What is Detection Risk?

Detection risk is the possibility that an auditor will not locate a material misstatement in a client's financial statements via audit procedures. This is particularly likely when there are several misstatements that are individually immaterial, but which are material when aggregated. The outcome is that an auditor would conclude that there is no material misstatement of the financial statements when such an error actually exists, which would then lead to the issuance of an erroneously favorable auditor’s opinion.

How to Reduce Detection Risk

The auditor is responsible for managing detection risk. The level of detection risk can be reduced by conducting additional substantive tests, as well as by assigning the most experienced staff to an audit. Examples of the tests that may be conducted are as follows:

Classification testing. Whether the client has recorded transactions and events in the proper accounts.
Completeness testing. Whether every transaction and event that should have been recorded by the client has in fact been recorded.
Occurrence testing. Whether the transactions and events recorded by the client have actually occurred, and whether they pertain to the client.
Valuation testing. Whether the assets, liabilities, and equity interests included in the client’s financial statements have been recorded at appropriate amounts.

There will always be some amount of detection risk in an audit, since audit procedures do not comprehensively examine every business transaction - instead, they only review a sampling of these transactions.

Detection is one of the three risk elements that comprise audit risk - which is the risk that an inappropriate auditor’s opinion will be issued. The other two elements are inherent risk and control risk.