Chapter 11

Bank Audit

11.1 Types of Banks

1.Commercial are the most wide spread banking institutions in India, that provide a
banks 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.
Analysis

2.Regional known as RRBs are the banks that have been set up in rural areas in
Rural Banks 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 Grameen Vikas Bank, etc.

3.Co- function like Commercial Banks only but are set up on the basis of
operative Cooperative Principles and registered under the Cooperative Societies
Banks Act of the respective state or the Multistate Cooperative Societies
Act and usually cater to the needs of the agricultural and rural sectors

4.Payments are a new type of banks which have been recently introduced by RBI.
Banks 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.

5.Development had been conceptualized to provide funds for infrastructural facilities

Banks important for the economic growth of the country.
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6.Small have been set up by RBI to make available basic financial and banking
Finance Banks facilities to the unserved and unorganised sectors like small marginal
farmers, small & micro business units, etc.

11.2 Reserve Bank of India-Important Functions

Regulating The functioning of banking industry in India is regulated by the Reserve
Body Bank of India (RBI) which acts as the Central Bank of our country.

RBI is • development and supervision of the constituents of the Indian

responsible financial system (which comprises banks and non-banking financial
for institutions)
• determining, in conjunction with the Central Government, the
monetary and credit policies keeping in with the need of the hour.
• regulating the activities of commercial and other banks
Important • issuance of currency;
functions of • regulation of currency issue;
RBI are :- • acting as banker to the central and state governments; and
• acting as banker to commercial and other types of banks
including term- lending institutions. Besides, RBI has also been
entrusted with the responsibility of regulating the activities of
commercial and other banks.

No bank can commence the business of banking or open new branches

without obtaining license from RBI. The RBI also has the power to
inspect any bank.
Analysis

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11.3 Types of Audit Reports to be issued (generally)
Statutory Auditors 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 issued by the ICAI.
(b) Long Form Audit Report.
(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 frauds
(h) Report on instances of adverse credit-deposit ratio in the rural areas.

Analysis

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11.4 Understanding of Accounting System in Banks
There has been a sea change in banking as use of technology and its continuous evolution
has enabled banks to reach their customers in providing them the convenience and comfort
of anytime-anywhere-banking by letting them access their information/data on real time
basis, as stored in a safe and secure environment on the bank’s servers.
With many customers having access to Internet and mobile connectivity, monetary
transactions from inception to finish have become expeditious through E-banking; but for
Core banking technology and extensive advancement therein and the availability and
extensive use of technology tools, banks could not have achieved such phenomenal and
accelerated growth, and could not have ventured into and offered a wide range of
innovative products and services to their customers.
The transactions in banks have become voluminous and it needs to be ensured that in the
system of recording, transmission and storage of information/ data, integrity thereof is
optimally maintained and control systems ensure that the same is free of errors,
omissions, irregularities and frauds.
Considering the challenges of technology, bank managements continuously endeavour to
make their internal control systems robust, safe and secure as well as convenient and
expeditious for the customers.
In the computerized environment, it is imperative that the auditor is familiar with and
satisfied that all the norms/parameters as per the latest applicable RBI guidelines are
incorporated and built into the system that generates information/data having a bearing
on the classification/ provisions and income recognition.
The auditor should not go by the assumption that the system generated information is
correct and can be relied upon without evidence that demonstrates that the system driven
information is based on the required parameters.
He should use Professional Skepticism and Prudence wherever he feels that something
manually needs to be performed to check the authenticity and consistency of the
information obtained from the systems and document the results of such activities
performed.

Analysis

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11.5 Bank Audit Approach
1.Drawing An audit plan should be drawn up based on: -
an Audit
• the nature and level of operations,
Plan
• nature of adverse features,
• level of compliance based on previous reports and
• audit risks based on inadequacy in or breach of internal controls
and the familiarization exercise carried out,

2. Control A bank should have appropriate controls to mitigate its risks, including
Environment effective segregation of duties (particularly, between front and back
at the Bank: offices), accurate measurement and reporting of positions, verification
and approval of transactions, reconciliation of positions and results,
setting up limits, reporting and approval of exceptions, physical security
and contingency planning.
The following are certain common questions /steps, which have to be kept
in mind while undertaking/ performing control activities:

Analysis

Nature of Questions to be considered / answered

Questions

Who ⚫ Who performs the control?

Does the above person have requisite knowledge and authority to

perform the control?

What What evidence is available to prove that the control is performed?

When ⚫ When and with what frequency is the control performed?

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Is the frequency enough to prevent, detect and correct risk of material
misstatements?

Where ⚫ Where is the evidence of performance of the control retained?

⚫ For how long is the evidence retained?

Is the evidence accessible/ available for audit?

Why ⚫ Why is the control being performed?

What type of errors are prevented or detected through the performance

of the control?

How ⚫ How is the control performed?

⚫ What are the control activities?

⚫ Can these activities be by passed?

⚫ Can the bypass, if any, be detected?

3.Engagement All personnel performing an engagement, including any experts

Team contracted by the firm in connection with that engagement are known to
Discussions: be the “Engagement Team”. The engagement team should hold discussions
to gain better understanding of the bank 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
between the members of the engagement team and the audit engagement
partner should be done on the susceptibility of the bank’s branch financial
statements to material misstatements. These discussions are ordinarily
done at the planning stage of an audit.
The engagement team discussion ordinarily includes a discussion
of the following matters:
(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;
(d) Audit responses to Engagement Risk, Pervasive Risks, and Specific
Risks;

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(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 (e.g., the bank’s
application of accounting policies in the given facts and circumstances).
Advantages of such a discussion: -
• Specific emphasis should be provided to the susceptibility of the bank’s
financial statements to material misstatement due to fraud, that enables
the engagement team to consider an appropriate response to fraud risks,
including those related to engagement risk, pervasive risks, and specific
risks.
• It further enables the audit engagement partner to delegate the work
to the experienced engagement team members, and to determine the
procedures to be followed when fraud is identified.
• Further, audit engagement partner may review the need to involve
specialists to address the issues relating to fraud.

