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Auditing an Ethics
Chapter - 10

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 AUDITING AND ETHICS

Concepts Notes

Chapter-10

AUDIT OF BANKS

INTRODUCTION

The banking sector plays a vital role in fostering sustainable economic growth and
maintaining financial stability. Given its handling of substantial public funds and
susceptibility to reputational risks, the sector is exposed to various operational risks.
Ensuring the health and soundness of the banking sector is paramount, with reliable
financial information being a crucial factor. Quality bank audits are instrumental in providing
the assurance and transparency needed to maintain the sector's stability, contributing to
overall economic well-being.

TYPES OF BANKS

1. Commercial Banks: Commercial banks, the most widespread institutions in India, provide
essential financial services to the public and various economic sectors. Their main functions
involve accepting deposits and granting advances, contributing significantly to economic
activities and financial circulation.

2. Regional Rural Banks (RRBs): Regional Rural Banks (RRBs) are specialized banks
established in rural areas across various states in India, specifically designed to address the
fundamental banking and financial requirements of rural communities. Examples include
institutions like Punjab Gramin Bank, Tripura Gramin Bank, Allahabad UP Gramin Bank, and

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Andhra Pradesh Grameen Vikas Bank, each playing a crucial role in fostering financial
inclusion and development in rural regions.

3. Co-operative Banks: Co-operative Banks operate similarly to Commercial Banks but are
founded on cooperative principles and registered under the Cooperative Societies Act or
Multistate Cooperative Societies Act. These banks, such as The Gujarat State Co-operative
Bank Ltd. and Chhattisgarh Rajya Sahakari Bank Maryadit, typically focus on serving the
financial needs of the agricultural and rural sectors, emphasizing community-driven and
cooperative-based financial services.

4. Payments Banks: Payments Banks, a recent introduction by the Reserve Bank of India
(RBI), are authorized to accept restricted deposits while being restricted from issuing loans
and credit cards. Despite these limitations, customers can open Current and Savings
accounts, and access services like ATM cum Debit cards, Internet banking, and Mobile
banking. Examples include Airtel Payments Bank, India Post Payments Bank, and Paytm
Payments Bank, contributing to enhanced financial accessibility and digital services for
customers.

5. Development Banks: Development Banks, such as Industrial Finance Corporation of India

(IFCI), Industrial Development Bank of India (IDBI), and Small Industries Development Bank
of India (SIDBI), were established with the primary objective of providing financial support
for crucial infrastructural facilities that play a vital role in the economic growth of the
country. These institutions focus on funding projects and initiatives that contribute to the
overall development and progress of the nation.

6. Small Finance Banks: Small Finance Banks, established by the Reserve Bank of India
(RBI), serve the critical purpose of providing essential financial and banking services to the
underserved and unorganized sectors. These banks, including examples like Equitas Small
Finance Bank and AU Small Finance Bank, focus on extending basic financial facilities to
segments such as small marginal farmers and micro-business units, fostering financial
inclusion and economic empowerment in these sectors.

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UNDERSTANDING OF ACCOUNTING SYSTEM IN BANKS

The evolution of technology has transformed banking from physical visits to anytime-
anywhere access through E-banking. Core banking technology and continuous
advancements have driven phenomenal growth and enabled banks to offer innovative
products. In this digital landscape, maintaining the integrity of recorded, transmitted, and
stored data is crucial to prevent errors, omissions, irregularities, and frauds. Bank
managements strive to ensure robust, secure, and convenient internal control systems.
Auditors, in this computerized environment, must be well-versed in the latest RBI
guidelines, ensuring that system-generated information is accurate and reliable.
Professional skepticism is essential, prompting auditors to manually verify information,
documenting results where necessary to ensure authenticity and consistency.

BANK AUDIT APPROACH

1. Audit Plan: Consider nature of operations, adverse features, compliance history, and
audit risks. Base the plan on the adequacy of internal controls and findings from the
familiarization exercise.
2. Control Environment at the Bank: A bank's control environment is vital for risk
management and operational integrity. This includes effective segregation of duties,
accurate measurement and reporting of positions, thorough verification and approval of
transactions, reconciliation processes, setting up activity limits, reporting and approving
exceptions, ensuring physical security, and having contingency plans for unforeseen events.
These measures collectively contribute to a robust control framework within the bank.

