Impact on audit risk
- Certain threats may directly indicate that certain assertions in the financial statements may be inaccurate, that is, certain assertions are at high risk of misstatement. For example, threats from competitors or new entrants can lead to lost sales. If this threat causes obsolete inventory, valuation of inventory may be problematic. If the entire business relies entirely on making such obsolete products, there may be a wider issue of asset impairment.
- Affect control environment
- Some threats have a significant impact on controlling the environment, making management feel that the only response they can make is to take inappropriate action. For CPAs, this threat is very important because management authorities may perform accounting manipulation to camouflage their business failure. For example, stock options provide incentives for management to manipulate returns. Because the value of stock options is closely linked to the company's stock price, if bad news causes the company's stock price to drop significantly, management will suffer. This can lead to management manipulating accounting information to cover up bad news, and some manipulations are even allowed by accounting standards. Certified public accountants must be alert to the stimulus that can lead to management manipulation.
- Opportunities for value-added services
- The existence of residual risks indicates that the audited unit failed to take effective measures to respond to threats from the internal and external environment of the enterprise (such as failure to implement effective internal control). In this case, there is a potential need for the audited entity to improve risk management. This creates opportunities for CPAs to provide value-added services.