ReutersSometime in 2024, ‘derivative valuation‘– the hot potato in the IndusInd Bank story – dropped off the radar of the bank’s auditors just a year after they had spotted it as a sensitive issue.
In the IndusInd bank annual report of 2022-23, the bank’s auditors, MSKA Associates and M.P.Chitale & Co, had identified ‘Valuation of Derivatives’ as one of the ‘Key Audit Matters‘. However, it was no longer so in the audit report for the financial year 2023-24.
Under the accounting policy framework, key audit matters are items which according to the auditor’s professional judgment were the most significant in the audit of the financial statements of a particular period. In selecting them, an auditor takes into account matters where there is possibility of higher risks of misstatements, areas involving significant management judgement, and accounting estimates having a degree of uncertainty.
Under the circumstances, it is unclear why within a year ‘derivative valuation’ ceased to be a delicate subject for the auditors – particularly because 2023-24, as it now appears, was a crucial year for the bank. It was in September 2023 that the Reserve Bank of India had issued the directive that eventually drove IndusInd Bank to announce its derivative losses in March 2025.
Although the RBI circular became effective from the year beginning April 1, 2024, the possible impact of the regulatory action was widely known to the banking industry by the end of 2023-24 -especially those dealing with derivatives and its complex accounting rules.
A spokesperson for MSKA & Associates, a member firm of BDO India, declined to comment on the matter “owning to confidentiality considerations.” Neither IndusInd spokesman nor the relevant partner in the other audit firm M.P.Chitale & Co responded to ET’s email.
The standards on auditing developed by the Institute of Chartered Accountant of India (ICAI) does not necessarily require an auditor to update key audit matters included in the prior period’s auditor’s report. However, the guidelines say that “….it may nevertheless be useful for the auditor to consider whether a matter that was a key audit matter in the audit of the financial statements of the prior period continues to be a key audit matter in the audit of the financial statements of the current period.”
Under the sub-head ‘Key Audit Matters (Risk)”, the 2022-23 audit report of IndusInd stated that a significant degree of management judgment is involved in the application of valuation techniques through which the value of the bank’s derivatives is determined. “The financial statement risk arises particularly with respect to complex valuation models, valuation parameters, and inputs that are used in determining fair values,” said the report. In addressing this, the auditors said that they had obtained an understanding of the valuation process on a test-check basis, and examined samples to ensure that they complied with RBI regulations.
“After such observations, it is somewhat unusual that derivative valuation does not figure as a key audit matter in 2023-24. A plain explanation could be that the auditors were satisfied with the procedure followed by the bank,” said an accounting practitioner unconnected to IndusInd.
In September 2023, RBI told banks to follow the ICAI guidance on foreign currency derivatives. IndusInd, according to sources, followed accrual accounting in internal derivative transactions (between the asset-liability management desk and the bank’s treasury department) and mark-to-market (MTM) accounting for external derivative deals (between the treasury and another bank). Ideally, the two back-to-back transactions should largely offset each other. However, the accrual accounting allowed IndusInd to defer the losses on the internal transactions while book gains upfront on the back of MTM valuation on the external deals. If the bank had followed either accrual or MTM valuation for both the transactions, no questions would have been raised on the accounting policy. However, divergent accounting to show profits and later rolling them back to fall in line with the RBI circular resulted in the announcement of losses of ₹1,500 crore – a number which may be revised following the special and forensic audits that are currently underway.
