Audit of Banks
12.1 - Banking Operations
Q.1 There are different types of banks prevailing in India. Explain giving examples of such banks.
[MTP-March 21]
Ans.: Different types of banking institutions prevailing in India are as follows:
(1)Commercial banks are the widest spread banking institutions in India, that provide a number of products and services to general public and other segments of economy. Two of its main functions are:
(a)accepting deposits, and (b)granting advances.
(2)Regional Rural Banks known as RRBs are the banks that have been set up in rural areas in different states of the country to cater to the basic banking and financial needs of the rural communities. Examples are Punjab Gramin Bank, Tripura Gramin Bank, Allahabad UP Gramin Bank, Andhra Pradesh Grameena Vikas Bank, etc.
(3)Co-operative Banks function like Commercial Banks only but are set up on the basis of Cooperative Principles and registered under the Cooperative Societies Act of the respective state or the Multistate Cooperative Societies Act and usually cater to the needs of the agricultural and rural sectors. Examples are Gujarat State Co-operative Bank Ltd., Chhattisgarh Rajya Sahakari Bank, etc.
(4)Payments Banks are a new type of banks which have been recently introduced by RBI. They are allowed to accept restricted deposits but they cannot issue loans and credit cards. However, customers can open Current & Savings accounts and also avail the facility of ATM cum Debit cards, Internet-banking & Mobile banking. Examples are Airtel Payments Bank, India Post Payments Bank, Paytm Payments Bank, etc.
(5)Development Banks had been conceptualized to provide funds for infrastructural facilities important for the economic growth of the country. Examples are Industrial Finance Corporation of India (IFCI), Industrial Development Bank of India (IDBI), Small Industries Development Bank of India (SIDBI), etc.
(6)Small Finance Banks have been set up by RBI to make available basic financial and banking facilities to the unserved and unorganised sectors like small marginal farmers, small & micro business units, etc. Examples are Equitas Small Finance Bank, AU Small Finance Bank, etc.
12.2 - Auditing Framework
Q.2 “If an accounting professional, whether in the course of internal or external audit or in the process of institutional audit finds anything susceptible to be fraud or fraudulent activity or act of excess power or smells any foul play in any transaction, he should refer the matter to the regulator. Any deliberate failure on the part of the auditor should render himself liable for action”. Analyse and explain the above RBI Circular regarding liability of accounting and auditing profession. [MTP-Aug. 18]
Ans.: Reporting of Fraud to RBI:
Circular issued by RBI regarding liability of accounting and auditing profession, provides that “If an accounting professional, whether in the course of internal or external audit or in the process of institutional audit finds anything susceptible to be fraud or fraudulent activity or act of excess power or smell any foul play in any transaction, he should refer the matter to the regulator. Any deliberate failure on the part of the auditor should render himself liable for action”
This requirement is applicable to all scheduled commercial banks excluding Regional Rural Banks. Auditor is not expected to look into each and every transaction but to evaluate the system as a whole.
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While reporting such kind of matters as stated in the circular, auditor need to consider the provisions of SA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements”.
SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements” further expounds the concept and states that an auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.
Q.3 In the case of a nationalised bank, the auditor is required to make a report to the Central Government. The report of auditors of State Bank of India is also to be made to the Central Government and is almost identical to the auditor’s report in the case of a nationalised bank. Explain what would the auditor state in his report. [MTP-Oct. 18]
Ans.: Auditor’s Report in case of Nationalised Banks:
In the case of a nationalised bank, the auditor is required to make a report to the Central Government in which the auditor should state the following:
(1) Whether, in the auditor’s opinion, the balance sheet is a full and fair balance sheet containing all the necessary particulars and is properly drawn up so as to exhibit a true and fair view of the affairs of the bank.
(2)In case the auditor had called for any explanation or information, whether it has been given and whether it is satisfactory.
(3) Whether or not the transactions of the bank, which have come to the auditor’s notice, have been within the powers of that bank.
(4)Whether or not the returns received from the offices and branches of the bank have been found adequate for the purpose of audit.
(5) Whether the profit and loss account show a true balance of profit or loss for the period covered by such account.
(6)Any other matter which the auditor considers should be brought to the notice of the Central Government.
Q.4 Mr. Piyush, the Bank Manager develops controls to aid in managing key business and financial risks. Discuss the various requirements for an effective risk management system in a bank.
[May 19 (4 Marks)]
What are the general requirements of an effective Risk Management System in Banks? [MTP-Sep. 22]
Ans.: Understanding the Risk Management Process: An effective risk management system in a bank generally requires the following:
(a) Involvement of TCWG: Risk Management policies should be approved by TCWG. While approving the policies, TCWG should ensure that the policies should be consistent with the bank’s business objectives and strategies, capital strength, management expertise, regulatory requirements and the types and amounts of risk it considers as acceptable.