Analysis

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11.6 Income Recognition Policy

When to The policy of income recognition should be objective and based on record
recognize of recovery rather than on any subjective considerations. Income from
non- performing assets (NPA) is not recognized on accrual basis but is
booked as income only when it is actually received. (Dealt in detail later
on)

Analysis

11.7 Form and Content of Financial Statements

Section 29 of the Banking Regulations Act, 1949 deal with the form and content of
financial statements of a banking company and their authentication.
This section is also applicable to nationalised banks, State Bank of India, and Regional
Rural Banks.
Every banking company is required to prepare a Balance Sheet and a Profit and Loss
Account in the forms set out in the Third Schedule to the Act or as near thereto as the
circumstances admit.
Form A of the Third Schedule to the Banking Regulation Act, 1949, contains the form of
Balance Sheet and Form B contains the form of Profit and Loss Account.

Analysis

AUDIT OF ACCOUNTS

Section 30 of the Banking Regulations Act, 1949 requires that the balance sheet and
profit and loss account of a banking company should be audited by a person duly qualified
under any law for the time being in force to be an auditor of companies.

APPOINTMENT OF AUDITOR

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11.7 Form and Content of Financial Statements

• The auditor of a banking company is to be appointed at the annual general meeting of the
shareholders,
• The auditor of a nationalised bank is to be appointed by the bank concerned acting
through its Board of Directors.
(In either case, approval of the Reserve Bank of India is required before the appointment
is made.)
• The auditors of regional rural banks are to be appointed by the bank concerned
with the approval of the Central Government.

Analysis

REMUNERATION OF AUDITOR

(a) The remuneration of auditor of a banking company is to be fixed in accordance with

the provisions of Section 142 of the Companies Act, 2013 (i.e., by the company in general
meeting or in such manner as the company in general meeting may determine).

(b) The remuneration of auditors of nationalised banks and State Bank of India is to be
fixed by the Reserve Bank of India in consultation with the Central Government.

POWERS OF AUDITOR

The auditor of a banking company, nationalised bank, State Bank of India, or regional rural
bank has the same powers as those of a company’s auditor in the matter of access to the
books, accounts, documents and vouchers.

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11.8 Engagement Team Discussions

Meaning of All personnel performing an engagement, including any experts

Engagement contracted by the firm in connection with that engagement are known to
Team be the “Engagement Team”.
The engagement team should hold discussions to gain better
understanding of the bank and its environment, including internal control,
and also to assess the potential for material misstatements of the
financial statements.
The discussion between the members of the engagement team and the
audit engagement partner should be done on the susceptibility of the
bank’s branch financial statements to material misstatements.
These discussions are ordinarily done at the planning stage of an audit.

Analysis

ordinarily (a) Errors that may be more likely to occur;

includes (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;
(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 (e.g., the bank’s application
of accounting policies in the given facts and circumstances).

Analysis

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11.8 Engagement Team Discussions

Advantages • Specific emphasis should be provided to the susceptibility of the

of such a bank’s financial statements to material misstatement due to fraud, that
discussion :- enables the engagement team to consider an appropriate response to
fraud risks, including those related to engagement risk, pervasive risks,
and specific risks.
• It further enables the audit engagement partner to delegate the work
to the experienced engagement team members, and to determine the
procedures to be followed when fraud is identified.
• Further, audit engagement partner may review the need to involve
specialists to address the issues relating to fraud.

Analysis

11.9 Appointment of Auditor

Banking the auditor of a banking company is to be appointed at the annual

Company general meeting of the shareholders

Nationalised Bank concerned acting through its board of directors

Bank

In both above cases, approval of the Reserve Bank of India is required before the
appointment is made.

State Bank The auditors of the State Bank of India are to be appointed by the
of India Comptroller and Auditor General of India in consultation with the
Central Government.

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11.9 Appointment of Auditor

Subsidiaries The auditors of the subsidiaries of the State Bank of India are to be
of State appointed by the State Bank of India
Bank of India

Regional rural The auditors of regional rural banks are to be appointed by the bank
banks concerned with the approval of the Central Government.

Analysis

11.10 Remuneration of Auditor

• The remuneration of auditor of a banking company is to be fixed in accordance with
the provisions of Section 142 of the Companies Act, 2013 (i.e., by the company in
general meeting or in such manner as the company in general meeting may
determine).

• The remuneration of auditors of nationalized banks and State Bank of India is to

be fixed by the Reserve Bank of India in consultation with the Central Government.

11.11 AUDITOR’S REPORT-Specially for Nationalised Bank only

In the case (a) whether, in his opinion, the financial statements present a true and
of a fair view of the affairs of the bank;
nationalised
bank, the
(b) whether or not the transactions of the bank, which have come to his
auditor is
notice, have been within the powers of that bank;
required to
make a
report to the

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11.11 AUDITOR’S REPORT-Specially for Nationalised Bank only
Central (c) whether or not the returns received from the offices and branches
Government of the bank have been found adequate for the purpose of his audit; and
in which he
has to state
(d) any other matter which he considers should be brought to the notice
the following: of 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.

Analysis

11.12 Format of Report

Statutory The auditors, should ensure that the audit report issued by them complies
Audit Report with the requirements of Standards on Auditing
The auditor should ensure that not only information relating to number
of unaudited branches is given but quantification of advances, deposits,
interest income and interest expense for such unaudited branches has
also been disclosed in the audit report.
In addition, the auditor of a banking company is also required to state in
his report the matters covered by Section 143 of the Companies Act,
2013.
However, reporting requirements relating to the Companies (Auditor’s
Report) Order, 2016 is not applicable to a banking company, as defined in
clause (c) of Section 5 of the Banking Regulation Act, 1949.

