NFRA Auditor-Audit Committee Interaction Series Pushes for Enhanced Communication between Auditors and TCWG
The Auditor-Audit Committee Interaction Series is part of an initiative by the NFRA to facilitate better compliance and monitoring practices amidst the Audit process
The National Financial Reporting Authority (NFRA) has released the second part of its Auditor-Audit Committee Interactions Series 1, focusing on enhancing communication between statutory auditors and those charged with governance (TCWG) with audit committees in particular. The first part of this interaction series was published on January 10, 2025, while the second part of the series...
The National Financial Reporting Authority (NFRA) has released the second part of its Auditor-Audit Committee Interactions Series 1, focusing on enhancing communication between statutory auditors and those charged with governance (TCWG) with audit committees in particular. The first part of this interaction series was published on January 10, 2025, while the second part of the series was released through the official website of the NFRA on March 7, 2025.
The initiative stems from the enforcement, review, and monitoring activities undertaken by the NFRA, highlighting the necessity to bring in structured and transparent communication between auditors and audit committees. The document extensively discusses the requirements laid out in the Companies Act, 2013, and the Securities and Exchange Board of India (SEBI) Listing Obligations and Disclosure Requirements (LODR) in relation to accounting estimates and judgments. The report also underscores the audit of Deferred Tax Assets (DTA) and Deferred Tax Liabilities (DTL) as per Ind AS 12 – Income Taxes.
Read More: NFRA Issues Guidelines on Auditing of Accounting Estimates and Judgments
Communication Methods
NFRA, through the series, reiterates the benefits that effective communication between auditors and audit committees can have in yielding high-quality financial reporting. The report suggests that auditors should engage in structured, documented discussions with audit committees, providing them with clear explanations of complex accounting estimates and judgments.
Furthermore, the Standards on Auditing (SAs) 260 (Revised) and 265 highlight the role of such communication, ensuring that material misstatements or issues requiring audit committee attention are addressed adequately. According to NFRA, auditors must proactively present their findings and concerns related to key financial areas, particularly those involving taxation and deferred tax estimates.
What the Companies Act, 2013 and SEBI Mandate
Section 134(5) of the Companies Act, 2013 requires the Board of Directors to confirm in the Director’s Responsibility Statement that accounting policies have been applied consistently throughout the audit process and that the financial statements present a true and fair view of the financial position enjoyed by the company. Similarly, SEBI (LODR) Regulations require audit committees to review major accounting entries, particularly those involving estimates and judgments exercised by management.
Audit committees have been advised to actively engage with auditors to ensure compliance with these legal requirements, ensuring that companies adopt appropriate accounting practices and adopt a transparent financial disclosure approach.
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Auditing Standards and Process
To maintain audit quality, NFRA endorses several key auditing standards, including:
SA 540 - Auditing of Accounting Estimates, including Fair Value Estimates.
SA 701 - Communication of Key Audit Matters (KAM) in the auditor’s report.
SA 260 (Revised) - Communication with those charged with governance.
Auditors must adhere to these standards to ensure that the methodologies for recognizing deferred tax assets and liabilities are robust and justified by appropriate evidence. Audit committees are encouraged to question auditors on these standards to ensure financial reports maintain integrity and accuracy.
The Accounting Process and Open Disclosure
Preparation and presentation of financial statements require management to make critical accounting estimates and judgments. According to NFRA, such estimates include the recognition and measurement of deferred tax assets, deferred tax liabilities, and uncertain tax treatments (UTTs) under Ind AS 12.
NFRA also urges audit committees to question and verify the assumptions made by management regarding tax-related financial reporting, ensuring that key disclosures align with regulatory requirements.
Deferred Taxes - Measurement of Assets and Liabilities
Deferred taxes arise due to temporary differences between the book values of assets and liabilities and their tax bases. NFRA outlines the key principles of Ind AS 12, which govern the recognition and measurement of deferred tax assets (DTAs) and deferred tax liabilities (DTLs).
Recognition of Deferred Tax Assets (DTAs)
Deferred tax assets are recorded when there is reasonable certainty of future taxable profits against which such assets can be utilized. NFRA highlights that the recoverability of DTA should be based on realistic projections of future taxable income and that companies mustassess whether sufficient taxable profits may be available for realization.
According to NFRA:
“Deferred tax assets related to carried-forward unused tax losses or credits are recognized only when there is convincing evidence that sufficient taxable profit will be available.”
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Recognition of Deferred Tax Liabilities (DTLs)
Deferred tax liabilities represent future tax obligations due to taxable temporary differences. An example of when DTLs arise is when tax depreciation rates differ from book depreciation rates, resulting in higher book profits but lower tax profits.
NFRA advises audit committees to ensure that DTL recognition is consistent and appropriately measured. Audit committees must also verify that tax laws and enacted rates are accurately applied in DTL calculations.
Measurement and Disclosure of Deferred Taxes
NFRA emphasizes that companies must:
● Apply tax rates enacted or substantively enacted at the reporting date.
● Disclose deductible and taxable temporary differences, unused tax losses, and tax credits.
● Provide clear explanations of how DTAs and DTLs are recognized, including assumptions used in their measurement.
The Audit Committee and Key Questions
To strengthen governance in financial reporting, NFRA lists potential questions that audit committees should query auditors on with regards to income taxes and deferred tax treatment. Some of the key questions suggested by NFRA include:
1. Has the auditor properly identified and applied relevant income tax laws at the reporting date?
2. What methodology was used to determine the recognition and recoverability of DTAs?
3. What factors were considered when assessing the sufficiency of future taxable profits for DTA realization?
4. Has the auditor independently verified the management’s assumptions regarding deferred tax assets and liabilities?
5. Has the company appropriately reflected tax law changes in its deferred tax estimates?
6. How does the auditor ensure the completeness of identified temporary differences?
The posing of queries by the Audit Committee is a significant determinant of how involved the Audit Committee is within the financial affairs of the company and strengthens transparency and reliability in financial statements while also giving tighter reins to the TCWG to steer the company.
Conclusion
The NFRA Auditor-Audit Committee Interaction Series 1 (Part 2) underscores the critical role of effective communication in ensuring the accuracy and reliability of financial reporting. With an increased focus on income tax accounting under Ind AS 12, particularly deferred tax assets and liabilities, the report is another guiding light for auditors and TCWG to strengthen governance and accountability in corporate audits.
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