(b) Identification, measurement & monitoring of risks: Risks that may significantly affect the achievement of bank’s goals and objectives should be identified, measured and monitored against pre-approved limits and criteria.
(c) Control activities: Banks must have appropriate controls to manage its risks, including the following:
effective segregation of duties, verification and approval of transactions,
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Or
setting of limits, and reporting and approval of exception.
(d) Monitoring activities: Independent risk management unit should be set up which regularly assess the risk management models, methodologies and assumptions used to measure and manage risk.
(e) Reliable information systems: Banks must have a reliable information system that provide adequate financial, operational and compliance information on a timely and consistent basis to management and TCWG.
Q.5 You are appointed as an auditor of Banking Co., and hold discussions with engagement team. List out matters which you would discuss at planning stage of an audit to gain better understanding of the bank and its environment. [May 19 (4 Marks)] Or
The discussion between members of the engagement team members and the audit engagement partner should be done on the susceptibility of the bank's financial statements to material misstatements. Briefly discuss the points ordinari ly included in discussion of the engagement team. [Nov. 19 (3 Marks)]
Or
Discuss the advantages of engagement team discussion done at the planning stage of the bank audit. [July 21 (3 Marks)]
Or
The engagement team discussion ordinarily includes a discussion of the matters such as - Errors that may be more likely to occur; Errors which have been identified in prior years; Method by which fraud might be perpetrated by bank personnel or others within particular account balances and/or disclosures; etc.
In the above context, explain the advantages of such a discussion.
Ans.: Engagement Team Discussions:
[RTP-Nov.21]
Engagement team should hold discussions to gain better understanding of banks and its environment, including internal control, and also to assess the potential for material misstatements of the financial statements. All these discussions should be appropriately documented for future reference. The discussion should be done on the susceptibility of the bank’s financial statements to material misstatements. These discussions are ordinarily done at the planning stage of an audit.
Benefits of discussion:
Opportunity for team members to share their insights based on their knowledge of the bank and its environment.
Opportunity for team members to exchange information about the bank’s business risks.
To make an understanding amongst the team members about effect of the results of the risk assessment procedures on other aspects of the audit, including decisions about the NTE of further audit procedures.
Matters to be discussed:
(a)Errors that may be more likely to occur;
(b)Errors which have been identified in prior years;
(c)Method by which fraud might be perpetrated by bank personnel or others within particular account balances and/or disclosures;
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(d)Audit responses to Engagement Risk, Pervasive Risks, and Specific Risks;
(e)Need to maintain professional skepticism throughout the audit engagement;
(f)Need to alert for information or other conditions that indicates that a material misstatement may have occurred.
Q.6 As an Auditor of XYZ Bank Limited, how would you assess the Risk of Fraud including Money Laundering in line with SA 240? [Jan. 21 (3 Marks)]
Ans.: Assessing Risk of Fraud:
As an Auditor of XYZ Bank Limited, risk of fraud including money laundering would be assessed as explained hereunder which is in line with SA 240.
As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”, the auditor’s objective is to identify and assess the risks of material misstatement in the financial statements due to fraud, to obtain sufficient appropriate audit evidence on those identified misstatements and to respond appropriately.
The attitude of professional skepticism should be maintained by the auditor so as to recognise the possibility of misstatements due to fraud.
The RBI has framed specific guidelines that deal with prevention of money laundering and “Know Your Customer (KYC)” norms. The RBI has from time to time issued guidelines (“Know Your Customer Guidelines – Anti Money Laundering Standards”), requiring banks to establish policies, procedures and controls to deter and to recognise and report money laundering activities.
Q.7 Your firm of auditors, SRG & Co., has been appointed as Statutory Central Auditors of Reliable Bank. Explain the reporting requirements of the Statutory Central Auditors (SCAs) in addition to their main audit report. [RTP-May 21]
Ans.: Reporting requirements of the Statutory Central Auditors (SCAs) in addition to their main audit report:
Presently, the Statutory Central Auditors (SCAs) have to furnish the following reports in addition to their main audit report:
(a) Report on adequacy and operating effectiveness of Internal Controls over Financial Reporting in case of banks which are registered as companies under the Companies Act in terms of Section 143(3)(i) of the Companies Act, 2013 which is normally to be given as an Annexure to the main audit report as per the Guidance Note on Audit of Internal Financial Controls over Financial Reporting issued by the ICAI.