Analysis

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11.12 Format of Report

Long Form Besides the audit report as per the statutory requirements, the terms of
Audit Report appointment of auditors of public sector banks, private sector banks and
foreign banks (as well as their branches), require the auditors to also
furnish a long form audit report (LFAR).
The matters which the banks require their auditors to deal with in the
long form audit report have been specified by the Reserve Bank of India.
The LFAR is to be submitted before 30th June every year.
To ensure timely submission of LFAR, proper planning for completion of
the LFAR is required.
While the format of LFAR does not require an executive summary to be
given, members may consider providing the same to bring out the key
observations from the whole document.

Analysis

Reporting to The RBI issued a Circular relating to Bank Frauds applicable to all
RBI scheduled commercial banks (excluding Regional Rural Banks).
Auditor should also 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 “states that an auditor conducting an audit in
accordance with SAs is responsible for obtaining reasonable assurance

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11.12 Format of Report
that the financial statements taken as a whole are free from material
misstatement, whether caused by fraud or error.

Analysis

Duty to As per sub-section 12 of section 143 of the Companies Act, 2013, if an

report on auditor of a company, in the course of the performance of his duties as
Frauds under auditor, has reason to believe that an offence of fraud involving such
the amount or amounts as may be prescribed, is being or has been committed
Companies in the company by its officers or employees, the auditor shall report the
Act, 2013 matter to the Central Government within such time and in such manner as
may be prescribed.

Analysis

11.13 CONDUCTING AN AUDIT-Stages involved

The audit of banks or their branches involves the following stages –

1. Initial (i) Declaration of Indebtedness: The RBI has advised that the banks,
consideration before appointing their statutory central/branch auditors, should
by the obtain a declaration of indebtedness.
statutory
auditor
(ii) Internal Assignments in Banks by Statutory Auditors: The RBI
decided that the audit firms should not undertake statutory audit
assignment while they are associated with internal assignments in the
bank during the same year.

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11.13 CONDUCTING AN AUDIT-Stages involved
(iii) Planning: Standard on Auditing (SA) 300, “Planning an Audit of
Financial Statements” requires that the auditor shall undertake the
following activities prior to starting an initial audit:
(a) Performing procedures required by SA 220, “Quality Control for
Audit Work” regarding the acceptance of the client relationship and
the specific audit engagement; and
(b) Establish understanding of terms of engagement as per SA 210,
“Agreeing the Terms of Audit Engagements”.

(iv) Communication with Previous Auditor: Chartered Accountant in

practice cannot accept position as auditor previously held by another
chartered accountant without first communicating with him in writing.

(v) Terms of Audit Engagements: SA 210, “Terms of Audit

Engagements” requires that for each period to be audited, the auditor
should agree on the terms of the audit engagement with the bank.

(vi) Initial Engagements: The auditor needs to perform the audit

procedures as mentioned in SA 510 “Initial Audit Engagements-
Opening Balances”

(vii) Establish the Engagement Team: The size and composition of the
engagement team would depend on the size, nature and complexity of
the bank’s operations.

(viii) Understanding the Bank and its Environment: SA 315 “Identifying

and Assessing the Risks of Material Misstatement Through
Understanding the Entity and Its Environment” lays down that the
auditor should obtain an understanding of the entity and its
environment, including its internal control

Analysis

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11.13 CONDUCTING AN AUDIT-Stages involved

2. Identifying SA 315 requires the auditor to identify and assess the risks of
and Assessing material misstatement at the financial statement level and the
the Risks of assertion level for classes of transactions, account balances and
Material disclosures to provide a basis for designing and performing further
Misstatements: audit procedures.

Analysis

3. Understanding of the accounting process is necessary to identify

Understanding and assess the risks of material misstatement whether due to fraud
the Bank’s or not and to design and perform further audit procedures
Accounting
Process:

Analysis

4. Engagement The engagement team should hold discussions to gain better

Team understanding of banks and its environment, including internal
Discussions: control, and also to assess the potential for material misstatements
of the financial statements.

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11.13 CONDUCTING AN AUDIT-Stages involved

5.Understanding Management develops controls and uses performance indicators to

the Risk aid in managing key business and financial risks. An effective risk
Management management system in a bank generally requires the following:
Process (a) Oversight and involvement in the control process by those
charged with governance: Those charged with governance (Board of
Directors/Managing Director) should approve written risk
management policies. 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 regards as acceptable.
(b) Identification, measurement and monitoring of risks: Risks that
could significantly impact the achievement of bank’s goals should be
identified, measured and monitored against pre-approved limits and
criteria.
(c) Control activities: A bank should have appropriate controls to
mitigate its risks including effective segregation of duties
(particularly between front and back offices), accurate measurement
and reporting of positions, verification and approval of transactions,
reconciliation of positions and results, setting up limits, reporting and
approval of exceptions, physical security and contingency planning.
(d) Monitoring activities: Risk management models, methodologies
and assumptions used to measure and mitigate risk should be
regularly assessed and updated. This function may be conducted by
the independent risk management unit.
(e) Reliable information systems: Banks require reliable information
systems that provide adequate financial, operational and compliance
information on a timely and consistent basis. Those charged with
governance and management require risk management information
that is easily understood and that enables them to assess the
changing nature of the bank’s risk profile.

Analysis

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11.13 CONDUCTING AN AUDIT-Stages involved

5. Establish the Audit engagement partner should establish the overall audit strategy,
Overall Audit prior to the commencement of an audit
Strategy: SA
300 “Planning
an Audit of
financial
Statements’’

Analysis

6. Develop the SA 300 deals with the auditor’s responsibility to plan an audit of
Audit Plan: financial statements in an effective manner. It requires the involvement
of all the key members of the engagement team while planning an audit.

7. Audit The auditor should summarise the audit plan by preparing an audit
Planning planning memorandum in order to:
Memorandum Describe the expected scope and extent of the audit
procedures to be performed by the auditor.
Highlight all significant issues and risks identified during their
planning and risk assessment activities.

