Page 74 - CA Inter Bhaskar Vol 1

RISK ASSESSMENT AND INTERNAL CONTROL CA RAVI TAORI

Detection Risk Meaning: -
(MCQ-315.10) The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low
level will not detect a misstatement that exists and that could be material, either individually or
when aggregated with other misstatements.
Suppose auditor of a company uses certain audit procedures for the purpose of obtaining audit
evidence and reducing audit risk, but still there will remain a risk that audit procedures used by the
auditor may not be able to detect a misstatement which by nature is material, then that risk is AUDIT BHASKAR CH 03 - PART 01
known as Detection Risk.

Example
While auditing the books of accounts of Grateful Limited for the financial year 2020-21, the
auditor of the above mentioned company used various audit procedures, for example-observation,
inspection, reperformance, recalculation etc for obtaining audit evidence regarding stock, Debtors,
sales, purchases etc., and consequently reducing the audit risk. However, there will always remain
a risk that various audit procedures as used by auditor of Grateful Limited will not be able to detect
misstatements which are material in nature. This risk is known as Detection Risk.

Interrelationship of the components of audit risk:
Inherent and control risks differ from detection risk in that they exist independently of an audit of
financial information. Inherent and control risks are functions of the entity's business and its
environment and the nature of the account balances or classes of transactions, regardless of
whether an audit is conducted.

Even though inherent and control risks cannot be controlled by the auditor, the auditor can assess
them and design his substantive procedures to produce an acceptable level of detection risk,
thereby reducing audit risk to an acceptably low level.

For a given level of audit risk, the acceptable level of detection risk bears an inverse relationship to
the assessed risks of material misstatement at the assertion level. For example, the greater the
risks of material misstatement the auditor believes exists, the less the detection risk that can be
accepted and, accordingly, the more persuasive the audit evidence required by the auditor.

AUDIT RISK
Chart of
Audit Risk Risk that Auditor gives inappropriate opinion
Meaning In circumstances where there exist MMST
Auditor gives unmodified opinion
AR = RMM × DR
Equation
AR = IR × CR × DR
Risk that auditor reports MMST Insignificant Risk
when they don't exist (Rarest Chance)
Not included in
Loss of Reputation
Audit Risk Does not refer to auditor's
business risk because of Adverse Publicity
inappropriate opinion
Other related events

Audit risk Audit risk means the risk that the auditor gives an inappropriate audit opinion when the financial
(QNO- statement are materially misstated. Thus, it is the risk that the auditor may fail to express an
315.05) appropriate opinion in an audit assignment.
(MCQ-
Incs.10.2)

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