(b)Long Form Audit Report. (LFAR)
(c)Report on compliance with SLR requirements.
(d) Report on whether the treasury operations of the bank have been conducted in accordance with the instructions issued by the RBI from time to time.
(e)Report on whether the income recognition, asset classification and provisioning have been made as per the guidelines issued by the RBI from time to time.
(f) Report on whether any serious irregularity was noticed in the working of the bank which requires immediate attention.
(g) Report on status of the compliance by the bank with regard to the implementation of recommendations of the Ghosh Committee relating to frauds and malpractices and of the recommendations of Jilani Committee on internal control and inspection/credit system.
(h)Report on instances of adverse credit-deposit ratio in the rural areas.
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Audit of Banks
12.3 - Audit of Advances
Q.8 Mr. A approaches a bank for financial assistance for his upcoming project. The bank branch manager, after verifying the proposal, is agreeable to financial Mr. A, but asks for the security of be offered to the bank. Discuss the nature of securities required to be offered to the bank. [May 18 (4 Marks)] Ans.: Nature of Securities to be offered :
(a) Primary security: Security offered by the borrower for bank finance or the one against which credit has been extended by the bank.
(b) Collateral security: It is an additional security and can be in any form i.e. tangible or intangible asset, movable or immovable asset. Security may be created by different modes like Mortgage, Pledge, Hypothecation, Lien, Assignment.
(a) Mortgage: Registered Mortgage can be affected by a ‘Mortgage Deed’ signed by the mortgagor. Equitable mortgage, is affected by a mere delivery of title deeds or other documents of title with intent to create security thereof.
(b) Pledge: It involves physical delivery of goods by the borrower to the lending bank with the intention of creating a charge thereon as security for the advance. Legal ownership of the goods remains with the pledger while the lending banker gets certain defined interests in the goods.
(c) Hypothecation: Hypothecation is the creation of an equitable charge, which is created in favour of the lending bank by execution of hypothecation agreement in respect of the movable securities belonging to the borrower. Borrower holds the physical possession of the goods. Neither ownership nor possession are transferred to the bank. Borrower periodically submits statements regarding quantity and value of hypothecated assets (like stocks, debtors, etc.) to the bank on the basis of which the drawing power of the borrower is fixed.
(d) Lien: Lien is creation of a legal charge with consent of the owner, which gives lender a legal right to seize and dispose/liquidate the asset under lien.
Q.9 Your firm of Chartered Accountants has been appointed as the Auditor of two branches of OBC which are located in the Industrial area. Considering that the location of the branches of bank in industrial area, these would be advances oriented branches and audit of advances would require the major attention of the auditors. Advise how would you proceed to obtain evidence in respect of audit of advances. [RTP-May 18, MTP-Oct. 19]
The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation of internal controls relating to advances. Explain in the context of Audit of Banks. [RTP-Nov. 19]
Ans.: Collection of Evidences in respect of Advances: Evidences in respect of advances may be collected by performing compliance and substantive procedures.
Compliance Procedures (Evaluation of Internal Control) :
The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation of internal controls relating to advances, and by:
(i)examining the validity of the recorded amounts;
(ii)examining loan documentation;
(iii)reviewing the operation of the accounts;
(iv)examining the existence, enforceability and valuation of the security;
(v)checking compliance with RBI norms including appropriate classification and provisioning; and
(vi)carrying out appropriate analytical procedures.
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Audit of Banks
Substantive Procedures:
(a)Verify that amounts included in balance sheet in respect of advances are outstanding at the date of the balance sheet.
(b)Verify that advances represent amount due to the bank.
(c)Ensure that outstanding amount is appropriately supported by Loan documents.
(d)Ensure that there are no unrecorded advances.
(e)Verify the appropriateness of basis of valuation of advances.
(f)Ensure that the recoverability of advances is recognised in their valuation.
(g) Check that the advances are disclosed, classified and described in accordance with recognised accounting policies and relevant statutory and regulatory requirements.
(h)Ensure that appropriate provisions towards advances have been made as per the RBI norms.
Q.10 “Ramjilal & Co. had been allotted the branch audit of a nationalised bank for the year ended 31st March, 2023. In the audit planning, the partner of Ramjilal & Co., observed that the allotted branches are predominantly based in rural areas and major portion of the advances were for agricultural purpose.”
Now he needs your assistance on the following points so as to incorporate them in the audit plan:
(i) for determine of NPA norms for agricultural advances.