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Analysis

8. Determine The auditor should consider the relationship between the audit
Audit materiality and audit risk when conducting an audit.
Materiality:

9. Consider While obtaining an understanding of the bank, the auditor should

Going Concern: consider whether there are events and conditions which may cast
significant doubt on the bank’s ability to continue as a going concern.

10. Response to It requires the auditor to design and implement overall responses
the Assessed to address the assessed risks of material misstatement
Risks: SA 330
“The Auditor’s
Responses to
Assessed Risks”

Analysis

11. Assess As per SA 240 “The Auditor’s Responsibilities Relating to

the Risk of Fraud in an Audit of Financial Statements”, the auditor’s
Fraud including objective is to identify and assess the risks of material misstatement
Money in the financial statements due to fraud, to obtain sufficient
Laundering: 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

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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.

Analysis

11. Assess The auditors should identify and assess the risks of material
Specific Risks misstatement at the financial statement level which refers to risks
that relate pervasively to the financial statements as a whole and
potentially affect many assertions.

13. Risk The modern-day banks make extensive use of outsourcing as a means
Associated with of both reducing costs as well as making use of services of an expert
Outsourcing of not available internally. There are, however, a number of risks
Activities: associated with outsourcing of activities by banks and therefore, it
is quintessential for the banks to effectively manage those risks.

14. Stress Stress testing is a software testing activity that determines the
Testing: robustness of software by testing beyond the limits of normal
operation. Stress testing is particularly important for "mission
critical" software, but is used for all types of software (Source –
Wikipedia). RBI has required that all commercial banks shall put in
place a Board approved ‘Stress Testing framework’ to suit their
individual requirements which would integrate into their risk
management systems.

Analysis

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11.13 CONDUCTING AN AUDIT-Stages involved

15. BASEL III The Basel Committee on Banking Supervision (BCBS) and the
framework: Financial Stability Board (FSB) has undertaken an extensive review
Basel norms or of the regulatory framework in the wake of the sub-prime crisis. In
accords are the the document titled ‘Basel III:
International A global regulatory framework for more resilient banks and banking
Banking systems’, released by the BCBS in December 2010, it has inter alia
regulations proposed certain minimum set of criteria for inclusion of instruments
issued by the in the new definition of regulatory capital.
BCBS.
The set of agreement by the BCBS, which mainly focuses on risks to
banks and the financial system are called Basel accord.

16. Reliance on The auditor should take into account the adverse comments, if any,
/ review of on advances appearing in the following-
other reports: Previous year’s audit reports.
Reserve Bank’s latest inspection report.
Concurrent / Internal audit report.
Report on verification of security.
Any other internal reports specially related to particular accounts.

Analysis

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ADVANCES

Meaning Advances are amount of money or credit, given as a loan from a

bank to another party with an agreement that the money will be
repaid.
In carrying out his substantive procedures, the auditor should
examine all large advances while other advances may be examined on
a sampling basis. The accounts identified to be problem accounts,
however, need to be examined in detail unless the amount involved is
insignificant. The extent of sample checking would also depend on the
auditor’s assessment of efficacy of internal controls. What
constitutes a ‘large advance’ would need to be determined in the
context of volume of operations of the branch

Types of Advances

Funded loans Funded loans are those loans where there is an actual transfer of
funds from the bank to the borrower. Examples of funded loans are
Term loans, Cash credits, Overdrafts, Demand Loans, Bills Discounted
and Purchased, Participation on Risk Sharing basis, Interest-bearing
Staff Loans.

Non-funded Non-funded facilities are those which do not involve such transfer.
facilities Examples of non-funded loans are Letters of credit, Bank guarantees,
etc.

Analysis

Classification of Advances

Sector Wise RBI issues common guidelines for lending to Priority Sector which
banks are required to follow. These guidelines cover rate of interest;
service charges, receipt, sanction, rejection, disbursement Register;

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ADVANCES
issue of Loan Application Acknowledgement. RBI also issues targets
for banks for lending to Priority Sector.
Examples of Priority Sectors are Agriculture , MSME , Education
, Housing , etc.

Security Wise Banks ask Security or Collateral while lending to assure that the
Borrower will return the money to bank in prescribed time else the
Banks have legal authority to sell the collateral to recover its money.
Nature of Security
A. 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.
B. Collateral security is an additional security. Security can be in any
form i.e. tangible or intangible asset, movable or immovable asset.

Analysis

Mode of Creation of Security

(i) Mortgage Registered Mortgage can be affected by a registered instrument

called the ‘Mortgage Deed’ signed by the mortgagor. It registers the
property to the mortgagee as a security.
Equitable mortgage, on the other hand, is effected by a mere delivery
of title deeds or other documents of title with intent to create
security thereof.

(ii) Pledge A pledge thus involves bailment or delivery of goods by the borrower
to the lending bank with the intention of creating a charge thereon
as security for the advance. The legal ownership of the goods remains
with the pledger while the lending banker gets certain defined

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ADVANCES
interests in the goods. The pledge of goods constitutes a specific (or
fixed) charge.

(iii) The hypothecation is the creation of an equitable charge (i.e., a

Hypothecation charge created not by an express enactment but by equity and
reason), which is created in favor of the lending bank by execution of
hypothecation agreement in respect of the moveable securities
belonging to the borrower.
Neither ownership nor possession is transferred to the bank.
However, the borrower holds the physical possession of the goods as
an agent/trustee of the bank.
The borrower periodically submits statements regarding quantity and
value of hypothecated assets (stocks, debtors, etc.) to the lending
banker on the basis of which the drawing power of the borrower is
fixed.

(iv)Assignment Assignment represents a transfer of an existing or future debt, right

or property belonging to a person in favor of another person. Only
actionable claims (i.e., claim to any debt other than a debt secured by
a mortgage of immovable property or by hypothecation or pledge of
moveable property) such as book debts and life insurance policies are
accepted by banks as security by way of assignment.
An assignment gives the assignee absolute right over the
moneys/debts assigned to him.

