NFRA Raises Audit Bar, Warns Uncorrected Misstatements Can Distort Financial Statements

The National Financial Reporting Authority (NFRA) has urged statutory auditors to adopt a more rigorous approach while evaluating audit misstatements, cautioning that errors which may appear insignificant individually could become material when considered collectively or in the context of the financial statements as a whole.

The issue was discussed during an NFRA webinar on Standard on Auditing (SA) 450 — Evaluation of Misstatements Identified During the Audit. The regulator emphasised that auditors should not rely only on predetermined numerical benchmarks while deciding whether a misstatement is material. Professional judgement, qualitative considerations and the cumulative impact of identified errors must also form part of the assessment.

Auditors Have a Public Interest Responsibility

NFRA Chairperson Nitin Gupta, while addressing the webinar, highlighted the important role played by auditors in improving the credibility of corporate financial reporting.

The regulator's message was clear: the evaluation of misstatements is not merely a compliance exercise at the end of an audit. It is an important part of the auditor's responsibility to determine whether the financial statements, taken as a whole, are free from material misstatement.

Under SA 450, auditors are required to evaluate different categories of identified misstatements, including factual errors, judgemental differences and projected misstatements. The combined effect of these items must be considered before the auditor concludes whether the financial statements require correction, additional disclosures or, in appropriate circumstances, a modified audit opinion.

Communication With Audit Committees and Boards in Focus

NFRA also stressed the importance of timely and meaningful communication between statutory auditors and Those Charged With Governance (TCWG), including audit committees and boards of directors.

The regulator referred to its January 2026 circular concerning auditor communication with governance bodies. The framework places emphasis on timely discussions relating to matters such as:

• audit planning and scope;
• determination and revision of materiality;
• significant accounting and audit judgements;
• fraud risks;
• deficiencies in internal financial controls; and
• identified and uncorrected misstatements.

NFRA's focus on governance communication follows regulatory observations that, in some cases, important audit matters were either communicated late or were not adequately brought to the attention of those responsible for oversight of financial reporting.

Misstatements Should Not Be Examined in Isolation

Technical discussions during the webinar highlighted the need for audit teams to maintain a complete record of identified misstatements throughout the audit engagement.

Except for matters that are clearly trivial, identified errors should generally be accumulated and periodically reassessed. The auditor may also need to reconsider the audit strategy where the nature or volume of identified errors indicates a broader weakness in internal controls or suggests that further audit procedures are necessary.

The discussions also clarified that misstatements are not confined to incorrect numbers. They may also arise from:

• improper classification;
• incorrect presentation;
• inadequate or misleading disclosures; and
• inappropriate accounting treatment.

Accordingly, an error may require serious evaluation even where the reported profit remains unchanged.

Materiality Is Not Only About Numbers

One of the key messages emerging from the session was that audit materiality cannot be decided solely by applying a percentage to revenue, profit, net worth or another financial benchmark.

Qualitative considerations may make a comparatively small misstatement material. Examples discussed included circumstances where an error could affect:

• compliance with loan covenants;
• managerial remuneration;
• reported key performance indicators;
• regulatory compliance;
• investor understanding or decision-making; or
• the manner in which the company's financial position is presented.

This means that the nature and circumstances of an error may be as important as its monetary value.

Classification Errors May Also Be Material

The webinar also highlighted the importance of evaluating classification mistakes carefully.

An error should not be treated as harmless merely because it does not change the company's reported profit. Incorrect classification of current and non-current liabilities, operating and financing cash flows, or principal and agent relationships can affect the understanding of the financial statements and therefore require proper assessment under SA 450.

Auditors were encouraged to examine the effect of such errors on presentation, disclosures, ratios, contractual obligations and the overall understanding of the financial position of the entity.

Auditors Warned Against Repeating Prior-Year Assumptions

The technical discussions also cautioned against automatically carrying forward accounting estimates and assumptions from earlier years.

Areas such as expected credit loss provisioning, inventory valuation and other significant accounting estimates may require fresh assessment when economic circumstances, business conditions or risk factors change.

Auditors should therefore challenge management assumptions and assess whether estimates continue to remain appropriate for the current reporting period.

The discussions also drew attention to the risk of excessive provisioning. Overstatement of provisions can be used to create reserves that may be released in future periods, potentially affecting the fair presentation of earnings across reporting periods.

Prior-Year Uncorrected Errors Cannot Be Ignored

NFRA's webinar also underlined the need to consider uncorrected errors carried forward from previous financial years.

Where a prior-period misstatement continues to affect the current year's financial statements, the auditor must evaluate its impact along with current-year misstatements.

The audit team should assess:

1. the effect of each individual misstatement;
2. the aggregate impact of all identified misstatements;
3. quantitative materiality;
4. qualitative factors; and
5. the continuing effect of previously uncorrected errors.

The discussions further indicated that materiality determined during the planning stage should be reconsidered before the audit report is finalised, particularly where actual audited results differ materially from the financial information originally used to determine planning materiality.

Refusal by Management to Correct Errors May Affect Audit Opinion

Where management refuses to correct a material misstatement, the matter should be escalated to Those Charged With Governance.

The auditor must then evaluate whether the uncorrected matter affects the audit opinion. Depending on the nature and circumstances of the misstatement, the auditor may need to consider the requirements of SA 705 (Revised) relating to modifications to the opinion in the independent auditor's report.

The regulator's message indicates that unresolved material misstatements should not be treated as routine closing matters merely for the purpose of completing the audit on schedule.

NFRA Continues Push for Higher Audit Quality

The webinar forms part of NFRA's continuing efforts to improve audit quality and strengthen confidence in corporate financial reporting.

Through technical sessions, regulatory advisories, circulars and engagement with auditors and other stakeholders, NFRA has been placing greater emphasis on professional scepticism, audit documentation, governance communication and the proper evaluation of financial reporting risks.

The regulator has also indicated that further technical webinars are proposed during 2026-27, covering complex issues relating to auditing and financial reporting.

For statutory auditors, the broader takeaway is significant: audit conclusions should not be based merely on whether an individual error crosses a numerical threshold. The auditor must examine the nature, context, cumulative effect and qualitative significance of identified misstatements before signing the audit report. CA Sansaar