(ii)for accounts where there is erosion in the value of security/frauds committed by the borrowers. [Nov. 18 (5 Marks)]
Ans.: (i) NPA Norms for agricultural advances:
An agricultural advance is classified as NPA is interest and/or instalment of principal is overdue for two crop seasons, in case loans granted for Short Duration crops, one crop season, in case loans granted for Long Duration crops ( i.e. more than 1 year)
For this purpose, the following points are to be considered:
(1)Long duration crops mean the crops with crop season longer than one year.
(2)Short Duration Crops means the crops, other than long duration crops.
(3)Crop season means the period up to harvesting of the crops, as determined by the State Level Bankers’ Committee in each State.
(ii) NPA Norms where there is erosion in the value of security/frauds committed by the borrowers:
In case there arise erosion in the value of security or any fraud is committed by Borrowers, banks can directly classify these accounts as Doubtful Assets or Loss Assets, irrespective of the period for which the account has remained NPA.
(i)Erosion in the value of securities by more than 50% of the value assessed by the bank or accepted by RBI inspection team at the time of last inspection, as the case may be, would be considered as “significant”, requiring the asset to be classified as doubtful straightaway and provided for adequately.
(ii) The realisable value of security as assessed by bank/approved valuers/RBI is less than 10% of the outstanding in the borrowal accounts, the existence of the security should be ignored and the asset should be classified as loss asset. In such cases the asset should either be written off or fully provided for.
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Q.11 “The Auditor should examine the efficacy of various internal controls over advances, to determine the nature, timing and extent of his substantive procedures.” Discu ss briefly.
[Nov. 18 (5 Marks), MTP-April 19] Or
The auditor should examine the efficacy of various internal controls over advances in case of Banks to determine the nature, timing and extent of his substantive procedures. Explain what is included in the internal controls over advances. [RTP-May 19]
Ans.: Aspects of Internal Control in the area of loans and advances:
To determine the nature, timing and extent of substantive procedures over advances, auditor should examine the efficacy of various internal controls over advances. Aspects of internal control to be examined for this purpose are:
(1)Advances should be made only after evaluating creditworthiness of the borrowers and obtaining sanction from the proper authorities of the bank.
(2) All the loan documents like promissory notes, letters of hypothecation, guarantee letter, etc. should be executed by the parties before advances are made.
(3) While determining the loan amount to be sanctioned, sufficient margin should be kept against securities taken so as to cover any decline in the value thereof and also to comply with RBI directives.
(4)Securities should be received and returned by responsible officer and should be kept in the joint custody of atleast two responsible officers.
(5)Securities requiring registration should be registered in the name of the bank.
(6)In the case of physical possession of goods as security, the goods should be test checked at the time of receipts. In respect of hypothecated goods not in possession of the bank, surprise checks should be made.
(7)Personal inquiries should be made so as to determine market value of goods.
(8)For any increase/decrease in the value of securities, drawing power should be adjusted. All the accounts should be kept within both the drawing power and the sanctioned limit at all times.
(9)All irregular accounts should be brought to the notice of the H.O. regularly.
(10)The operation in each advance should be reviewed at least once every year.
(11)There should exist a proper system for post disbursement supervision and follow-up.
(12)Classification of advances should be made as per RBI Guidelines.
(13)Ensure that the funds disbursed should be utilized only for the purpose for which advances has been granted.
Q.12 Advances generally constitute the major part of the assets of the bank. There are large number of borrowers to whom variety of advances are granted. The audit of advances requires the major attention from the auditors. In carrying out audit of advances, the auditor is primarily concerned with obtaining evidence about, among other points, the amounts included in balance sheet in respect of advances are outstanding at the date of the balance sheet. Explain. [RTP-Nov. 19] Or
Advances generally constitute the major part of the assets of the bank. There are large number of borrowers to whom variety of advances are granted. The audit of advances requires the major attention from the auditors. Explain the broad considerations about which the auditor is primarily concerned with obtaining evidence in carrying out audit of advances. [RTP-May 21]
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In carrying out audit of advances, the auditor is primarily concerned with obtaining evidence about amounts included in balance sheet in respect of advances which are outstanding. Explain stating clearly all the considerations in this context. [RTP- Nov. 22]
Ans.: Auditor’s considerations while obtaining evidence in carrying out audit of advances:
In carrying out audit of advances, the auditor is primarily concerned with obtaining evidence about the following:
(a) Amounts included in balance sheet in respect of advances which are outstanding at the date of the balance sheet.
(b)Advances represent amount due to the bank.
(c) Amounts due to the bank are appropriately supported by loan documents and other documents as applicable to the nature of advances.
(d)There are no unrecorded advances.
(e) The stated basis of valuation of advances is appropriate and properly applied and the recoverability of advances is recognised in their valuation.