(v) Set-off Set-off is a statutory right of a creditor to adjust, wholly or partly,

the debit balance in the debtor’s account against any credit balance
lying in another account of the debtor. The right of set-off enables a
bank to combine two accounts (a deposit account and a loan account)
of the same person provided both the accounts are in the same name
and same right (i.e., the capacity of the account holder in both the
accounts should be the same).
For the purpose of set-off, all the branches of a bank are treated as
one single
entity. The right of set-off can be exercised in respect of time-
barred debts also.

(vi) 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.

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ADVANCES

Analysis

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ADVANCES

11.14 Classification of Advances

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11.15 Prudential norms on Income Recognition, Asset Classification and Provisioning
pertaining to Advances:

1. Non- An asset becomes NPA when it ceases to generate income for the
performing Bank.:
Assets:
A non-performing asset (NPA) is a loan or an advance where -:
• interest and/ or instalment of principal remain overdue for
a period of more than 90 days in respect of a term loan;

• the account remains ‘out of order’ in respect of an

Overdraft/Cash Credit (OD/ CC);

• the bill remains overdue for a period of more than 90 days

in the case of bills purchased and discounted.

2. Out of Order: An account should be treated as ‘out of order’ if the outstanding

balance remains continuously in excess of the sanctioned
limit/drawing power.
In cases where the outstanding balance in the principal operating
account is less than the sanctioned limit/drawing power, but there
are no credits continuously for 90 days as on the date of Balance
Sheet or credits are not enough to cover the interest debited
during the same period, these accounts should be treated as ‘out of
order’.

3. Overdue: Any amount due to the bank under any credit facility is ‘overdue’ if
it is not paid on the due date fixed by the bank

Categories of Non-Performing Assets: Provision required

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11.15 Prudential norms on Income Recognition, Asset Classification and Provisioning
pertaining to Advances:

⚫ Substandard Assets:
Would be one, which has remained NPA for 15%
a period less than or equal to 12 months.
⚫ Doubtful Assets:
Would be one, which has remained in the
substandard category for a period of 12
(Secured + Unsecured)
months. Sub-categories:
25% + 100%
Doubtful up to 1 Year (D1)
40% + 100%
Doubtful 1 to 3 Years (D2)
100% + 100%
Doubtful more than 3 Years
(D3) 100%
⚫ Loss Assets:
Would be one, where loss has been identified
by the bank or internal or external auditors
or the RBI would
Asset classification inspection but the amount
be borrower-wise andhas not
not facility-wise. All facilities including
been written off wholly.
investments in securities would be termed as NPA.
4. Advances Consortium advances should be based on the record of recovery of
under the respective individual member banks
Consortium: 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.

Analysis

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11.15 Prudential norms on Income Recognition, Asset Classification and Provisioning
pertaining to Advances:

5. Agricultural As per the guidelines, Agricultural Advances are of two types:

Advances (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 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.

6. Accounts Not prudent to follow stages of asset classification. It should be

where there is straight-away
erosion in the classified as doubtful or loss asset as appropriate.
value of security
(i) Erosion in the value of security can be reckoned as
/ frauds
significant when the realisable value of the security is
committed by less than 50 per cent of the value assessed by the bank.
borrowers Such NPAs may be straight-away classified under

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11.15 Prudential norms on Income Recognition, Asset Classification and Provisioning
pertaining to Advances:
doubtful category and provisioning should be made as
applicable to doubtful assets.
(ii) If the realisable value of the security, as assessed
by the bank/ approved valuers/ RBI is less than 10
per cent of the outstanding in the borrowal accounts,
the existence of security should be ignored and the
asset should be straight-away classified as loss asset.
It may be either written off or fully provided for by
the bank.
7. Advances Advances against Term Deposits, NSCs eligible for surrender,
Against Term KVP/IVP and life policies need not be treated as NPAs, provided
Deposits, NSCs, adequate margin is available in the accounts.
KVPs/ IVPs, etc.

Analysis

8. Agricultural Master Circular issued by the RBI with the classification and
Advances income recognition issues due to impairment caused by natural
Affected by calamities.

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11.15 Prudential norms on Income Recognition, Asset Classification and Provisioning
pertaining to Advances:
Natural Banks may decide on their own relief measures, viz., conversion of
Calamities the short-term loan into a term loan or re-schedulement of the
repayment period and the sanctioning of fresh short-term loan,
subject to the guidelines issued by RBI

9. Advances to Interest-bearing staff advances as a banker should be included as

Staff part of advances
portfolio of the bank.
Such loans/advances should be classified as NPA only when there is
a default in repayment of installment of principal or payment of
interest on the respective due dates.
The staff advances by a bank as an employer and not as a banker are
required to be included under the sub-head ‘Others’ under the
schedule of Other Assets.

Analysis

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11.16 Computation of Drawing Power

1. Meaning: - Drawing power is the limit up to which a firm or company can withdraw
from the working capital limit sanctioned.

2 Different from Sanctioned Limit: - The Sanctioned limit is the total exposure that a
bank can take on a particular client for facilities like cash credit, overdraft, export
packing credit, non-funded exposures etc.
On the other hand, Drawing Power refers to the amount calculated based on primary
security less margin as on a particular date.

3. Considerations: - All accounts should be kept within both the drawing power and the
sanctioned limit at all times.
The accounts which exceed the sanctioned limit or drawing power should be brought to
the notice of the Management/Head Office regularly.

4. 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.
5. 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.

6. 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.

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11.16 Computation of Drawing Power
7. 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 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.

Analysis

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11.17 Audit of Advances

In carrying (a) Amounts included in balance sheet in respect of advances which are
out audit of outstanding at the date of the balance sheet.
advances, (b) Advances represent amount due to the bank.
the auditor is
(c) Amounts due to the bank are appropriately supported by loan
primarily
documents and other documents as applicable to the nature of advances.
concerned
(d) There are no unrecorded advances.
with
obtaining (e) The stated basis of valuation of advances is appropriate and properly
evidence applied and the recoverability of advances is recognised in their valuation.
about the (f) The advances are disclosed, classified and described in accordance
following: 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.

