Which scenario would heighten an auditor's risk due to external economic conditions?

• A. Declining industry demand
• B. Bonded cash handlers
• C. In-transit deposits
• D. Depreciated equipment sold

Answer: (A)

External economic conditions can raise inherent audit risk because they influence the likelihood and potential magnitude of misstatements in financial statements independent of internal controls. When industry demand is declining, pressure on margins, rising default risk among customers, faster inventory obsolescence, and more aggressive accounting estimates (like impairment, revenue recognition, and reserve levels) become more likely. These factors make valuations and disclosures more uncertain and increase the chance that financial statement amounts are misstated, requiring the auditor to place greater emphasis on estimation uncertainty, impairment tests, and going-concern considerations.

The other scenarios relate more to internal controls or specific transactions rather than the broader external environment. Bonded cash handlers point to controls over cash, not macro conditions. In-transit deposits are a timing issue in cash receipts. Depreciated equipment sold concerns asset disposal and depreciation policy, not the external market context.