(f)The advances are disclosed, classified and described in accordance with recognised accounting policies and practices and relevant statutory and regulatory requirements.
(g)Appropriate provisions towards advances have been made as per the RBI norms, Accounting Standards and generally accepted accounting practices.
Q.13 “There is no difference in provisioning of NPA as regards to categories of NPA, whether the debt is secured or unsecured.” Critically evaluate the statement on the basis of provisioning norms of NPA of nationalised bank. [Nov. 19 (4 Marks), MTP-Oct. 21]
There are different provisioning requirements as regards to categories of NPA such as Sub -standards assets, Doubtful assets and loss assets. Explain in detail. [RTP-May 22]
Ans.: Provisioning Requirements of NPA: Statement that “There is no difference in provisioning of NPA as regards to categories of NPA, whether the debt is secured or unsecured” is not correct as the provisioning requirements for substandard and doubtful categories of NPA are different for secured and unsecured advances.
(a) For Substandard advances: 15%. Additional provision is required @ 10% (5% for infrastructure advances.
(b) For Doubtful Advances: Provisioning requirements are given below:
Portion
(c) For Loss Assets: Provision required will be 100%.
Q.14 Distinguish between Primary Security and Collateral Security with reference to audit of Banks. Also give examples of most common types of securities accepted by the Banks. [RTP-Nov. 20]
Banks ask Security or Collateral while lending to assure that the Borrower will return the money to bank in prescribed time. Explain stating clearly the concept of Primary and Collateral Security. Also give examples of most common types of securities accepted by banks. [MTP-April 21]
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Or
Secured
Doubtful upto 1 year 25% 100% Doubtful 1 to 3 years 40% 100% Doubtful above 3 years 100% 100%
Portion Unsecured
Or
Ans.: Primary Security and Collateral Security: Primary security refers to the security offered by the borrower for bank finance or the one against which credit has been extended by the bank. This security is the principal security for an advance.
Collateral security is an additional security. Security can be in any form i.e. tangible or intangible asset, movable or immovable asset.
Examples of most common types of securities accepted by banks are the following:
(1)Personal Security of Guarantor
(2)Goods/Stocks/Debtors/Trade Receivables
(3)Gold Ornaments and Bullion
(4)Immovable Property
(5)Plantations (For Agricultural Advances)
(6)Third Party Guarantees
(7)Banker’s General Lien
(8)Life Insurance Policies
(9)Stock Exchange Securities and Other Instruments
Q.15 Depending on the nature of the item concerned, creation of security may take the form of a mortgage, pledge, hypothecation, assignment, set-off or lien. Explain with specific reference to Audit of Banks. [RTP-Nov. 20] Or
Explain hypothecation and assignment as the modes of creation of security with respect to advance granted by a bank. [MTP-Oct. 22]
Ans.: Modes of creating securities: Refer Answer of Q. No. 8
Q.16 Explain "Advances under Consortium" in the context of Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances. [Jan. 21 (4 Marks), MTP-Nov. 21]
Ans.: Advances under Consortium:
Consortium advances should be based on the record of recovery of the respective individual member banks and other aspects having a bearing on the recoverability of the advances.
Where the remittances by the borrower under consortium lending arrangements are pooled with one bank and/or where the bank receiving remittances is not parting with the share of other member banks, the account should be treated as not serviced in the books of the other member banks and therefore, an NPA.
The banks participating in the consortium, therefore, need to arrange to get their share of recovery transferred from the lead bank or to get an express consent from the lead bank for the transfer of their share of recovery, to ensure proper asset classification in their respective books.
Q.17 In case of a Bank, explain the meaning of Funded loans. Also give examples. [MTP-April 21, Oct. 21]
Ans.: Funded Loans:
Funded loans are those loans where there is an actual transfer of funds from the bank to the borrower. Advances comprise of funded amounts by way of:
(i)Term loans
(ii)Cash credits, Overdrafts, Demand Loans
(iii)Bills Discounted and Purchased
(iv)Participation on Risk Sharing basis
(v)Interest-bearing Staff Loans
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Q.18 N Ltd. has been sanctioned a Cash Credit Facility by XYZ Bank Ltd. for INR 1 crore and drawing power as per the Stock Statements furnished for the last quarter is INR 80 Lakh. Outstanding balance in the account is INR 75 lakh. Interest charged to the account is INR 3.5 Lakh and total credit into the account for the quarter is INR 2.5 Lakh. As an auditor how will you report this account in your report.
[July 21 (4 Marks)]
Ans.: Reporting of Cash credit Facility:
An Advance will be classified as non-performing advance if:
(b)It ceases to generate income for a bank; or
(c)Interest and/or instalment of principal in respect of such an advance have remain overdue or out of order for a specified period of time.