Evaluation of The auditor should examine the efficacy of various internal controls over
Internal advances to determine the nature, timing and extent of his substantive
Controls over procedures. In general, the internal controls over advances should
Advances: include the following:
The bank should make an advance only after satisfying itself as to the
credit worthiness of the borrower
All the necessary documents (e.g., agreements, demand promissory
notes, letters of hypothecation, etc.) should be executed by the parties
before advances are made.
The compliance with the terms of sanction and end use of funds should
be ensured.
Sufficient margin as specified in the sanction letter should be kept
against securities taken so as to cover for any decline in the value
thereof.
If the securities taken are in the nature of shares, debentures, etc.,
the ownership of the same should be transferred in the name of the bank
The accounts should be kept within both the drawing power and the
sanctioned limit.
All the accounts which exceed the sanctioned limit or drawing power
or are otherwise irregular should be brought to the notice of the
controlling authority regularly.

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11.17 Audit of Advances
The operation of each advance account should be reviewed at least once
an year and at more frequent intervals in the case of large advances.

Analysis

11.18 AUDIT OF REVENUE ITEMS - Audit Approach and Procedures

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
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 Accounting Standard 9.
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.
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.
Interest on advances against Term Deposits, National Savings Certificates (NSCs),
Indira Vikas Patras (IVPs), Kisan Vikas Patras (KVPs) and Life policies may be taken to
income account on the due date, provided adequate margin is available in the accounts.

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11.18 AUDIT OF REVENUE ITEMS - Audit Approach and Procedures
Bills Purchased:- In the case of bills purchased outstanding at the close of the year the
discount received thereon should be properly apportioned between the two years. [The
Unexpired discount/ rebate on bills discounted i.e., where part of receipt comprising
discount charges on bills purchased relate to the period beyond the year-end, should be
recorded as “Other Liabilities”]. Interest (discount) component paid by Bank/Branch on
rediscount of bills from other financial institutions, is not to be netted off from the
discount earned on bills discounted.
Bills for Collection:- In the case of bills for collection, the auditor should also examine
the procedure for crediting the party on whose behalf the bill has been collected. The
procedure is usually such that the customer’s account is credited only after the bill has
actually been collected from the drawee either by the bank itself or through its agents,
etc. This procedure is in consonance with the nature of obligations of the bank in respect
of bills for collection. The commission of the branch becomes due only when the bill has
been collected.
Renegotiations:- Fees and commissions earned by the banks as a result of re-negotiations
or rescheduling of outstanding debts should be recognised on an accrual basis over the
period of time covered by the re-negotiated or rescheduled extension of credit. Test
check the interest earned by the banks for the sample selected. Test check the fees and
commissions earned by the banks made for commission on bills for collection, letters of
credit and bank guarantees.

Analysis

Reversal of Income:

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11.18 AUDIT OF REVENUE ITEMS - Audit Approach and Procedures
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.

On leased assets: The component of finance income (as defined in AS 19 – Leases) on

the leased asset which was accrued and credited to the income account before the asset
became non-performing and remaining unrealised, should be reversed or provided for in
the current accounting period.

On Take-out finance: A takeout loan is a method of financing whereby a loan that is

procured later is used to replace the initial loan. More specifically, a takeout loan, or
takeout financing, is long-term financing that the lender promises to provide at a
particular date or when particular criteria for completion of a project are met. Takeout
loans are commonly used in property development (Source :- Investopedia). In the case
of take-out finance, if based on record of recovery, the account is classified by the
lending bank as NPA, it should not recognize income unless realised from the
borrower/taking-over institution (if the arrangement so provides).

On Partial Recoveries in NPAs:In the absence of a clear agreement between the bank
and the borrower for the purpose of appropriation of recoveries in NPAs (i.e., towards
principal or interest due), banks are required to adopt an accounting policy and exercise
the right of appropriation of recoveries in a uniform and consistent manner. The
appropriate policy to be followed is to recognise income as per AS 9 when certainty
attaches to realisation and accordingly amount reversed/derecognised or not
recognised in the past should be accounted.

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11.18 AUDIT OF REVENUE ITEMS - Audit Approach and Procedures
Memorandum Account: On an account turning NPA, banks should reverse the interest
already charged and not collected by debiting Profit and Loss account and stop further
application of interest. However, banks may continue to record such accrued interest in
a Memorandum account in their books for control purposes. For the purpose of
computing Gross Advances, interest recorded in the Memorandum account should not
be taken into account.

Interest partly/fully realised in NPAs can be taken to income. However, it should be

ensured that the credits towards interest in the relevant accounts are not out of
fresh/additional credit facilities sanctioned to the borrowers concerned.

Income from Investments

Interest Income on Investments: This includes all income derived from Government
securities, bonds and debentures of corporates and other investments by way of
interest and dividend, except income earned by way of dividends, etc., from subsidiaries
and joint ventures abroad/in India. Broken period interest paid on securities purchased
and amortisation of premium on SLR investments is net off from the interest income on
investments.

Profit on Sale of Investments: Investments are dealt in the course of banking activity
and hence the net profit or loss on sale of investments is taken to profit and loss account.

Profit/Loss on Revaluation of Investments: In terms of guidelines issued by the RBI,

investments are to be valued at periodical intervals and depreciation or appreciation in
valuation should be recognised and taken to profit and loss account.

