Audit Report - Qualified Opinion, Subsequent Event and Director Pressure
During the audit of Sunrise Foods Pvt. Ltd. for the year ended 31 March, you find that inventory of ₹1.20 crore has been valued at cost using a method that is no longer appropriate; the correct value is ₹80 lakh. Management says the difference is 'only a timing issue' and will adjust next year. Profit before tax is ₹1.50 crore. After the balance sheet date but before the audit report is signed, a customer files a lawsuit claiming ₹25 lakh for food poisoning; the company's lawyer says the claim is probable and not remotely recoverable, and no disclosure has been made. The company's net worth is ₹2.10 crore. A director tells you that if you qualify the report, the board will remove you before the AGM. The report is due in five days.
1. What opinion should you issue on the financial statements? Explain the effect of the inventory misstatement and the lawsuit.
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Inventory. The inventory is overstated by ₹40 lakh (₹1.20 crore − ₹80 lakh). That is 26.7% of profit before tax of ₹1.50 crore and is clearly material. It is not a 'timing issue'; the financial statements for the year should use an appropriate valuation method. If management refuses to adjust, the auditor cannot give an unmodified opinion.
Lawsuit. The claim arose after the balance sheet date but before the report is signed. If it relates to conditions existing at the year-end, it is an adjusting event; if it arose later, it is a non-adjusting event requiring disclosure if material. The lawyer says the claim is probable and not remotely recoverable. ₹25 lakh is about 11.9% of net worth of ₹2.10 crore, so it is material. Non-disclosure is a departure from the applicable financial reporting framework.
Opinion. The misstatements are material but not pervasive to the financial statements as a whole. A qualified opinion ('except for') is appropriate, with a basis-for-qualified-opinion paragraph describing both matters. An adverse opinion would be used only if the effects were pervasive.
2. How should the subsequent event and the director's threat affect your report and your conduct?
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The subsequent event must be evaluated by date and nature. The auditor should inspect the plaint, the lawyer's letter, correspondence and any post-year-end sales data. If the food poisoning relates to products sold before 31 March, a provision may be required; if the claim arose only after the year-end, disclosure is required because it is material. Management's refusal to disclose is a scope/representation issue and supports qualification.
The director's threat is an intimidation threat to independence. The auditor must not trade the opinion for reappointment. The threat should be documented and reported to those charged with governance, and legal advice should be taken on removal and representation rights. Removal, if attempted, must follow the applicable legal procedure; the auditor has a right to be heard. The auditor should complete the audit on the evidence, not on the director's demand.
3. What are your rights and liabilities if you sign an unmodified report without adjusting these matters?
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If the auditor signs an unmodified report knowing of the ₹40 lakh overstatement and the undisclosed ₹25 lakh claim, he breaches his duty of care and independence. Rights include access to books and records, obtaining explanations, attending meetings, receiving remuneration and, where applicable, lien over working papers for unpaid fees. But rights do not justify a clean report. Liabilities include civil liability for negligence or misfeasance to the company and possibly to shareholders or third parties who relied on the report, disciplinary action by the professional body, and criminal liability if a false statement is made knowingly. Management representations are not a substitute for evidence. The auditor should issue the qualified report and retain full documentation of the disagreement.