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CA Final · Integrated Business Solutions (Multidisciplinary Case Study with Strategic Management) · Advanced Auditing, Assurance and Professional Ethics

Case: Lakshmi Pharma Ltd has a bank credit facility with a covenant requiring a current ratio of at least 1.25. At the year end, the current ratio is 1.30 as per draft accounts. The audit team finds that Rs 8 crore of long-term debt falling due in 6 months was classified as non-current, and the lender has not agreed to roll it over. Current assets are Rs 130 crore and current liabilities in draft are Rs 100 crore. The company states it is a going concern. Which conclusion is correct for the auditor?

After reclassifying the Rs 8 crore debt as current, current liabilities become Rs 108 crore and the current ratio falls to about 1.20, breaching the 1.25 covenant. The auditor should require correction, evaluate going concern and its disclosures, and consider modifying the opinion if the issue remains.

  1. ANo issue arises because the draft ratio is above 1.25
  2. BAfter correction the current ratio is about 1.20, which breaches the covenant, so the auditor must require correction of classification and evaluate the going concern disclosures and opinion implicationsCorrect
  3. CThe ratio improves to 1.41 after reclassification, so no further work is required
  4. DThe classification error is irrelevant to the audit report because it is only a balance sheet presentation matter

Explanation

Debt due within 12 months must be current. Current liabilities become Rs 108 crore, so the ratio is 130/108 = 1.204, below 1.25. This breach could trigger repayment and raises going concern questions. The auditor must press for correction and, if not corrected, modify the opinion, and must evaluate the going concern disclosures. Check: 108 x 1.25 = 135 > 130, confirming the breach.

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