Analysis

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11.19 AUDIT OF EXPENSES - Audit Approach and Procedures

In carrying out an audit of interest expense, the auditor is primarily concerned with
assessing the overall reasonableness of the amount of interest expense by analysing ratios
of interest paid on different types of deposits and borrowings
The auditor should obtain from the bank an analysis of various types of deposits
outstanding at the end of each quarter. From such information, the auditor may work out
a weighted average interest rate. The auditor may then compare this rate with the actual
average rate of interest paid on the relevant deposits as per the annual accounts and
enquire into the difference, if material.
The auditor should also compare the average rate of interest paid on the relevant
deposits with the corresponding figures for the previous years and analyse any material
differences.
The auditor should, on a test check basis, verify the calculation of interest and ensure
that:
(a) Interest has been provided on all deposits upto the date of the balance sheet;
(b) Interest rates are in accordance with the bank’s internal regulations, the RBI
directives and agreements with the respective deposit holder;
(c) Interest on savings accounts are in accordance with the rules framed by the bank/RBI
in this behalf.
The auditor should ascertain whether there are any changes in interest rate on saving
accounts and term deposits during the period.

Analysis

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11.19 AUDIT OF EXPENSES - Audit Approach and Procedures

For audit of operating expenses, the auditor should study and evaluate the system
of internal control relating to expenses, including authorization procedures in order to
determine the nature, timing and extent of his other audit procedures.

The auditor should perform substantive analytical procedures in respect of these

expenses. e.g assess the reasonableness of expenses by working out their ratio to total
operating expenses and comparing it with the corresponding figures for previous years.

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.

The auditor should obtain an understanding as to how the bank computes provision on
standard assets and non- performing assets.

It will primarily include checking the basis of classification of loans and receivables into
standard, sub-standard, doubtful, loss and non- performing assets.

The auditor may verify the loan classification on a sample basis.

The auditor should obtain the detailed break up of standard loans, non-performing loans
and agree the outstanding balances with the general ledger.

Analysis

Disclosure of the prior period items

Since the format of the profit and loss accounts of banks prescribed in Form B under
Third Schedule to the Banking Regulation Act, 1949 does not specifically provide for

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11.19 AUDIT OF EXPENSES - Audit Approach and Procedures
disclosure of the impact of prior period items on the current year’s profit and loss, such
disclosures, wherever warranted, may be given.

Analysis

Correct/Incorrect
1 RBI has been entrusted with the responsibility of regulating the activities
of commercial banks only.
Solution Incorrect. RBI has been entrusted with the responsibility of regulating the
activities of commercial and other banks.
2 In the computerised environment, the auditor need not be familiar with
latest applicable RBI guidelines that have bearing on the classification/
provisions and income recognition.
Solution Incorrect. In the Computerised environment, it is imperative that the auditor
is familiar with, and is satisfied that, all the norms/parameters as per the
latest applicable RBI guidelines are incorporated and built into the system
that generates information/data having a bearing on the classification/
provisions and income recognition.
3 The auditor can assume that the system generated information is correct
and relied upon without evidence that demonstrates that the system
driven information is based on validation of the required parameters for
the time being in force and applicable.
Solution Incorrect. The auditor should not go by the assumption that the system
generated information is correct and can be relied upon without evidence that
demonstrates that the system driven information is based on validation of
the required parameters for the time being in force and applicable
4 Collateral security refers to the security offered by the borrower for
bank finance or the one against which credit has been extended by the
bank.

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Solution Incorrect. 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.
5 Registered mortgage is affected by a mere delivery of title deeds or
other documents of title with intent to create security thereof
Solution Incorrect. Equitable mortgage, on the other hand, is affected by a mere
delivery of title deeds or other documents of title with intent to create
security thereof.
6 Any amount due to the bank under any credit facility is ‘overdue’ if it is
not paid within 90 days of becoming due.
Solution Incorrect. Any amount due to the bank under any credit facility is ‘overdue’
if it is not paid on the due date fixed by the bank.
7 An account should be treated as 'out of order' if the outstanding balance
remains continuously in excess of the sanctioned limit/drawing power.
Solution Correct. An account should be treated as 'out of order' if the outstanding
balance remains continuously in excess of the sanctioned limit/drawing power.
8 Banks recognize income on Non-Performing Assets on accrual basis.
Solution Incorrect: Income from non-performing assets (NPA) is not recognised on
accrual basis due to its uncertainty but is booked as income only when it is
actually received i.e. on actual receipt basis.
9 Auditor of a Nationalised bank is to be appointed at the annual general
meeting of the shareholders.
Solution Incorrect- Auditor of a nationalized bank is to be appointed by the bank
concerned acting through its Boards of Directors and approval of the Reserve
bank is required before the appointment is made.
10 Reporting of fraud of INR 150 Lakhs by auditor will be done within three
days of the fraud coming to the knowledge of the auditor to the Board
or the Audit Committee along with remedial action taken in case of audit
of ABA Bank Ltd.
Solution Incorrect- The auditor shall report the matter to the Board or the Audit
Committee, as the case may be, immediately but not later than 2 days of his
knowledge of the fraud, seeking their reply or observations within 45 days.
The Banking Company is bound to disclose remedial action taken in Board’s
report.
11 Central Govt. guaranteed Advances, where the guarantee is not invoked/
repudiated would be classified as Standard Assets.
Solution Correct: Central Govt. guaranteed Advances, where the guarantee is not
invoked/ repudiated would be classified as Standard Assets, but regarded as
NPA for Income Recognition purpose.

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MCQs
CA M is conducting statutory audit of branch of MMC Bank. During the course of audit, it
is noticed as under: -
(i) Loans under “Kisan credit card” are given by Bank to farmers to meet their short-term
credit needs for cultivation of crops.
In respect of one agricultural advance classified under “Kisan Credit Card” having an
outstanding balance of ₹ 20 lacs as at year end, there is no transaction in account since
last 90 days. The said loan has been granted for cultivation of paddy which is harvested
in a period of 3-4 months from sowing. The branch has classified the said advance as
“Standard asset”.
(ii) It is also observed that account of one borrower availing cash credit limit of ₹50 lacs
was taken over from another bank. The proposal was sanctioned by branch manager instead
of immediate next higher authority as required in “Manual of Delegation of Powers” of
Bank.
(iii) It is noticed that head office of bank has flagged a savings account maintained in
branch in which interest was wrongly paid at higher rate due to wrong data feeding entry.
Now, situation has been rectified by debiting excess interest paid in the account. Since
there was little balance in savings account, a debit balance of ₹1.50 lac was created in the
said savings account due to above reversal. The matter was immediately informed to
account holder. However, he has not turned up for payment since matter was informed to
him about six months ago.
(iv) There are many cash credit accounts in the branch. Such borrowers are required to
submit monthly stock statements to branch showing calculation of drawing power.
(v) One borrower has availed a housing loan and a car loan from the branch. Housing loan
EMIs are overdue for 120 days as on date of Balance sheet. Car loan EMIs are overdue
for 60 days as on date of Balance sheet.

