Tea machinery firm: five audit findings and one refusal
You are auditing Borgohain & Co., a partnership firm manufacturing tea machinery, for the year ended 31 March 2024. Profit before tax is ₹18,00,000 and total assets are ₹1,20,00,000. Your findings:
- Land and building costing ₹25,00,000 are mortgaged to a bank. The title deeds are stated to be with the bank, and the bank has not replied to your confirmation request.
- Trade receivables include ₹6,00,000 from a dealer who has been in liquidation since February 2024; no provision has been made.
- Closing stock of ₹42,00,000 includes machinery costing ₹8,00,000 sent to a dealer on a sale-or-return basis. The dealer has not confirmed acceptance, but the goods have been billed at ₹10,00,000 and recorded as a sale.
- A fixed asset addition of ₹3,00,000 is supported only by a handwritten estimate from a fabricator; there is no invoice and no proof of payment.
- Petty cash of ₹12,000 is short; the cashier says it was spent on urgent repairs and produces no vouchers.
Management refuses to make any adjustment, arguing that 'these are matters of judgement and anyway the amounts are small'.
1. For each of the five findings, state whether the issue is vouching, verification, or both, the audit evidence you would seek, and the accounting treatment you would insist on.
Read the worked answer
Vouching tests the documentary evidence behind a transaction; verification tests the existence, ownership, valuation and disclosure of an asset or liability at the balance sheet date.
| Item | Nature | Evidence / procedure | Treatment |
|---|---|---|---|
| 1. Title deeds with bank | Verification | bank's confirmation or custody certificate, loan agreement, bank statement, charge search, physical inspection of the property | disclose the asset as mortgaged; no adjustment |
| 2. ₹6,00,000 from a company in liquidation | Verification / valuation | liquidator's notice, legal advice, correspondence | provide for the whole amount unless a recovery is expected |
| 3. Sale-or-return goods | Vouching of the sale plus cut-off | the dealer's agreement and confirmation, delivery challans, post-year-end returns | reverse the ₹10,00,000 sale and receivable; retain the ₹8,00,000 in stock |
| 4. ₹3,00,000 addition on an estimate | Vouching | invoice, payment proof, physical inspection, fabricator's confirmation | capitalise only if the cost is supported; otherwise reverse |
| 5. ₹12,000 petty cash short | Vouching of petty cash | petty cash book, vouchers, IOUs, cash count | write off as a loss; consider whether it points to wider fraud |
Item 3 is the most often mis-handled: it is not merely a valuation question - the sale is not complete until acceptance, so revenue recognition must be reversed, not just discounted.
2. Quantify the aggregate effect of the findings on profit and decide the appropriate audit opinion, using materiality reasoning.
Read the worked answer
| Finding | Effect on profit |
|---|---|
| 2. Irrecoverable receivable | −6,00,000 |
| 3. Sale wrongly recognised (₹10,00,000 reversed; goods stay in stock at cost, already included) | −10,00,000 |
| 5. Petty cash shortage written off | −12,000 |
| 1 and 4 | unquantified - limitation and unverified asset |
Adjusted profit would be about ₹1,88,000, against reported ₹18,00,000 - a reduction of roughly 90%. On any reasonable benchmark (profit, total assets of ₹1,20,00,000), ₹16,12,000 is not 'small'; it is material and affects the understanding of the accounts as a whole.
Because the misstatements are both material and pervasive - they touch the revenue, receivables and stock figures that drive the reported result - the appropriate opinion on the financial statements as they stand is an adverse opinion, with a basis-for-adverse-opinion paragraph describing each item and its effect.
If management corrects items 2 and 3 and only the scope limitations of 1 and 4 remain, the analysis changes to a qualified opinion (or a disclaimer if the possible effects are pervasive). If the uncorrected amounts were material but not pervasive - say ₹1,50,000 against ₹18,00,000 - the answer would be a qualified opinion, not an adverse one. The auditor must also consider whether the going concern assumption is affected.
3. Management refuses to provide the bank confirmation and refuses access to the title deeds. What should the auditor do, and how does this scope limitation interact with the misstatements already found?
Read the worked answer
Step 1 - remove or reduce the limitation by alternative procedures. For the land and building: obtain a bank statement and loan account statement, request a certificate of custody from the bank branch in writing, inspect the mortgage deed and the search of charges registered, inspect the property and municipal/tax records, and check the partners' representation. For the ₹3,00,000 addition: inspect the asset, obtain the fabricator's confirmation, look for bank payments or a bank statement trace, and check subsequent depreciation treatment.
Step 2 - communicate. Put the request in writing to the partners (those charged with governance), explain the effect on the report, and ask them to remove the limitation. Record the refusal in the working papers and obtain written representation.
Step 3 - decide the modification. If the limitation remains and its possible effects are confined to specific items (land and building, one addition), issue a qualified opinion with a clear basis paragraph. If the possible effects are material and pervasive - for example, if the title to the entire premises cannot be established - a disclaimer of opinion is required.
Step 4 - interaction. A disclaimer and an adverse opinion cannot both be given for the same set of statements: a pervasive limitation takes the auditor to a disclaimer, while pervasive misstatement takes them to an adverse opinion. The auditor must weigh which is more representative. Refusal to allow access is itself a governance matter and should be reported to the partners in writing.