An account is said to be ‘Overdue’, if it is not paid on the due date fixed by the Bank. An account should be treated as ‘Out-of-order’ if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power or if there are no credits continuously for 90 days as on the balance sheet date or the credits are not enough to cover the interest debited during the same period. In the given case, though outstanding balance of INR 75 Lakhs is within the drawing power but, the amount credited in the account (i.e. INR 2.5 Lakhs) is not enough to cover the interest charged in the account (i.e. INR 3.5 Lakhs).
Conclusion: Auditor should report the account as non-performing advance in the report.
Q.19 In a bank, all accounts should be kept within the drawing power and the sanctioned limit. The accounts which exceed the sanctioned limit or drawing power should be brought to the notice of the management regularly. Analyse the following points to be considered in the computation of drawing power in case of bank audit:
(i) Bank’s Duties
(ii) Auditor’s concern
(iii) Computation of DP
(iv) Stock audit. [Dec. 21 (4 Marks)]
Ans.: Drawing Power:
(i) Bank’s Duties: Banks should ensure that drawings in the working capital account are covered by the adequacy of the current assets. Drawing power is required to be arrived at based on current stock statement. However, considering the difficulties of large borrowers, stock statements relied upon by the banks for determining drawing power should not be older than three months. The outstanding in the account based on drawing power calculated from stock statements older than three months is deemed as irregular.
(ii) Auditor’s Concern: The stock statements, quarterly returns and other statements submitted by the borrower to the bank should be scrutinized in detail. The audited Annual Report submitted by the borrower should be scrutinized properly. The monthly stock statement of the month for which the audited accounts are prepared and submitted should be compared and the reasons for deviations, if any, should be ascertained.
(iii) Computation of DP: It needs to be ensured that the drawing power is calculated as per the extant guidelines formulated by the Board of Directors of the respective bank and agreed upon by the concerned statutory auditors. Special consideration should be given to proper reporting of sundry creditors for the purposes of calculating drawing power.
(iv) Stock Audit: The stock audit should be carried out by the bank for all accounts having funded exposure of more than 5 crores. Auditors can also advise for stock audit in other cases if the
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situation warrants the same. Branches should obtain the stock audit reports from lead bank in the cases where the Bank is not leader of the consortium of working capital. The report submitted by the stock auditors should be reviewed during the course of the audit and special focus should be given to the comments made by the stock auditors on valuation of security and calculation of drawing power.
Q.20 Explain the categories of Agricultural Advances in case of Banks and related NPA norms.
[MTP-March 22] Or
When is an agricultural advance considered as non -performing as per the RBI guidelines?
[MTP-Oct. 22]
Ans.: NPA Norms for Agricultural Advances:
As per the guidelines, Agricultural Advances are of two types:
(1)Agricultural Advances for “long duration” crops; and
(2)Agricultural Advances for “short duration” crops.
The “long duration” crops would be crops with crop season longer than one year and crops, which are not “long duration” crops would be treated as “short duration” crops. The crop season for each crop, which means the period up to harvesting of the crops raised, would be as determined by the State Level Bankers’ Committee in each State.
NPA Norms:
The following NPA norms would apply to agricultural advances (including Crop Term Loans):
A loan granted for short duration crops will be treated as NPA, if the instalment of principal or interest thereon remains overdue for two crop seasons; and
A loan granted for long duration crops will be treated as NPA, if the instalment of principal or interest thereon remains overdue for one crop season.
Q.21 Compute the Drawing Power for Cash Credit A/c of S Limited for the month of March 2023 with following information:
Debtor of ₹ 5,000 for an invoice dated 17.11.2022)
is 20% and on debtors is 50%.
Note: Debtors older than 3 months are ineligible for calculation of DP. [May 22 (3 Marks)]
Ans.: Computation of Drawing Power:
of Current Assets
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(Amount in ₹) Stock 50,000 Debtors 45,000 (Including
Sundry creditors 15,000 Sanctioned Limit 45,000 Margin on stock
Particulars
Drawing power (₹) (A) Stock Stock at realisable value 50,000 Less: Unpaid Stocks Creditors 15,000
Q.22 After becoming Chartered Accountant, you have got your first assignment as an auditor of a bank branch dealing in various types of advances. What are the areas which you will be looking for obtaining sufficient appropriate evidence (for advances) besides studying and evaluating internal controls? [May 22 (4 Marks)]
Ans.: Audit Procedure in Audit of Advances in case of Bank Audit:
The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation of internal controls relating to advances, and by:
(i)examining the validity of the recorded amounts;
(ii)examining loan documentation;
(iii)reviewing the operation of the accounts;
(iv)examining the existence, enforceability and valuation of the security;
(v)checking compliance with RBI norms including appropriate classification and provisioning; and
(vi)carrying out appropriate analytical procedures.
