Ic systems

An auditor will evaluate the effectiveness of ICs (through tests of controls) as a standard audit procedure and report deficiencies and recommendations to management – this is all routine.
If what you’re asking is can the auditor provide an assurance report on the effectiveness of internal financial controls (as well as an auditor’s report on the financial statements) – you have to recognise the self-review threat. To find guidance on this in the rulebook you have to recognise that providing assurance on ICs is an internal audit activity. For a PIE, what you suggest is not allowed (290.195). ICs are management’s responsibility, so for non-PIE clients safeguards will be needed such as separate teams for the assignments.
Providing advice and recommendations to assist management in discharging their responsibilities is ok (290.161) as long as management takes all decisions/accepts responsibility for their actions (290.162).

In the context of the scenario the requested review would result in a report to the audit committee – although the word “assurance” isn’t mentioned, the concerns raised point to this. Mumbai is a PIE per last line of scenario – so not allowed.

The Q asks for ethical and professional issues.
Imagine the scenario …. you just signed off the auditor’s report a few weeks ago and now the client flags concerns about control issues and increased fraud risk …
Does that bother you? Why does that bother you? Did you know? Should you have known? What does it mean if you should have known but didn’t?
You will be better prepared for the exam if you think through and try and identify as many points for yourself – then read the answer.

If you see phrases you don’t understand you have to practice interpreting them as best you can – they don’t necessarily have a technical meaning – here there is a risk that “business practices are not efficient” – business/commercial practices are just what the business does (process/procedure/activity/tactic) to achieve its objectives – i.e. make money. So if there is inefficiency it will be losing money.

It is unclear to me where you are seeing this “conclusion”.
The Q says that it is the audit committee that has now brought this to the attention of the auditor – indeed it is quite possible that some members of management could have been aware of issues but didn’t bring to the auditor’s attention.