Final answer:
It is true that auditors must understand internal control systems before assessing inherent risk. This understanding helps them evaluate how well the company manages risks and how they impact the financial statements. Without this knowledge, they cannot accurately measure the inherent risk associated with the company's financial reporting.
Step-by-step explanation:
The statement that the auditor must understand internal control before assessing inherent risk is true. Understanding the internal control systems of a company is a crucial step for an auditor in the audit process. By assessing internal controls, auditors can determine how well risks are managed within the organization, which in turn informs their assessment of the level of inherent risk associated with the company's financial statements.
Inherent risk refers to the susceptibility of an account balance or class of transactions to misstatement that could be material, either individually or when aggregated with misstatements in other balances or classes, assuming that there were no related internal controls. Internal controls, on the other hand, are processes put in place by the organization to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud.
Therefore, without an understanding of the internal control system, an auditor cannot accurately gauge the inherent risk. To provide a reasonable basis for their audit opinion, the auditor must assess both the design and implementation of relevant controls before evaluating the inherent risk associated with the financial statements.