Detection Risk

The term detection risk is indispensable for anyone preparing for the CPA exams, featuring prominently in the AUD section. It is the risk that an auditor’s procedures will fail to detect a material misstatement in the financial statements. Unlike inherent and control risk, which are entity-specific and beyond the auditor's control, detection risk is influenced by the audit procedures themselves.

The audit risk model typically summarizes the relationship as:

Audit Risk=Inherent Risk×Control Risk×Detection RiskAudit Risk=Inherent Risk×Control Risk×Detection Risk

Factors affecting detection risk include:

1. Level of Audit Work: The more comprehensive the audit work, the lower the detection risk.

2. Auditor’s Skill: The proficiency of the auditor can also influence detection risk.

Example: You’re auditing a large corporation with a complex network of overseas subsidiaries. If you choose to perform minimal testing on inter-company transactions due to time constraints, you would have a high level of detection risk for these transactions. The risk here is that material misstatements may exist that you won't catch due to the limitations of your audit procedures.