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

While auditing Sagar Foods Ltd for the year ended 31 March, the auditor finds that on 10 April the company's largest customer, owing Rs 90 lakh at the balance sheet date (total receivables Rs 4 crore), was declared insolvent following a collapse that had its roots in conditions before 31 March. The financial statements were approved by the board on 25 May, with no provision made. Which is the most appropriate audit response?

The auditor should treat the insolvency as an adjusting subsequent event, because it confirms conditions existing at the balance sheet date, and ask management to adjust the receivable. If management refuses and the amount is material, the auditor modifies the opinion under SA 560 and SA 705.

  1. ATreat it as a non-adjusting subsequent event and ask for disclosure only
  2. BTreat it as a subsequent event providing evidence of conditions existing at the balance sheet date, ask for an adjustment, and modify the opinion if management refusesCorrect
  3. CIgnore it because it occurred after the year end
  4. DWait until the next year's audit to deal with it

Explanation

Insolvency after year end that confirms the customer's deteriorated condition at the balance sheet date is an adjusting event under AS 4 and SA 560. The auditor asks management to adjust the Rs 90 lakh exposure (about 22.5% of receivables, material). If management refuses, the auditor modifies the opinion. Disclosure alone is wrong because the event gives evidence of an existing condition.

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