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

Nimbus Pharma Ltd reports a claim of Rs 2 crore by a customer for defective supplies. The company's lawyer, in the legal confirmation letter, states that an adverse outcome is probable and the amount can be reliably estimated at Rs 1.5 crore. Management has only disclosed the matter as a contingent liability and made no provision. The amount is material. What is the correct audit conclusion?

The statements are materially misstated because a provision of Rs 1.5 crore should be recognised when an outflow is probable and reliably estimable. If management will not adjust, the auditor must modify the opinion, qualified or adverse depending on pervasiveness. An Emphasis of Matter paragraph cannot substitute for correction.

1. ADisclosure as a contingent liability is acceptable since litigation is ongoing
2. BThe financial statements are misstated because a provision for Rs 1.5 crore should be recognised, so the auditor should request an adjustment and, if refused, express a qualified or adverse opinion depending on pervasivenessCorrect
3. CThe auditor should only include an Emphasis of Matter paragraph with an unmodified opinion
4. DThe auditor should raise the provision to the full claim of Rs 2 crore