In this video, I will explain risk mitigation such as risk avoidance risk retention, risk transfer and risk reduction as covered on the tax compliance and planning section of the CPA exam.
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Risk control methods are strategies used to manage and mitigate potential risks. These methods can be broadly categorized into four types: avoidance, reduction, retention, and transfer. Each approach has its unique application depending on the nature and severity of the risk involved.

Avoidance: This involves completely steering clear of the risk. It's chosen when no effective response to the risk is available or when the risk is too high to manage effectively.

Alternative Example: Instead of investing in a volatile stock market, choosing to invest in more stable, low-risk government bonds.
General Example: Deciding not to engage in extreme sports to avoid the risk of serious injury.
Reduction: This strategy aims to lessen the severity or likelihood of the risk occurring. It doesn't eliminate the risk but makes it more manageable.

Alternative Example: To reduce the risk of data breaches, a company might implement advanced cybersecurity measures.
General Example: Installing smoke detectors in a home to reduce the risk of undetected fire.
Retention: This approach involves accepting the risk and dealing with any consequences internally, often used when the cost of transferring the risk (e.g., through insurance) is too high.

Alternative Example: A small business decides to retain the risk of minor customer injuries (like slips and falls) rather than purchasing extensive liability insurance.
General Example: Choosing to pay for minor car repairs out of pocket instead of making an insurance claim to avoid increased premiums.
Transfer: This method involves shifting the risk to another party, often through insurance contracts, hold harmless agreements, or other legal means.

Alternative Example: A contractor transfers the risk of construction accidents to an insurance company through a comprehensive insurance policy.
General Example: Renting a car with an insurance package, transferring the risk of damage or theft to the rental company.

An example covering all risk control methods could be a scenario involving owning a car:

Avoidance: Choosing not to own a car and using public transportation instead.
Reduction: Installing an advanced alarm system in the car to reduce the risk of theft.
Retention: Accepting the risk of minor dents and scratches, and paying for these repairs out of pocket.
Transfer: Purchasing car insurance to cover significant damages or losses due to accidents or theft.

Risk management methods are tailored to match the severity and frequency of potential losses. Different strategies are more suitable for different types of risks:

High Severity, High Frequency Risks - Avoidance: When risks are both frequent and have severe consequences, the best approach is often to avoid them entirely. For example, owning a vacation home in a flood-prone area could lead to frequent and costly damages. In such cases, avoiding the risk by opting to rent in that area instead of owning property can be a wise decision. Avoidance here means sidestepping the risk altogether because the combination of high frequency and high severity makes it too costly or impractical to manage in other ways.

Low Severity, High Frequency Risks - Reduction: Risks that occur often but have minor consequences are best managed through reduction. An example is the risk of theft, which can be frequent but generally does not result in devastating losses. Implementing measures like installing security cameras can reduce the occurrence of these risks. This approach doesn’t eliminate the risk but makes it less likely or less impactful when it does occur.

High Severity, Low Frequency Risks - Transfer: For risks that are rare but could lead to significant losses, transferring the risk is usually the most effective strategy. This is typically done through insurance. For instance, the risk of a major medical emergency is infrequent but can be financially devastating. By purchasing health insurance, the financial risk is shared with the insurance company. In this way, the potential high cost of a rare event is mitigated.

Low Severity, Low Frequency Risks - Retention: When risks are both infrequent and not very severe, retaining the risk is often the best approach. These are risks that don’t happen often and, even when they do, the financial impact is minimal. An example could be the minor wear and tear on home appliances. In such cases, it's more cost-effective to simply accept and deal with these risks as they come, rather than spending resources to avoid, reduce, or transfer them.


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