Detection risk (DR) is simply the risk that material errors in the financial statements will not be identified by the procedures applied by the auditors. Such errors may be due to either fraud or mistake. To identify these misstatements, auditors make use of audit procedures. This is especially possible when there are many mistakes that are individually immaterial, but which, when aggregated, are material. The consequence is that an auditor will assume that when such a mistake actually occurs, there is no material misrepresentation of the financial statements, which will then lead to the issuance of an erroneously favorable audit opinion.
In any case, in light of the idea of review techniques, some location danger will consistently exist. For instance, evaluators frequently test a particular sort of organization exchange on the grounds that looking at each exchange is unfeasible. Expanding the example size can diminish identification hazards, however, some danger will consistently remain.
(Example of Detection Risk)
“No risk, no business” is a traditional proverb, but each business seeks a smooth way to maximize profit. They want to reduce the risk factor because the risk is the thing that can be calculated to some degree for business professionals. Detection risk is one of the three elements that include audit risk, the different two being an inherent risk, and control risk. The auditor is accountable for managing detection risk. By performing additional substantive checks, as well as by appointing the most experienced personnel to an audit, the degree of identification risk can be minimized.
Detection risk will reach unreasonable levels if an auditor fails to enforce the correct audit procedures, incorrectly implements the correct procedures, or fails to correctly judge the results. There are many auditors in every corporate enterprise whose role is to ensure the company’s accuracy and efficacy with respect to asset management, transactions, and financial statement records. It’s significant for examiners to survey both control and inalienable danger first and afterward dole out recognition danger to bring the complete review danger to an adequate level. Other than this, the examiners look for picking different strategies from which they would have the option to quantify the future danger, the danger that may influence their business.
It is doubtful, however, that an auditor can fully remove the possibility of detection, simply because most auditors can never review every single transaction that makes up a financial statement. Rather, auditors should strive to keep the risk of detection at an appropriate level.
These are the three main components of detection risk (DR):
- Applying an audit procedure incorrectly. For example, by using ratios to measure the face value accuracy of an account balance, an auditor applies the wrong appropriate ratio.
- Incorrect audit testing method. Choosing an audit testing procedure that is not suitable for the type of financial account being audited, such as testing the invoice for consistency rather than the event of a specific transaction.
- Misinterpreting the results of the audit, or just evaluating the results wrongly.
Auditors use different risk assessment approaches, particularly the risk of material mistakes, which are considered to be the risk of detection by those small leftover pieces that escape from the procedure applied by the auditors to quantify the material mistakes. Detection risk might be higher in areas where administrative bodies are generally insufficient. There are various review methodology that evaluators use to limit detection risk, including classification testing, completeness testing, valuation testing, and occurrence testing.
Detection risk is linked up with the other ties i.e. The market risk, information misstatement risk, and it’s two components which are the control risk and the inherent risk. If the risk of material errors increases, the risk of identification is decreased and the risk of auditors increases. Depending on their given industry and business climate, inherent risk is often present and is unique to the organization. The inherent risk is the possibility that a material error occurs on the basis of these specified factors in the financial statements of the company.
The material risk increases when its components manage chance and inherent risk increases. Control chance is the chance that the company’s very own interior controls will be unable to prevent, detect or correct material misstatements or errors that are existing in the monetary statements. If the auditors recognize that there are weak internal control procedures in the business being audited, this risk would be measured higher. The risk partnership would assist management and auditors to try multiple successful ways to reduce all risk at a lower cost.