[ITCPA]

I have a question for the crowd here as I am confused about a particular risk relationship.

Given:

Client gets involved in new type of material transactions that they have little experience in.

Obviously inherent risk goes up.

The question(s):

Does detection risk also go up too? because technically (w/o the auditor increasing testing) there’s a greater probability for a material misstatement.

Or am I thinking about this wrong and the CPA would have to lower detection risk because inherent risk went up, but detection risk doesn’t go up (w/o action by CPA) just because inherent risk goes up?

Confused.

Thanks to anyone that understands this well and would be willing to help clarify.

[kb24]

Think of the formula AR = IR * CR * DR. In your example the increased chance of a material misstatement increases IR. This doesn't mean, however, that DR increases. Rather, it means that the overall audit risk will increase unless the auditor decreases DR. The auditor plans the audit such that the DR is low enough that AR is at an acceptable level given the IR and CR present at the firm.

Hope this helps.

FAR 4/1/11 - 89
AUD 4/15/11 - 85
REG 4/29/11 - 80
BEC 5/13/11 - 85

[ITCPA]

Wow, very well put. That makes sense now.

Thank you!

[Author]

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