Detection Risk

CPA Exam Forum AUD AUD Review Detection Risk

This topic contains 8 replies, has 6 voices, and was last updated by  Nam 4 years, 9 months ago.

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    I understand that Detection Risk is the risk the auditor WILL NOT detect a misstatement, and that DR is under the external auditor's control. My hang up is its inverse relationship with RMM and substantive tests.

    If Detection risk is high, meaning the risk is high you don't find material misstatements, then the amount of substantive testing is lower. But that seems completely opposite of what it should be. If I'm not going to detect misstatements, I should have to INCREASE my substantive tests…

    What's even more frustrating is the fact I understand it's an inverse relationship so I can usually get the questions correct in MCQ, but I'm getting them right based on a formula and not my actual knowledge of it.

    Can someone help clarify! Thanks.



    I think what you're referring to is the acceptable level of risk. Remember that Audit risk = Detection x Inherent x Control. If the auditor assesses inherent and control at a low level, they can accept a higher level of detection risk and still keep the same audit risk. Since they can accept a higher detection risk, they can reduce their substantive testing.

    Another way to think about it is that detection risk is controlled by the level of substantive testing. To achieve a lower detection risk, you must increase substantive testing. If a high detection risk is acceptable, less substantive testing is required because you don't need to lower it.



    OHHHH think I got you.

    Because it's part of an equation to determine overall level of audit risk, it inter-relates. So if RMM is high, you are trying to LOWER detection risk by doing MORE substantive tests?

    <3 Thank you.



    Yep, you got it!



    “Because it's part of an equation to determine overall level of audit risk, it inter-relates. So if RMM is high, you are trying to LOWER detection risk by doing MORE substantive tests?”

    I know this is a nit-picky clarification, but you are trying to lower AUDIT risk by increasing your substantive testing. The auditor originally assesses risk before tests are performed. If IRR is assessed high, the DR is automatically low. They have an inverse relationship. If your DR is low, you HAVE to perform more substantive testing to ensure AUDIT risk is assessed at a low level.

    Like I said, not trying to be particularly anal…it's an important concept.



    If you have a high control risk, meaning you can't rely on the internal control structure, this will lead you to increase your substantive testing ( you need to do more evidence gathering as you cant rely on controls.) If you increase your substantive testing, this will drive down your detection risk due to the fact that you are looking at more evidence. If you were looking at less evidence, you would have a higher detection risk. So with that being said, detection risk will have an inverse relationship with the amount of substantive testing, inherent risk and control risk.



    AR= DR/RMM(IR x CR)



    Inverse as in being in the numerator while the other two being in the denominator.



    AR= DR x CR*IR

    > RMM = CR*IR

    *AR and DR has direct relation..

    *RMM & DR has inverse relation (Always)

    Concept –

    1) if there is more IR or CR – Auditor has to do more substantive testing to reduce the DR , which reduce the AR.

    2) But if IR or control risk is less, auditor can rely on company’s internal control and do less substantive testing. Therefore DR can increase . relying on company RMM(IR*CR) can increase audit risk..

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