Certified Fraud Examiner Practice Exam 2025 – All-in-One Guide to Master Your Certification!

Inherent risk refers to the level of risk that exists in the absence of any controls or mitigating factors. It is the natural level of risk associated with an activity or process before any internal controls have been implemented. This risk is influenced by various factors, including the nature of the business, the environment in which it operates, and the complexity of its transactions.

Residual risk, on the other hand, is the remaining risk that exists after internal controls have been applied. It is the level of risk that remains even after management has implemented processes and procedures designed to mitigate the inherent risk. Organizations must continuously assess this residual risk to ensure that it remains at an acceptable level.

Understanding this distinction is vital for risk management. By recognizing that inherent risk exists without controls, and that residual risk reflects the impact of those controls, organizations can effectively evaluate their overall risk exposure. This knowledge helps in making informed decisions about additional controls needed to further reduce risk or to accept the existing residual risk level based on the organization's risk tolerance.

The other options do not accurately describe the relationship between inherent and residual risk, which centers on their timing in relation to internal controls.