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CA Intermediate · Auditing and Ethics · Risk Assessment and Internal Control

Under the Companies Act, 2013, the auditor of a listed company, Sagar Pharma Ltd, must report on internal financial controls. In the current year, testing shows a control over inventory valuation was not operating effectively, and the deficiency could result in a material misstatement not being prevented or detected on a timely basis, though no actual misstatement arose. Which conclusion is most appropriate for the report on internal financial controls over financial reporting?

This is a material weakness, so the auditor's report on internal financial controls is likely to be modified. A material weakness exists whenever a material misstatement might not be prevented or detected timely, even if none actually occurred.

  1. AGive an unmodified opinion because no actual misstatement occurred
  2. BTreat it as a material weakness, which may lead to a modified opinion on the adequacy or operating effectiveness of internal financial controlsCorrect
  3. CDisclaim reporting because inventory is outside internal financial controls
  4. DReport only to the audit committee and omit it from the audit report

Explanation

A material weakness exists when there is a reasonable possibility that a material misstatement will not be prevented or detected timely; an actual misstatement is not required. Hence the opinion on internal financial controls is likely modified. Omitting it from the report is wrong because the reporting is mandated under section 143(3)(i).

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