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CA Intermediate · Auditing and Ethics · Audit of Items of Financial Statements

Auditor of Sagar Infra Ltd discovers that management has not made any provision for a lawsuit where the company's own legal counsel states the outflow is probable and the amount can be reliably estimated at Rs 80 lakh. Profit before tax is Rs 6 crore and the auditor judges the amount to be material but not pervasive. The company refuses to adjust. What is the correct audit report response?

The auditor should give a qualified opinion, stating the effect of the missing Rs 80 lakh provision. Under AS 29 a probable and measurable obligation must be provided for. The misstatement is material but not pervasive, so SA 705 requires a qualification, not an Emphasis of Matter, adverse opinion or disclaimer.

  1. AUnmodified opinion with an Emphasis of Matter paragraph on the lawsuit
  2. BQualified opinion (except for) describing the misstatement and its effect, because the omission of the provision is material but not pervasiveCorrect
  3. CAdverse opinion because a legal matter is involved
  4. DDisclaimer of opinion because management refused to adjust

Explanation

A probable, reliably estimable obligation requires a provision under AS 29. Non-recognition is a material misstatement; since it is not pervasive, SA 705 requires a qualified opinion. Emphasis of Matter cannot substitute for correcting a misstatement. Adverse applies only if pervasive, and disclaimer applies when evidence cannot be obtained.

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