Q.23 CA. Puranjay is appointed as statutory branch auditor of two branches of a nationalized bank for year 2022-23. While verifying advances of one semi-urban branch, he noticed substantial number of accounts categorized as SMA (Special Mention Accounts). In this context, explain the nature and significance of SMA. [RTP- Nov. 22]
Ans.: Special Mention Accounts (SMA): Special Mention Accounts (SMA) are those accounts which are resulting signs of incipient stress leading to the possibility that borrowers may default on debt obligations. These are in the nature of warning system to alert the banks about probable NPAs so that remedial action can be taken before accounts actually turn NPAs. Therefore, their significance lies in the fact that proper and timely identification of SMAs can help in preventing turning potential NPAs into actual NPAs.
Q.24 CARD Ltd. is into the banking business and handles large amount of loans and advances of different kinds. Non-performing assets are on the rise since last two quarters. The management is concerned with correct provisioning for the same. CA R is appointed to check whether correct provisioning of NPA's is being made by the bank or not. What are the aspects that will be verified by CA R for this purpose? [Nov. 22 (4 Marks)]
Ans.: Provisioning Requirements of NPA:
Provisioning requirement in case of NPA shall be as follow:
(a) For Substandard advances: 15%. Additional provision is required @ 10% (5% for infrastructure advances.
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Particulars of Current Assets Drawing power (₹) Paid for Stocks 35,000 Less: Margin @ 20% 7,000 28,000 (B) Debtors Total debtors 45,000 Less: Ineligible debtors 5,000 40,000 Less: Margin @ 50% 20,000 20,000 Total eligible amount 48,000 Drawing Power (Cannot exceed sanctioned limit) 45,000
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(b) For Doubtful Advances: Provisioning requirements are given below: Secured Portion Unsecured Portion
Doubtful upto 1 year
Doubtful 1 to 3 years
Doubtful above 3 years
(c) For Loss Assets: Provision required will be 100%.
Auditor is required to examine whether the provision made by the bank as per the rates as specified above.
12.4 – Audit of Revenue Items (Income)
Q.25 Write a short note on reversal of income under bank audit.
Ans.: Reversal of Income:
If any advance, including bills purchased and discounted, becomes NPA as at the close of any year, the entire interest accrued and credited to income account in the past periods, should be reversed or provided for if the same is not realised. This will apply to Government guaranteed accounts also. In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected.
Further, in case of banks which have wrongly recognised income in the past should reverse the interest if it was recognised as income during the current year or make a provision for an equivalent amount if it was recognized as income in the previous year(s).
Furthermore, the auditor should enquire if there are any large debits in the Interest Income account that have not been explained. It should be enquired whether there are any communications from borrowers pointing out differences in interest charge and whether appropriate action has been taken in this regard.
Q.26
In view of the significant uncertainty regarding ultimate collection of income arising in respect of nonperforming assets, the guidelines require that banks should not recognize income on non -performing assets until it is actually realised. When a credit facility is classified as non-performing for the first time, interest accrued and credited to the income account in the corresponding previous year which has not been realized should be reversed or provided for. This will apply to Government guaranteed accounts also. Analyse and explain. [RTP-May 20]
Ans.: Reversal of Income: Refer answer of Q. No. 25.
Q.27
CA. Puranjay is appointed as statutory branch auditor of two branches of a nationalized bank for year 2022-23. While verifying interest income of a mid-corporate branch of an urban centre having advances consisting of only cash credit limits for large borrowers, it was noticed that advances of ₹ 300 crores were outstanding as on balance sheet date carrying average interest rate @ 8% p.a. One articled clerk in audit team makes quick back of the envelope calculations of interest income of ₹ 24 crores on advances. However, schedule of profit & loss a/c shows interest income on advances for ₹ 10 crores. Discuss any two probable reasons for such variation. [RTP-Nov. 22]
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25%
100%
40% 100%
100% 100%
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Ans.: Probable reasons for difference in interest calculation:
The probable reasons for difference in interest calculation could be due to following:
(i)Cash credit accounts, by their very nature, are running accounts and their utilization depends upon needs of business. Further, interest on cash credit account is charged on the extent of funds utilized by the borrower. It could be possible that all cash credit limits were not fully utilized during the year which resulted in lower interest income.
