Lesson: Residual Risk

Instructor: Nick Palazzolo

In this lesson, delve into the world of business risks with Nick Palazzolo, CPA, as he explores the concept of residual risk—one of the many types of risks that businesses must confront. Nick breaks down residual risk, highlighting it as what remains after management's efforts to mitigate it are applied. Besides discussing inherent risk, which exists independently of any action by management, he also walks through a memorable formula that helps illustrate how residual risk is calculated. By the end of the lesson, Nick ensures that a clear understanding is established of both the concept of inherent risk and how to figure out the level of residual risk after management intervention.

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Transcript

Instructor: Nick Palazzolo

Nick Palazzolo is head instructor of ExamPrep.ai CPA Review. Nick's teaching style is engaging & upbeat, combining practical Big 4 tax & assurance expertise with years of 1-on-1 coaching. His lessons are concise and emphasize what you need to know to pass. Whether you're a recent grad or working full-time, we’re confident you can conquer your CPA exams with Nick’s review.

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Now I was thinking about this before. We've got our types of risk. When it comes to management, we've got residual risk, you know, there's just so much risk. There's a lot of risk. Why does anyone go into business?

There's way too much risk in it. We've got a whole other lesson on our risk management and our handling of it. But here we'll just tackle these few types of risks. We've got residual risk. This is the risk that remains after management's efforts to identify and eliminate some or all types of risk have been made. Inherent risk is the risk that exists without management doing anything to curb it.

Now, I'm going to quantify this and please memorize this residual risk formula. So let's say inherently there's a risk factor of ten. I don't know what that means, but we're using my scale. Ten is in the middle of the road. Let's say 20 is the highest. Now let's say management takes four efforts, they take four efforts. And now what are we left with? We're left with residual risk. So this is inherent risk and inherent risk you might know or be familiar with from audit.

And if you haven't taken audit, you will see this again in audit. This is management's response. And then we have a risk factor of six. And this is residual risk. This is the risk left behind after Management does something.

All you got to know is to memorize this formula, memorize what inherent risk is and memorize what residual risk is. Know that residual risk is after Management does something.

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