Definition: Detection risk is the possibility that an auditor fails to identify material misstatements in the financial statements of a firm and determines that there are no omissions or material errors before the statements are issued even though there are mistakes present.
What Does Detection Risk Mean?
What is the definition of detection risk? One of the most common mistakes that auditors do is to believe that a misstatement in a financial statement is trivial. This is true when examining the misstatements on an individual basis, but when accumulated, they may alter the result of the audit. Actually, the detection risk increases the audit risk at an above acceptable level, since the other two components of audit risk, inherent risk, and control risk, increase as a result of the business risk.
Let’s look at an example.
Mark is an auditor at a prominent auditing firm, and he is responsible for the audit of company ABC, a leading technology company.
Over the last month, the company’s manager has taken a false call, hence increasing the company’s business risk. This had an immediate impact on the inherent risk as the accountant of the company tampered into the financial information so that investors do not sell the stock of the company. However, the company’s management should act in good faith and provide accurate financial statements to the public. Also, the management should implement proper control mechanisms during the reporting procedure to lower the control risk.
Nevertheless, Mark fails to detect the misstatements in the company’s financial statements, and, therefore, the interpretation of the audit results is wrong. His colleague realizes that Mark was not strict in the implementation of the audit procedure, and he decides to apply another round of auditing to lower the risk, and eventually, the audit risk.
Therefore, at the day of the day, what Mark needed to do was to lower the risk of non-detection by applying stricter audit procedures.
Define Detection Risks: Detection risk means the chance that auditors will not catch a material misstatement in the financial statements before they are issued.