Arohan Annual Report FY 20-21

Auditor’s Report Key audit matter How our audit addressed the key audit matter Arohan Financial Services Limited Independent Auditors’ Report of even date to the members of Arohan Financial Services Limited on the financial statements for the year ended 31 March 2021 (cont’d) Impairment losses on loan assets and implementation of COVID-19 relief measures Refer Note 3(k) for significant accounting policies and Note 40 for credit risk disclosures As at 31 March 2021, the Company has reported gross loan assets of INR 463,585.68 lacs against which an impairment loss of INR 70,994.15 lacs has been recorded. The Company recognised impairment provision for loan assets based on the expected credit loss approach laid down under ‘Ind AS 109 – Financial Instruments’. The calculation of impairment losses on loans is complex and is based on application of significant management judgement and the use of different modelling techniques and assumptions which could have a material impact on reported profits. The Company has applied a three-stage approach based on changes in credit quality to measure expected credit loss on loans which is as follows: • If the loan is not credit-impaired on initial recognition, then it is classified in ‘Stage 1’ and its credit risk is continuously monitored by the Company i.e. the default in repayment is within the range of 0 to 30 days. • If a significant increase in credit risk since initial recognition is identified, it is moved to ‘Stage 2’ but is not yet deemed to be credit-impaired i.e. the default in repayment is within the range of 31 to 90 days. • If the loan is credit-impaired, it is then moved to ‘Stage 3’ i.e. the default in repayment is more than 90 days. The Expected Credit Loss (“ECL”) is measured at 12-month ECL for Stage 1 loan assets and at lifetime ECL for Stage 2 and Stage 3 loan assets. Significant management judgement and assumptions involved in measuring ECL is required with respect to: • determining the criteria for a significant increase in credit risk • factoring in future economic assumptions • techniques used to determine probability of default, loss given default and exposure at default. These parameters are derived from the Company’s internally developed statistical models and other historical data. Our audit focused on assessing the appropriateness of management’s judgment and estimates used in the impairment analysis through procedures that included, but were not limited to, the following: • Obtained an understanding of the modelling techniques adopted by the Company including the key inputs and assumptions. Since modelling assumptions and parameters are based on historical data, we assessed whether historical experience was representative of current circumstances and was relevant in view of the recent impairment losses incurred within the portfolios; • Considered the Company’s accounting policies for estimation of expected credit loss on loans and assessing compliance with the policies in terms of Ind AS 109; • Tested the design and operating effectiveness of key controls over completeness and accuracy of the key inputs and assumptions considered for calculation, recording and monitoring of the impairment loss recognized. Also evaluated the controls over the modelling process, validation of data and related approvals; • Tested the assumptions underlying the impairment identification and quantification including the forecast of future cash flows by corroborating it with the revised repayment schedules of the borrowers which included the impact of the moratorium and restructuring. Further, understood and challenged the aforesaid assumptions adjusted for COVID-19 pandemic through our understanding of the risk profile of the customers of the Company; 121