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

In auditing Mehta Pharma Ltd, the auditor identifies a long outstanding trade receivable of Rs 12 lakh from a customer which has been declared insolvent. Management has made no provision, arguing that a legal case is pending. What is the most appropriate audit response?

The auditor should evaluate recoverability using evidence like the debtor's insolvency and subsequent receipts. If a needed provision is not made, it is a misstatement whose effect on the audit report must be considered. A pending legal case does not by itself justify no provision.

  1. AAccept management's view since a legal case is pending, and no adjustment is needed
  2. BEvaluate recoverability using evidence such as the insolvency status and subsequent receipts; if a provision is warranted and not made, consider the effect on the audit report as a misstatementCorrect
  3. CConfirm the balance with the customer and rely solely on the reply as conclusive of recoverability
  4. DAdvise management to write off the balance directly against reserves

Explanation

The auditor must assess valuation using evidence about collectability. An insolvent debtor indicates likely impairment, so non-provision is a misstatement to be evaluated and, if material and uncorrected, reflected in the opinion. A direct write-off to reserves is not an acceptable treatment, and a confirmation reply alone does not establish recoverability.

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