NFRA pushes for stronger auditor-audit committee coordination in companies to boost corporate governance

In a guidance published on its website, the National Financial Reporting Authority (NFRA) has said that audit committees, which are typically led by independent directors, need to have deeper interactions with companies’ statutory auditors for better understanding of future tax savings, profitability and liabilities. 

To be sure, NFRA’s guidance is addressed to all companies. Entities under its oversight include listed and large unlisted companies, insurance and banking companies and electricity utilities.

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According to NFRA, such close engagement will ensure that financial statements are not passed by the auditor in a routine manner. The idea is to ensure greater accountability of management judgements in financial statements by bringing in checks and balances so that the professionals tasked with governance oversight can detect signs of financial failure or fraud early on and prevent a collapse.

Audit committees in companies, which act independently of the management that prepares financial statements, asking critical questions to the statutory auditor of the company—another gatekeeper of corporate governance, will help in testing management assumptions thoroughly.

NFRA said that significant judgement is involved in assessing the likelihood of realizing deferred tax asset (DTA) or future tax savings. The audit committee should be informed about the methodology used to assess the recoverability of DTAs and impact on them from changes in business operations, tax laws, or economic conditions. 

Experts lauded the move, with Nemish Kapadia, partner at chartered accountancy firm Sudit K Parekh & Co LLP saying that effective two-way communication between the auditor and the audit committee (or those charged with governance in case of unlisted companies) is indispensable while conducting an audit of financial statements. 

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“This involves, among other things, discussion on key areas involving estimates and judgements,” Kapadia said. “Review of deferred tax assets, which inherently relies on assumptions regarding future taxable profits, including uncertain tax treatments, where material, can be one such area of discussion.” 

He added that the first line of defence in ensuring that the estimates are reasonable and the underlying assumptions are appropriate lies with the management and the internal controls they have established. “For the audit committee, review of these controls is critical in discharging their oversight responsibility,” said Kapadia.

“A constructive and informed dialogue on such areas between the auditor and audit committee where the company has one and ‘those charged with governance’, in case of other non-listed companies, can significantly contribute in achieving the defined goals of both the parties,” added Kapadia.

Advocacy is a key part of NFRA’s efforts to ensure that statutory auditors critically question the assumptions in financial statements and the assertions of the management. The audit watchdog has been making efforts to improve the credibility of the financial statements, which could further enhance the appeal of India’s corporate sector as an investment destination.

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Board of directors of companies are required to state in their annual report that they have opted for accounting policies and reasonable and prudent judgements to give a true and fair view of the state of the affairs of the company.