NFRA AUDITOR - AUDIT COMMITTEE INTERACTIVE SERIES – EXPECTED CREDIT LOSS

January 29, 2026

Introduction

NFRA stands for National Financial Reporting Authority. It was constituted on 01st October,2018 by the Government of India under Sub Section (1) of section 132 of the Companies Act, 2013

One of the auditing and accounting supervisory authority in India. It is entrusted with responsibility of overseeing quality of service of professions associated with ensuring compliance with such standards and suggest measures for improvement in the quality of service;

In course of implementation, there has been a serious requirement of communication between auditors and audit committee in particular drawing upon the requirements in the Companies Act 2013 (CA 2013), the two relevant Standards on Auditing (SA 260 (R) and 265), other related SAs and the Standard on Quality Control (SQC). Therefore, in accordance with NFRA’s obligations to suggest measures for improvement in overall audit quality and to promote awareness and significance of accounting and auditing standards, auditor’s responsibilities, audit quality, and keeping in view NFRA’s objectives of protecting public interest and investor protection, NFRA is commencing with this series of Auditor-Audit Committee Interactions, which will be issued on significant areas of accounting and auditing, from time to time.

Expected Credit Loss: IND AS references

IND AS 109 : Recognition & measurement of ECL.

IND AS 107: Credit Risk related disclosures

What is ECL Approach?

The credit risk and loss is identified on timely basis promptly - it begins at the time financial asset is accounted for and not at a later stage when objective evidences of losses appear and start to affect the account balances.

ECL applies to all types of financial assets such as investments, loans and advances , trade receivables , unbilled revenue, security deposits and bank balances. Also, loan commitments and financial guarantee contracts are subject to these ECL requirements.

COMPUTATION OF ECL

ECL computation are required to reflect time value of money i.e credit loss is measured based on present value of future cash flows. Additionally, ECL has to take into account future forecast economic conditions and is not just based on historical credit loss experience.

The expected credit loss will be measured at each reporting date.

Example 1

ECL provision to be created for FY 2023-24 is @ 6.77% of turnover. If Turnover for FY 2023-24 was Rs. 30,00,000, ECL to be created is as under

Rs. 30,00,000* 6.77% = Rs. 203,100/-

Example 2:

Imagine the following scenario:

Financial Instrument Carrying Value (Exposure - E ) : Rs. 5,00,000

Probability of Default in next 4 months (PD): 4%

Expected loss in case of default (EL): 30%

The formula for calculating 12-month ECL remains the same: ECL = E × PD × EL

Plugging in the values: ECL = ₹5,00,000 × 0.04 × 0.30 = ₹6,000

This ₹6,000 represents the allowance for credit losses based on the expectation of defaults occurring within the next 12 months.

CHECKLIST FOR AUDITOR’S CONSIDERATION

1. Has the auditor considered the changes and trends thereof, in the opening and closing balances, and reversals and charges to P&L on account of ECL?

2. Has the auditor considered the various classes of financial assets and verified the appropriateness of ECL recognition for different category?

3. Has auditor verified existence of sufficient internal control systems including robust credit risk management systems so that management estimates and judgments are appropriate and accurate in terms of IND AS 109?

4. Are there any unusual features of loans , advances or receivables which need to be addressed?

5. Do any of the financial assets comprise of related party transactions? If yes, then has auditor considered rationality of such RPT? Are there any clauses in the RPT agreements which shall have significant impact on the ECL provisioning?

6. In case of RPT, has the recoverability and accuracy of balances traceable?

7. Has the auditor relied on work of any experts to base his judgement ? If yes, then has auditor accessed data shared with such expert team and validated basis of opinion of expert team?

8. Does the entity approach of ECL meet the fundamental principles of IND AS 109?

AUDITING STANDARDS :

Following key SAs would be of interest to Auditors and Audit Committees

SA 540: Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures, is a Standard on Auditing (SA) issued by the Institute of Chartered Accountants of India (ICAI). It provides guidance to auditors on how to handle accounting estimates and related disclosures during an audit

SA 315 : Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment

SA 330: The Auditor’s Responses to Assessed Risks

SA 701: Communicating Key Audit Matters in the Independent Auditor’s Report