This is a composite, illustrative scenario, not an account of a named client. The company had recognised a deferred tax asset of roughly ₹1.1 crore against accumulated business losses carried forward from the two preceding years, on the basis that sufficient future taxable profit would be available to utilise those losses within the permitted carryforward period. When the audit asked for the profitability projection management said it had relied on in reaching that conclusion, no such document existed — the recognition had been based on a general verbal expectation that the business would turn around, not on any board-approved forecast, budget, or sensitivity analysis.
Why this is a recognition problem, not just a documentation gap
Recognising a deferred tax asset on carried-forward losses requires convincing evidence that sufficient future taxable profit will be available against which the asset can be utilised — a higher bar than for other temporary differences, precisely because a history of recent losses is itself evidence pointing the other way. Without a profitability projection to examine, there was nothing to test the recognition against: no revenue assumptions, no margin assumptions, no basis to assess whether 'sufficient future taxable profit' was actually probable or simply hoped for.
What the audit asked for, and what came back
- 01Requested the board-approved budget or forecast used to support recognitionNone existed for the period covering the loss carryforward window — only an informal operating plan for the next year alone, which did not even cover the full utilisation period.
- 02Checked the company's actual track record against its own past budgets, where any existedThe one prior budget that could be found had itself not been met, undermining confidence in an unwritten verbal expectation of a turnaround.
- 03Assessed whether any other convincing evidence existedA large committed order from a new customer, signed after the year end, was offered as support — relevant, but insufficient on its own to project profitability sufficient to absorb the full loss carryforward within the available period.
- 04Quantified the asset recognised against what could actually be supportedUsing only the evidence that could be substantiated, a portion of the deferred tax asset was supportable; the remainder was not.
| Amount | |
|---|---|
| Deferred tax asset recognised by management | ₹1.1 crore |
| Supportable against the new customer order and realistic near-term profitability | Roughly ₹0.4 crore |
| Proposed write-down for lack of convincing evidence | Roughly ₹0.7 crore |
What went into the file
- The request for a profitability projection and the documented absence of one, as the starting point of the finding.
- The assessment of the new customer order as partial, not full, support for recognition.
- The proposed adjustment and management's revised recognition after the discussion, scaled back to the supportable portion.
- A recommendation that any deferred tax asset recognised against loss carryforwards going forward be supported by a board-approved forecast at the point of recognition, not reconstructed after the fact when the auditor asks.
Regulatory requirement
Recognition of a deferred tax asset for unused tax losses requires convincing evidence, applying a more demanding standard than for ordinary temporary differences, that sufficient future taxable profit will be available. A recent history of losses is itself evidence against recognition unless there is specific, documented evidence to the contrary — a verbal expectation of a turnaround does not meet that bar.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Audit documentationHow to test deferred tax asset recoverabilityTrace every deferred tax asset to the temporary difference that created it, test the profit forecast behind recognition, and document the judgement rather than the arithmetic.
- Audit documentationAuditing the deferred tax reconciliation — the working paper mechanicsA deferred tax working paper is only as reliable as the asset-by-asset tax base comparison underneath it — the effective rate reconciliation at the top is just the output of that comparison.
- Audit workflow & automationMAT credit carry-forward audit under section 115JBThe MAT computation itself is one check. Whether the resulting credit is still available to carry forward, and whether it should be recognized on the balance sheet, is a separate and frequently skipped one.
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