(ii)Some large accounts may have been sanctioned during later part of the year resulting in lower interest income on advances for whole year.
Q.28 In carrying out audit of income, the auditor is primarily concerned with obtaining reasonable assurance that the recorded income arose from transactions, which took place during the relevant period and pertained to the bank, there is no unrecorded income and the income is recorded at appropriate amount. Explain the Audit Approach and Procedures regarding following points in the above context:
(i) RBI’s Directions
(ii) Materiality
(iii) Revenue Certainty
(iv) Revenue Uncertainty [MTP- April 22]
Ans.: Audit Approach and Procedures:
(i) RBI’s Directions: RBI has advised that in respect of any income which exceeds one percent of the total income of the bank if the income is reckoned on a gross basis or one percent of the net profit before taxes if the income is reckoned net of costs, should be considered on accrual as per AS 9.
(ii) Materiality: If any item of income is not considered to be material as per the above norms, it may be recognised when received and the auditors need not qualify their report in that situation.
(iii) Revenue Certainty: Banks recognise income (such as interest, fees and commission) on accrual basis, i.e., as it is earned. It is an essential condition for accrual of income that it should not be unreasonable to expect its ultimate collection. In modern day banking, the entries for interest income on advances are automatically generated through a batch process in the CBS system.
(iv) Revenue Uncertainty: In view of the significant uncertainty regarding ultimate collection of income arising in respect of non-performing assets, the guidelines require that banks should not recognize income on non-performing assets until it is actually realised. When a credit facility is classified as non-performing for the first time, interest accrued and credited to the income account in the corresponding previous year which has not been realized should be reversed or provided for. This will apply to Government guaranteed accounts also.
12.5 – Audit of Revenue Items (Expenses)
Q.29 In carrying out an audit of interest expense, the auditor is primarily concerned with assessing the overall reasonableness of the amount of interest expense. Analyse and explain stating the audit approach and procedure in regard to interest expense. [RTP-Nov. 21]
Ans.: Verification of Interest Expenditure:
(a)Obtain from the bank an analysis of various types of deposits outstanding at the end of each quarter and compute a weighted average interest rate. The rate so computed should be compared with the actual average rate and enquire into the difference, if material.
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(b)Compare the average rate of interest paid on deposits with the corresponding figures for the previous years and enquire into the difference, if material.
(c)Verify the calculation of interest and ensure the following:
Interest has been provided on all deposits upto the date of the balance sheet and determine whether there is any excess or short credit.
Interest rates are in accordance with the bank’s internal regulations, RBI directives and agreements with the depositors.
In relation to fixed deposits, examine whether the interest rate in the accounting system are same as mentioned in the Fixed Deposit Receipt/Certificate.
Interest on Savings Account should be checked on a test check basis in accordance with the rules framed by the bank.
Interest on inter–branch balances has been provided at the rates prescribed by the head office.
Interest on overdue/ matured term deposits should be estimated and provided for.
(d)Ascertain whether there are any changes in interest rate on saving deposits and term deposits during the period.
Q.30 Write short note on: Audit procedures for verification of provisions and contingencies in case of bank audit.
You are appointed as statutory audit of DEF Bank Limited for the year 202 2-23. As an auditor how will you verify provision created by DEF Bank Li mited? [Nov. 20 (4 Marks)]
Ans.: Audit Procedure for Verification of Provisions and Contingencies:
(1)Ascertain compliance with the various regulatory requirements for provisioning as contained in the various circulars.
(2) Obtain an understanding as to how the Bank computes provision on standard assets and nonperforming assets. It includes the basis of the classification of loans into standard, sub-standard, doubtful and loss assets.
(3)Obtain the detailed break up of standard loans, non-performing loans and agree the outstanding balance with the general ledger.
(4)Examine whether the provisions in respect of standard loans and NPA comply with the regulatory requirements.
(5) Obtain statement of computation of tax provision from the bank’s management and verify the nature of items debited and credited to profit and loss account to ascertain that the same are appropriately considered in the tax provision computation.
(6) Recompute the provision for tax by applying the applicable tax rate after considering the allowances and disallowances as per Income-tax Act, 1961.
(7)Other provisions for expenditure should be examined vis-a-vis the circumstances warranting the provisioning and the adequacy of the same by discussing and obtaining the explanations from the bank’s management.
Q.31 Explain the following in the context of Bank audit:
(a)For audit of operating expenses, the auditor should study and evaluate the system of internal control relating to expenses.
(b) For audit of Provisions and contingencies, the auditor should ensure that the compliances for various regulatory requirements for provisioning as contained in the various circulars have been fulfilled. [RTP-May 22]
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