The following are certain common questions /steps, which have to be kept in mind while
undertaking/ performing control activities:

Nature of Questions to be considered / answered

Questions
Who 1. Who performs the control?
2. Does the above person have requisite knowledge and authority

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 to perform the control?
What What evidence is available to demonstrate /prove that the control is
performed?
When 1. When and with what frequency is the control performed?
2. Is the frequency enough to prevent, detect and correct risk of
material misstatements?
Where 1. Where is the evidence of performance of the control retained?
2. For how long is the evidence retained?
3. Is the evidence accessible/ available for audit?
Why 1. Why is the control being performed?
2. What type of errors are prevented or detected through the
performance of the control?
How 1. How is the control performed?
2. What are the control activities?
3. Can these activities be bypassed?
4. Can the bypass, if any, be detected?
5. How are exceptions / deviations resolved on identification?
6. What is the time frame for resolving the exceptions / deviations?

3. Engagement Team Discussions: The Engagement Team, consisting of all individuals

involved in an audit, conducts thorough discussions to enhance understanding of the bank,
its environment, and internal controls. These discussions aim to assess the potential for
material misstatements in financial statements. Comprehensive documentation of these
discussions is crucial for future reference. Key conversations, particularly between team
members and the audit engagement partner, focus on evaluating the susceptibility of the
bank's branch financial statements to material misstatements. Typically conducted during
the planning stage, these discussions lay the foundation for a rigorous and effective audit
process.

The engagement team discussion ordinarily includes a discussion of the following matters:

 Identify potential errors more likely to occur.

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 Review errors identified in prior years.
 Assess methods of potential fraud within account balances or disclosures.
 Formulate audit responses to Engagement Risk, Pervasive Risks, and Specific Risks.
 Emphasize the importance of maintaining professional skepticism throughout the audit.
 Stay alert for information indicating material misstatements, such as the bank's
application of accounting policies in specific circumstances.

Advantages of Discussion on Fraud Risks:

 Emphasis on the susceptibility of the bank's financial statements to material

misstatement due to fraud enables tailored responses to fraud risks, covering engagement
risk, pervasive risks, and specific risks.
 Facilitates delegation of tasks to experienced team members by the audit engagement
partner, along with defining procedures for handling identified fraud.
 Allows the audit engagement partner to assess the necessity of involving specialists to
address fraud-related issues efficiently.

INCOME RECOGNITION POLICY

The income recognition policy emphasizes objectivity based on actual recovery records
rather than subjective factors. Specifically, income from non-performing assets (NPA) is not
recognized on an accrual basis; instead, it is booked as income only upon actual receipt. This
approach ensures a conservative and realistic recognition of income in financial reporting,
aligning with the actual cash flow from recoveries.

FORM AND CONTENT OF FINANCIAL STATEMENTS

Section 29 of the Banking Regulations Act, 1949, mandates that banking companies,
including nationalized banks and Regional Rural Banks, must prepare financial statements in
the specified formats outlined in the Third Schedule. Form A of the schedule details the

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format for the Balance Sheet, and Form B specifies the format for the Profit and Loss
Account. This standardized approach ensures uniformity in financial reporting, facilitating
regulatory oversight and comparability across banking institutions.

AUDIT OF ACCOUNTS

Section 30(1) of the Banking Regulations Act, 1949, mandates that the balance sheet and
profit and loss account of a banking company must undergo auditing. This auditing process
must be conducted by an individual who is qualified under the prevailing laws to serve as an
auditor for companies. Essentially, the provision ensures that a qualified professional
examines the financial statements of banking companies to verify their accuracy and
compliance with relevant financial regulations.

APPOINTMENT OF AUDITOR

According to relevant enactments, the appointment of auditors for different types of banks
is regulated as follows:

1. Banking Company: The auditor of a banking company is appointed at the annual general
meeting of the shareholders.
2. Nationalised Bank: The auditor of a nationalized bank is appointed by the bank's Board
of Directors, subject to the approval of the Reserve Bank of India.
3. Regional Rural Banks (RRBs): Auditors for RRBs are appointed by the bank itself with the
approval of the Central Government. In all cases, approval from the Reserve Bank of India or
the Central Government is a prerequisite before the auditor's appointment.

