Risk Assessment

Risk assessment

Risk assessment, as a priority of risk management, contributes to one of the main components of internal control. The key objective of risk assessment is to critically examine risks that might adversely affect or hinder the accomplishment of entities’ goals (COSO 2013).

There are various reasons for its importance to not only accounting information system but also overall entities’ operation. The primary evidence is its relevance to control environment in internal control process. Since risks arise from both internal and external environment, consideration should be given in risk assessment process to both internal and external sources (COSO 2013). It is essential and critical for the entities to examine the influence of changes in external environment in which the entities operate, as these changes may lead to the uncertainty of internal control system. Once potential risks have been assessed, the methods of risk management could be accordingly determined. The other main aspect is its effectiveness for risk management as a fundamental tool. Risk assessment is integrated into business cycle covering planning, execution, and evaluation (PWC 2008). Through obtaining reasonable resources, the process of risk assessment helps to analyze and report business performance data (PWC 2008). Combined with some other relative factors, risk assessment has been regarded an indispensible part of control system.

The bankruptcy of Lehman is one typical example in which the unsophisticated risk assessment triggers the tragic fall (Investopedia 2008). For internal reasons, considerable and prudent risk assessment was absence before Lehman extended its business into subprime securitization filed (Ryback 2008). Additionally, risk appetite was established with overly confidence and defective examination, which was the cause of following delinquency. The credit crisis and the downturn of American housing market was the major external influence that eventually crashed Lehman (Investopedia 2008). The unforeseen loss, which was caused by external changes of economic environment, consequently demonstrated strong support for the lack of effective risk assessment.  Real changeable economic situation should be emphasized rather than overly depending on mathematic models for analysis. Although Lehman’s situation is much more complicated, the role of risk assessment is powerfully crucial in this case.