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CA Final · Advanced Auditing, Assurance and Professional Ethics · Due Diligence, Investigation & Forensic Accounting

During a pre-acquisition due diligence of Zenith Auto Components Pvt Ltd, CA Arjun finds that the target has a pending tax demand under dispute, which the target's management has neither provided for nor disclosed. What should the due diligence report ideally do?

The report should disclose the pending demand as a contingent exposure, stating its nature and amount and its possible effect on valuation or deal terms such as price adjustment or indemnity. Omitting it, assuming it is certain, or telling the acquirer only orally would be inadequate.

  1. AOmit the matter since it is unresolved and may favour the target
  2. BReport it as a contingent exposure with the nature, the amount involved and its possible effect on valuation or deal terms, such as price adjustment or indemnityCorrect
  3. CRecord it as a certain liability and reduce the target's net worth by the full demand in all cases
  4. DDisclose it only orally to the acquirer to avoid affecting negotiations

Explanation

Due diligence aims to identify risks that affect the acquirer's decision. A disputed demand is a contingent exposure that should be reported in writing with the amount and implications, such as price adjustment or indemnity. Treating it as certain presumes the outcome, and omission or oral-only disclosure fails the client.

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