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REMUNERATION OF AUDITOR

(a) The auditor's remuneration for a banking company is determined in accordance with
Section 142 of the Companies Act, 2013, either by the company in a general meeting or in a
manner decided by the general meeting.

(b) The remuneration for auditors of nationalized banks and the State Bank of India is set by
the Reserve Bank of India, in consultation with the Central Government.

POWERS OF AUDITOR

Auditors of banking companies, nationalized banks, State Bank of India, and regional rural
banks are endowed with powers equivalent to those of auditors for companies. This grants
them unrestricted access to examine the books, accounts, documents, and vouchers of the
financial institution. This authority ensures that auditors can thoroughly assess and verify
the financial records, contributing to the transparency and accuracy of the banks' financial
reporting.

AUDITOR’S REPORT

For nationalized banks and the State Bank of India, the auditor's report to the Central
Government must address the following:

(a) Express an opinion on whether the financial statements provide a true and fair view of
the bank's affairs and indicate if requested explanations were satisfactory.

(b) Confirm whether the bank's transactions observed during the audit were executed
within its authorized powers.

(c) Assess the adequacy of returns received from the bank's offices and branches for the
audit's purposes.

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(d) Report on any other pertinent matters that merit the attention of the Central
Government. The auditor's report for the State Bank of India closely mirrors the
requirements for nationalized banks.

FORMAT OF REPORT

Auditors, both central and branch auditors, must ensure that their audit reports comply
with Standards on Auditing. The report should not only mention unaudited branches but
also disclose specific details like advances, deposits, interest income, and interest expense
for these branches. This aligns with international standards and provides valuable
information to financial statement users. Additionally, auditors of banking companies need
to address matters covered by Section 143 of the Companies Act, 2013, in their reports. It's
important to note that reporting requirements under the Companies (Auditor’s Report)
Order, 2020 do not apply to banking companies as defined in the Banking Regulation Act,
1949.

LONG FORM AUDIT REPORT

In addition to the statutory audit report, auditors of public sector banks, private sector
banks, and foreign banks, including their branches, are mandated to submit a Long Form
Audit Report (LFAR). The Reserve Bank of India specifies the matters that auditors must
address in the LFAR. Statutory Central Auditors must submit the LFAR to the banks by June
30 each year. Although the LFAR format doesn't mandate an executive summary, auditors
may choose to include one to highlight key observations from the comprehensive
document. Timely completion and submission of LFAR require careful planning.

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REPORTING TO RBI

1. As per RBI's Circular on bank frauds, auditors, whether internal or external, must
promptly report any suspicion of fraud or fraudulent activity, excess power, or foul play in
transactions to the regulator. Deliberate failure to do so renders the auditor liable for
action.
2. In line with Standard on Auditing (SA) 250, auditors must consider laws and regulations,
and the duty of confidentiality can be overridden by statutes, laws, or court requirements.
3. SA 240 emphasizes the auditor's responsibility to obtain reasonable assurance that
financial statements are free from material misstatements due to fraud or error. While
auditors need not scrutinize every transaction, they are obligated to report any issues
encountered during their normal duties to RBI and the bank's leadership.

CONDUCTING AN AUDIT

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

A. Initial consideration by the statutory auditor

1. Declaration of Indebtedness: Banks must obtain a declaration of indebtedness before
appointing statutory auditors, ensuring transparency in financial relationships.
2. Internal Assignments: Audit firms are prohibited from taking on statutory audit
assignments while concurrently engaged in internal assignments like concurrent audits for
the same bank in the same year.
3. Planning: The auditor, following standards like SA 300 and SA 220, engages in planning
activities, including understanding the terms of engagement, communication with the
previous auditor, and assessing engagement risk.
4. Terms of Audit Engagements: SA 210 necessitates agreeing on terms before significant
fieldwork, documented to prevent misunderstandings about responsibilities.
5. Initial Engagements: Auditors perform procedures outlined in SA 510 for opening
balances, expressing a qualified or adverse opinion if misstatements materially affect
financial statements.

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6. Assessment of Engagement Risk: A critical pre-engagement step, assessing engagement
risk influences the decision to accept the audit and planning considerations.
7. Engagement Team: Forming a qualified team based on the bank's size, nature, and
complexity is crucial for managing engagement risk effectively.
8. Understanding the Bank: SA 315 directs auditors to comprehend the bank and its
environment, including internal controls, to identify and assess risks of material
misstatement and design appropriate audit procedures.

