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

While auditing Himalaya Foods Ltd for the year ended 31 March, the auditor notes that a customer went into insolvency on 20 April, before the financial statements were approved. The customer owed a material amount at 31 March, and the insolvency stems from a deteriorating financial position that existed at the balance sheet date. Management has made no provision. What should the auditor conclude?

The insolvency is an adjusting event because it gives evidence of conditions that existed at the balance sheet date. The receivable should be provided for or written down. If management does not adjust and the amount is material, the auditor must modify the opinion. Mere disclosure is not enough.

  1. AThe event provides evidence of a condition at the reporting date, so the receivable should be adjusted; otherwise the opinion is qualifiedCorrect
  2. BIt is a non-adjusting event and needs only a disclosure in the notes
  3. CNo action is needed because the event occurred in the next financial year
  4. DThe auditor should defer the audit report until the insolvency order is final

Explanation

A customer's insolvency after the balance sheet date that confirms the deterioration existing at that date is an adjusting event, so the financial statements need adjustment. If management refuses, the misstatement is material and the opinion is qualified or adverse as appropriate. Treating it as a mere disclosure item is the common error and is wrong here.

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