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

Sundaram & Co., Chartered Accountants, are engaged by Veda Pharma Ltd to carry out a financial due diligence of Zenith Labs Ltd, a target the client wants to acquire. During the work, the engagement partner finds that Zenith's receivables ageing shows a large balance outstanding for more than two years with no provision. Which action is most appropriate for the due diligence team?

The team should report the unprovided long-outstanding receivables as a finding that overstates earnings and net assets and recommend a valuation adjustment. Due diligence assesses quality of earnings and balance sheet reliability for the acquirer; it is not a statutory audit, and it does not direct the target's bookkeeping.

  1. AReport the unprovided old receivables as a finding affecting quality of earnings and net assets, and suggest an adjustment in valuationCorrect
  2. BIgnore the matter because due diligence covers only future projections and not historical balances
  3. CModify the statutory audit opinion of Zenith Labs Ltd for the matter
  4. DInstruct Zenith's management to book the provision before the team proceeds

Explanation

Financial due diligence examines the quality of earnings and the reliability of assets and liabilities. Under-provided old receivables overstate profit and net assets, so the team reports them and flags a price or adjustment. Due diligence is not a statutory audit, so no audit opinion is modified, and the team does not direct the target's accounting.

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