B. Communication with Previous Auditor: Before accepting the position of auditor

previously held by another chartered accountant, a practicing Chartered Accountant must
adhere to Clause (8) of the Part I of the First Schedule to the Chartered Accountants Act,
1949. This involves a written communication with the previous auditor to seek a No
Objection Certificate (NOC). The purpose is to ascertain if the previous auditor has any valid
objections to the new appointment, ensuring transparency and ethical practices in the
transition.

C. Identifying and Assessing Risks: SA 315 mandates auditors to identify and evaluate risks
of material misstatement at both the financial statement and assertion levels for
transactions, account balances, and disclosures. This forms the basis for planning and
executing subsequent audit procedures.

D. Understanding the Bank and Its Environment: For effective auditing, a comprehensive
understanding of the bank and its environment, including internal control, is crucial. This
understanding allows auditors to assess risks accurately and design appropriate audit
procedures. Comprehending the bank's accounting process is essential for identifying and
assessing risks of material misstatement, whether due to fraud or other factors. This
understanding aids in the design and implementation of relevant audit procedures.

E. Risk Management Process: Management's use of controls and performance indicators

for key business and financial risks is crucial for effective risk assessment during the audit.

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F. Engagement Team Discussions: Engagement teams conduct discussions to enhance
understanding of the bank and its environment, including internal controls, and assess the
potential for material misstatements in financial statements.

G. Overall Audit Strategy: SA 300 emphasizes the importance of establishing an overall

audit strategy, ensuring effective planning and execution of the audit.

H. Develop the Audit Plan: In line with SA 300, key engagement team members collaborate
to develop an audit plan, involving considerations of engagement risk and other factors.

I. Audit Planning Memorandum: The auditor prepares an audit planning memorandum

summarizing the audit plan, scope, and decisions, providing evidence of appropriate
planning and responses to risks.

J. Determine Audit Materiality: Auditors consider the relationship between audit

materiality and audit risk, exercising professional judgment based on knowledge of the
bank, engagement risk, and reporting requirements.

K. Consider Going Concern: While understanding the bank, auditors assess events and
conditions that may cast doubt on the bank's ability to continue as a going concern.

L. Assess the Risk of Fraud including Money Laundering: SA 240 guides auditors in
identifying and assessing risks of material misstatement due to fraud, maintaining
professional skepticism, and addressing money laundering risks as per RBI guidelines.

M. Assess Specific Risks: Auditors identify and assess risks of material misstatement at the
financial statement level, influencing many assertions throughout the financial statements.

N. Risk Associated with Outsourcing: Considering the risks associated with outsourcing,
banks must effectively manage these risks given the modern-day reliance on external
expertise.

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O. Response to Assessed Risks: SA 330 guides auditors in designing and implementing
responses to assessed risks, shaping further audit procedures based on the nature, timing,
and extent of these risks.

P. Stress Testing: Banks are required by RBI to implement a Board-approved 'Stress Testing
framework' integrating into their risk management systems.

Q. BASEL III Framework: Basel III norms, formulated by BCBS, provide a global regulatory
framework for resilient banks and banking systems, focusing on risks and enhancing
stability.

R. Reliance on / Review of Other Reports: Auditors consider adverse comments on

advances from various reports, including previous audit reports, internal inspection reports,
RBI inspection reports, concurrent/internal audit reports, and other relevant internal
reports. Statutory Central Auditors must review RBI's Annual Financial Inspection report and
ensure proper consideration of reported variations by the bank management.

ADVANCES

Lending is a key function of banks, involving the provision of credit through advances, which
constitute a significant portion of a bank's balance sheet and a major income source.
Auditors play a crucial role in assessing and verifying these advances during bank audits. To
effectively audit this area, auditors need comprehensive knowledge of the banking industry,
regulations governing banks, and a deep understanding of a bank's functional areas,
processes, procedures, and internal controls related to advances. This ensures a thorough
examination of the bank's lending activities, contributing to the accuracy and reliability of
financial statements.