(1) As regards description of agricultural advance, which of the following

statements is most appropriate in this regard?
(a) The branch has erred in making classification as per RBI norms. It is a “Sub-
standard” asset.
(b) The classification made by branch is proper. However, there are no transactions in
account since last 90 days, it is SMA.
(c) The classification made by branch is proper.
(d) The branch has erred in making classification as per RBI norms. It is a
“doubtful” asset.

(2) Regarding taken over account from another bank, which of following statements
is most appropriate?
(a) It is an internal issue of Bank and auditor is not concerned with it.
(b) It is an internal issue of Bank. However, the auditor may, at his discretion, report it.

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(c) It is a serious violation of laid down procedures of bank for sanction of advances and
should be reported by auditor without fail.
(d) There is no issue involved as credit facility was properly sanctioned.

(3) As regards debit balance of ₹ 1.50 lacs in Savings account, which of the
following is correct from point of view of an auditor?
(a) The situation does not attract RBI norms on asset classification.
(b) The debit balance of ₹1.50 lacs should be classified as NPA.
(c) The situation does not attract RBI norms on asset classification as no credit facility
was granted.
(d) The bank cannot demand excess interest paid to account holder.

(4) Which of the following statements is not true about “drawing power” (DP)?
(a) Drawing Power refers to the amount calculated based on primary security less margin
as on particular date.
(b) It is always less than sanctioned limit.
(c) It can be different from sanctioned limit.
(d) Creditors for goods are reduced for purpose of calculating Drawing Power.

(5) Considering housing loan and car loan availed by a borrower, which of the
following statements is appropriate?
(a) Both Housing loan as well as car loan should be classified as “Non-
Performing Assets” in accordance with RBI norms on asset classification.
(b) Housing Loan should be classified as “Non-Performing Asset” in accordance with RBI
norms on asset classification. However, Car loan should be classified as Standard asset.
(c) Car Loan should be classified as “Non-Performing Asset” in accordance with RBI
norms on asset classification. However, Housing Loan should be classified as Standard
asset.
(d) Both Housing as well as car loans should be classified as Standard assets.

(1) Which of the following is included in “Interest Earned” in Profit & loss A/c of a
bank?
(a) Discount on Bills
(b) Loan Processing fees
(c) Commission on bills for collection
(d) Credit Card Fees

(2) While auditing advances of a bank as statutory auditor, which of the following
is not a likely concern of auditor?
(a) Appropriate documentation of advances
(b) Ensuring budgeted targets of advances given by bank management
(c) Compliance of sanctioned terms and conditions

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(d) Operations in advance accounts

(3) Any amount due to the bank under any credit facility is ‘overdue’ if: -
(a) it is not paid on the due date fixed by the bank
(b) it is not paid within 30 days of due date fixed by the bank
(c) it is not paid within 60 days of due date fixed by the bank
(d) it is not paid within 90 days of due date fixed by the bank

(4) Which of the following statement is true regarding appointment of statutory

branch auditor of a nationalized bank?
(a) The appointment is made by bank acting through its board of directors with prior
approval of Central govt.
(b) The appointment is made by bank acting through its board of directors with prior
approval of RBI
(c) The appointment is made by bank acting through its board of directors with prior
approval of ICAI
(d) The appointment is made by shareholders in AGM.

(5) Identify the correct statement: -

(a) Income from non-performing assets is recognized on accrual basis
(b) Income from non-performing assets is never recognized.
(c) Income from non-performing assets is recognized on basis of actual recovery
(d) Income from non-performing assets is recognized only when such assets are
upgraded to standard assets

Case Laws / Detailed Answers

Quest-1 Discuss outline of audit approach including audit procedures while auditing
“provisions and contingencies” in financial statements of a bank.
Quest-2 Discuss importance of implementation of KYC norms by a bank from
perspective of an auditor of bank.
Quest-3 List out any four points which highlight peculiarities involved in banking
operations.
Quest-4 Is statutory auditor of a bank required to report on the requirements relating
to Companies (Auditor’s Report) Order, 2020?
Quest-5 Account of a borrower availing cash credit facility from branch of a bank has
become “Out or order.” Discuss the term “Out of order”.
Quest-6 The functioning of banking industry in India is regulated by the Reserve Bank
of India (RBI) which acts as the Central Bank of our country. Explain
Quest-7 “The engagement team should hold discussions to gain better understanding of
the bank and its environment, including internal control, and also to assess the

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potential for material misstatements of the financial statements. All these
discussions should be appropriately documented for future reference”. Explain
Quest-8 Write a short note on reversal of income under bank audit.
CA P is conducting stock audit of a borrower availing cash credit facility of
₹100 lacs from branch of a bank. The cash credit facility is against security of
Quest-9 paid stocks and debtors up to 90 days. Margin stipulated is 25% for stocks and
40% for debtors. Following further information is available as on 31.12.22: -
Value of stocks ₹ 125 lacs

Value of stocks (fully damaged) included in 5 lacs

above
Value of debtors 50 lacs
Value of debtors exceeding 90 days 10 lacs
included in above
Value of creditors for goods 50 lacs
Is Drawing Power computed by CA P for ₹ 82.50 lacs proper?

Solution

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