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Characteristics that tend to increase inherent risk:

•    General characteristics
•    Office characteristics
•    Engagement characteristics
•    Other considerations

Assessing inherent risk requires reviewers to evaluate the likelihood that the reviewed firm might perform engagements that do not conform to professional standards assuming that no system of quality control is in place. Both internal and external circumstances influence the assessed level of inherent risk. In practice, most firms have with have at least some characteristics that can tend to increase inherent risk. Some of the more common considerations that can affect inherent risk are listed below.

Given the inherent risks present, the firm then designs and implements quality control policies and procedures to mitigate the inherent risks.

• One or more partners have engagements in several specialized industries.
• Staff turnover within the firm is high or the firm is having a difficult time locating prospective staff.
• The firm is applying new or complex professional standards for the first time.
• Changes in regulatory requirements occur.
• Adverse economic developments exist in an industry in which the firm clients operate.

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• Number and size (in terms of accounting and auditing hours and personnel).
• Offices with one or a few engagements that comprise a significant portion of the office’s accounting and auditing practice.
• Offices with concentrations of high-risk engagements.
• Offices with a pattern of litigation or regulatory actions reported to the quality control inquiry committee.
• Offices identified in the preceding peer review or recent inspections as operating at a level significantly below the firm’s quality standards.
• Offices with many SEC clients.
• Offices with concentrations of new engagements that are SEC registrants for which the firm’s first report related to a period that ended during the peer review year.
• Offices with new SEC engagements since the prior peer review where, as reported in a form 8-K, or a similar public filing, (1) the former accountant resigned or declined to stand for re-election, (2) there was a reported disagreement over accounting principles or practices, financial statement disclosure, or auditing scope or procedure, or (3) there was a reportable event as defined in item 304(a)(1)(v)(A) through (D) of SEC Regulation S-K.
• Offices with an unreasonably large number of accounting and auditing hours per engagement partner.
• Offices with only one or a few engagements in a specialized industry.
• Offices recently merged, acquired, or opened.
• Offices not inspected or not scheduled to be inspected since the last peer review.
• Offices where individual partners practice in many industries.
• Offices in geographic areas that are experiencing economic hardships.
• Offices with numerous clients in industries experiencing economic hardships.

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• Engagements that are large in size, in terms of the number of personnel assigned and the hours required to plan and perform them.
• Level of audit and accounting services performed (for example, audit, review, or compilation of historical financial statements) is weighted toward engagements with higher risk.
• Engagements involving merged personnel, experienced personnel hired from other firms, and partners who also have office, regional, or firm-wide management, administrative, or functional responsibilities.
• Engagements identified in the firm’s system of quality control or guidance material as having a high degree of risk.
• Engagements where departures from professional standards and failures to comply with the firm’s quality control policies and procedures were noted in the preceding year’s inspection.
• Engagements that might be affected by possible weaknesses in the design of or compliance with the firm’s system of quality control alleged in litigation, proceedings or investigations, particularly in matters reported to the quality control inquiry committee.
• Engagements affected by recently implemented revisions of the firm’s quality control policies and auditing procedures.
• Engagements affected by recent professional standards.
• Engagements performed by personnel not routinely assigned to audit and accounting engagements.
• Clients in industries experiencing economic difficulty.
• Engagements with a high turnover of engagement personnel.
• Clients with complex or sophisticated transactions.
• Engagements from merged-in practices.
• Initial engagements.
• Engagements that might be affected by the same quality control deficiencies as those that may have been factors in losing other engagements.
• SEC Engagements.
• Engagements subject to Governmental Auditing Standards or otherwise subject to regulatory oversight.

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Firms should be aware of these risks as they perform monitoring, including inspection procedures. Peer reviewers and inspectors alike must also recognize that these risks can change year to year. Some additional symptoms of risk include:

• Engagements where work on segments has been referred to other firms, foreign offices, domestic or foreign affiliates, or correspondents.
• Engagements where one or more affiliated entities (for example, parent companies and subsidiaries or brother/sister companies) constitute a large portion of the firm’s overall clientele.
• Clients in poor financial condition.
• Engagements where significant reportable conditions or material weaknesses in the client’s internal controls were reported in the preceding year.
• Engagements where internal audit participation was extensive.
• Engagements where the work of specialists is used in significant areas.
• Engagements where MAS fees exceed audit fees.

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Peer Review Guide > Inherent Risk Indicators