NFRA asks auditors to closely scrutinise ECL estimates, calls for stronger communication with audit committees, ETCFO
The National Financial Reporting Authority (NFRA), India’s independent audit regulator, has issued a new report, stressing on the need for stronger communication between auditors and audit committees regarding the audit of Expected Credit Loss (ECL) under Ind AS 109.
This report is part of NFRA’s ongoing commitment to improving audit quality and ensuring transparency in the financial reporting process. It encourages auditors and audit committees to collaborate effectively, focusing on areas critical to ensuring the integrity of financial statements, particularly in complex areas involving accounting estimates.
The NFRA’s report highlights the important role that audit committees must play in overseeing the audit of accounting estimates, especially ECL related to financial assets. The report stresses that audit committees need to engage in detailed discussions with auditors about management’s approach to estimating credit losses, which is an area involving significant judgment and complex modeling.
“The audit of ECL requires robust internal controls and expert judgment,” the NFRA report states. The document provides auditors with a set of questions that may arise during interactions with audit committees. For example, it asks auditors to verify the appropriateness of the approach adopted by management in recognizing and measuring ECL for different financial asset categories.
Auditors Urged to Validate Management’s ECL Models and ClassificationThe NFRA stresses that auditors must ensure that the management’s approach to ECL complies with the requirements laid out in Ind AS 109. Auditors are asked to scrutinize the classification of financial assets such as loans, trade receivables, and investments, verifying whether the appropriate ECL recognition is applied.
Has the auditor verified the appropriateness of ECL recognition and measurement approach adopted by the management for different classes of financial assets?NFRA report asks
This includes evaluating whether the simplified approach for trade receivables and lease receivables is correctly applied.The Importance of Internal Credit Risk Management Systems
The NFRA underscores that auditors must evaluate the effectiveness of internal credit risk management systems, especially for companies with significant loans or investments. Auditors are tasked with verifying whether the ECL estimates are based on reliable data and robust internal controls.
“Are there any indicators of increased credit risk, such as write-offs or litigation involving receivables?” the report queries, urging auditors to remain vigilant to signs of increased risk that could affect the accuracy of ECL estimates.
Special Attention to Related Party Transactions
The report draws attention to the need for auditors to examine related party transactions, particularly loans and receivables involving promoters or related entities. NFRA stresses that auditors must verify the creditworthiness of these transactions to ensure adequate ECL provisioning.
Has the auditor verified the business rationale of transactions or the creditworthiness of related party entities?The report asks
Auditors are also encouraged to look for any changes in business terms that could impact ECL provisioning.
Expert Judgment and Independence
Considering the complexity of ECL calculations, particularly in financial institutions such as Non-Banking Financial Companies (NBFCs), the NFRA highlights the importance of subject matter experts. Auditors are reminded to evaluate the independence and objectivity of any expert used by management in formulating ECL estimates.
“Has the auditor evaluated the objectivity of management’s experts and ensured that their work is suitable for audit purposes?” the report queries, reinforcing the need for independent judgment in the audit process.
Adherence to Global Standards and Regulatory Guidelines
NFRA also highlights the importance of aligning auditing practices with international regulatory frameworks such as the Basel Committee on Banking Supervision (BCBS). Auditors are encouraged to refer to BCBS guidelines, which provide valuable insights into auditing ECL, particularly in financial institutions.
Has the auditor considered regulatory guidance such as the BCBS’s expectations on ECL?The report asks
Strengthening Audit Quality through CollaborationNFRA’s report concludes by calling for enhanced collaboration between auditors and audit committees to ensure the thorough and transparent auditing of ECL. The document stresses that both parties share the goal of protecting investor interests and maintaining the integrity of financial statements.
“Both auditors and audit committees must work together to ensure that the audit of ECL is thorough and transparent,” the NFRA report concludes.