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TYPES OF ADVANCES

1. Funded Loans: Funded loans involve the actual transfer of funds from the bank to the
borrower. Examples include term loans, cash credits, overdrafts, demand loans, bills
discounted and purchased, participation on a risk-sharing basis, and interest-bearing staff
loans.
2. Non-Funded Facilities: Non-funded facilities do not entail a direct transfer of funds.
Examples include letters of credit and bank guarantees. In these cases, the bank provides a
commitment or guarantee to fulfil a financial obligation on behalf of the borrower, without
an immediate transfer of funds.

CLASSIFICATION OF ADVANCES

Sector Wise: RBI issues guidelines directing banks to follow specific criteria, including
interest rates and service charges, for lending to Priority Sectors such as Agriculture, MSME,
Education, Housing, etc. Targets are set to ensure sufficient credit flow into these critical
sectors, promoting inclusive growth and socio-economic development.

Security wise: When lending, banks require security or collateral to ensure the borrower's
commitment to repay the loan within the specified time. The nature of security can be
categorized into two types

A. Primary Security: Security provided by the borrower for bank finance. The primary
security is the principal assurance for the advance.

B. Collateral Security: Additional security, which can be tangible or intangible, movable or

immovable. Serves as supplementary protection for the loan.

MODE OF CREATION OF SECURITY

The creation of security in banking involves various modes depending on the nature of the
item:

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1. Mortgage:

a. Registered Mortgage involves a formal instrument, the 'Mortgage Deed,' registered by

the mortgagor.

b. Equitable Mortgage is established by delivering title deeds, indicating an intent to create

security.

2. Pledge: Pledge in banking entails the borrower delivering goods to the lender, creating a
charge for the advance. Legal ownership remains with the pledger, but the lending bank
holds specific, defined interests in the goods, constituting a specific charge.

3. Hypothecation: Hypothecation involves creating an equitable charge, established through

a hypothecation agreement for movable securities. The borrower retains ownership and
possession, acting as an agent/trustee, providing periodic statements to the bank for
determining drawing power based on the quantity and value of hypothecated assets such as
stocks and debtors.

4. Assignment: Assignment in banking involves the transfer of an existing or future debt,

right, or property from one person to another. Banks accept actionable claims, such as book
debts and life insurance policies, as security through assignment. This process grants the
assignee absolute rights over the assigned moneys or debts.

5. Set-off: Set-off is a statutory right allowing a creditor, like a bank, to offset a debit
balance in a debtor's account against any credit balance in another account of the same
person. This applies to accounts with the same name and right. All branches of a bank are
treated as one entity for set-off purposes, even for time-barred debts.

6. Lien: Lien is the establishment of a legal charge, sanctioned by the owner's consent,
providing the lender with a legal entitlement to seize and liquidate the asset held under lien.

PRUDENTIAL NORMS ON INCOME RECOGNITION, ASSET CLASSIFICATION AND

PROVISIONING PERTAINING TO ADVANCES

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1. Non-performing Assets: (NPAs) refer to loans or advances that cease to generate income
for the bank. An asset becomes an NPA under the following conditions: for a term loan,
when interest and/or instalment of principal remain overdue for more than 90 days; for an
Overdraft/Cash Credit (OD/CC), when the account remains 'out of order'; and for bills
purchased and discounted, when the bill remains overdue for more than 90 days.

2. Out of Order: An account is considered 'out of order' if the outstanding balance

consistently exceeds the sanctioned limit/drawing power. Alternatively, even if the
outstanding balance is below the sanctioned limit/drawing power, the account is treated as
'out of order' if there are no credits for 90 consecutive days as of the Balance Sheet date.
Additionally, if credits are present but insufficient to cover the interest debited during the
same period, the account should be classified as 'out of order.'

3. Overdue: Any amount owed to the bank under a credit facility is considered 'overdue' if it
is not paid by the due date set by the bank.

