Now let's talk about one more component of audit risk and that is detection risk, and how it relates to audit risk. So, you see up here on the slide, audit risk being the product of risk of material misstatement, which itself by the way, remember, is the product of inherent risk and control risk. Okay. So what we have here. And, risk of material misstatement multiplied by detection risk. So the detection risk is really like the auditor's...analogous to the auditor's controls. Right? The management has what they can do to prevent or detect misstatements, and if they do a great job and the auditor can test their controls and document, yes they are doing a great job. The amount of residual assurance that's left for the auditor to get, before getting to that reasonable assurance threshold can be, not so large. Right? Can be actually, sometimes surprisingly small for the lay investor. So detection risk is the risk that the audit procedures performed by an auditor will fail to...and it's actually just defined in term of detect, but conceptually, outside of audit standards it's all about prevention as well. But if you're answering a CPA exam or like question, go with detect. So it's a risk that audit procedures performed by the auditor will fail to detect a material misstatement. This one, unlike inherent risk and control risk, is directly controllable by the auditor. The plan level detection risk is inversely related to the planned level of evidence needed. Right? So if you have to drive down overall audit risk because you think the risk of material misstatement is high, that means you're going to have to collect a lot of evidence as the auditor. Okay. Be careful what you're asked for on exams for this class, but in the real world or when you're studying for your CPA, if that's what you're going to do, are they asking you about how much evidence is needed? How much substantive evidence, substantive assurance is needed? That goes one direct...versus how much detection risk can you tolerate. The basic idea here is detection risk needs to be lower, it needs to be driven down when risk of material misstatement is higher. Okay? Now, I'm going to just do a little bit of jogging of your memory from the last lesson. Remember when I told you that, don't get too focused on just the audit risk model in its arguments, which is inherent risk, control risk, and detection risk and even goes farther than that I'll get to that in just a second. But I said, remember that you also care about your own business risk as the auditor, and of course the client's business risk. It may be that if you think and you're nervous about accepting this client, because perhaps you're worried about does client management have enough integrity for us to be associated with this client? Okay. If that's the case, you could have walked away, but you decided to bring the client on. You can very purposely say, we're going to have our acceptable audit risks, not only be as low as it needs to be to be in compliance with professional standards, but because we're a bit worried about the integrity of management, beyond its effect on the risk of material misstatement. Because we're worried about the possibility that there could be litigation after the audit. You can take that audit risk and not just stop at that minimum required hurdle by regulators, you can purposely draw it down and say, we're going to do more work than we otherwise would need. If you think about that, that is really... if you're familiar with insurance, that's really kind of an underwriting response to specific risks. So sometimes when I have people, you know...if you apply for life insurance, if I were to apply for a huge life insurance policy it's, maybe the company will say, yeah we'll do that, but Mark it's going to cost you a lot more money in your premium. Right? And before they even decide to issue the policy, what will they do? What do you think they'll do? If you've bought insurance, depending on your age you may have bought life insurance. If they're worried about you being an insurable risk, they will actually hire a physician and have you checked out. Sometimes a joke is, if you really want to know how healthy you are, just buy a very large life insurance policy, when you're above 40 anyway. So there's an underwriting element here.