Categories of Non-Performing Assets: Provision required

Substandard Assets:
Would be one, which has remained NPA for a period less than 15%
or equal to 12 months.
Doubtful Assets:
Would be one, which has remained in the
Substandard category for a period of 12 months. (Secured + Unsecured)
Sub-categories:
Doubtful up to 1 Year (D1) 25% + 100%
Doubtful 1 to 3 Years (D2) 40% + 100%
Doubtful more than 3 Years (D3) 100% + 100%

Loss Assets: 100%

Would be one, where loss has been identified by the bank or
internal or external auditors or the RBI inspection but the
amount has not been written off wholly

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4. Accounts regularized near the Balance Sheet Date: This concept highlights the need for
careful scrutiny of borrower accounts that show a sudden or isolated recording of credits
just before the balance sheet date. The asset classification should be objective, and if there
are signs of inherent weakness, the account should be treated as a Non-Performing Asset
(NPA). Auditors should examine sample transactions right before and after the financial year
close to understand the purpose and potential relationships between these transactions.
This is crucial to detect any attempts to manipulate transactions and prevent borrower
accounts from being classified as NPAs.

5. Government Guaranteed advances: For Central Government guaranteed advances, if the

guarantee is intact and not invoked or repudiated, they are classified as Standard Assets.
However, for income recognition purposes, they are treated as Non-Performing Assets
(NPA). In contrast, when the State Government guarantees the advance, it is considered an
NPA if it remains overdue for more than 90 days for both provisioning and income
recognition. This distinction acknowledges the varying criteria for classification and
treatment based on the nature of the government guarantee.

6. Advances under Consortium: Consortium advances involve multiple banks jointly lending
to a borrower, typically led by one bank. Joint appraisal and monitoring enable information
exchange. The record of individual member banks' recovery influences consortium
advances. If remittances are pooled with one bank and not shared, it's treated as not
serviced and classified as an NPA. To ensure accurate classification, consortium banks must
transfer their share of recovery from the lead bank or obtain consent, emphasizing
coordination in managing consortium loans.

ACCOUNTS WHERE THERE IS EROSION IN THE VALUE OF SECURITY / FRAUDS COMMITTED

BY BORROWERS

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Erosion, indicating a gradual decline or diminution, warrants skipping the usual stages of
asset classification. Instead, it should be promptly classified as either doubtful or a loss
asset, depending on the severity of the erosion.

a. Significant erosion occurs when the realizable value of security is less than 50% of the
assessed value. In such cases, non-performing assets are promptly classified as doubtful,
requiring corresponding provisioning.
b. When the realizable value of security is below 10% of the outstanding borrowal accounts,
the security is disregarded, and the asset is immediately classified as a loss asset. The bank
has the option to either write off the asset or provide for it in full.

AGRICULTURAL ADVANCES AFFECTED BY NATURAL CALAMITIES

In cases of agricultural advances affected by natural calamities, the RBI's Master Circular
addresses classification and income recognition issues. Banks can implement relief
measures, such as converting short-term production loans into term loans or rescheduling
repayment periods, and sanctioning fresh short-term loans. The classification of non-
performing assets (NPAs) is determined by the terms outlined in the rescheduled
agreements, in accordance with the latest RBI guidelines on Prudential Norms for Income
Recognition, Asset Classification, and provisioning related to Advances.

ADVANCES TO STAFF

Advances to staff, especially interest-bearing ones like housing loans, are treated as part of
the bank's overall advances portfolio. In cases where interest on housing loans is payable
after principal recovery, it's not considered overdue until the first quarter. Classification as a
non-performing asset (NPA) only occurs if there's a default in principal or interest
repayment on the specified due dates. However, staff advances given by the bank as an

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employer, not in its banking capacity, are categorized under 'Others' in the schedule of
Other Assets, distinguishing them from the bank's traditional lending activities.

AGRICULTURAL ADVANCES

Agricultural Advances are categorized into two types: those for "long duration" crops and
those for "short duration" crops. "Long duration" crops have a crop season longer than one
year, while the rest are considered "short duration" crops. The determination of the crop
season for each type is delegated to the State Level Bankers' Committee in each state,
reflecting regional variations in crop harvesting periods.

COMPUTATION OF DRAWING POWER

Drawing Power (DP) is a crucial concept for entities utilizing Cash Credit (CC) facilities from
banks or financial institutions. It represents the maximum limit that a firm or company can
withdraw from the sanctioned working capital limit. Essentially, it signifies the available
funds a business can access within its approved credit facility to manage day-to-day
operational needs.

1. Difference between Sanctioned Limit and Drawing Power: The sanctioned limit
represents the overall exposure a bank can extend to a client across various facilities such as
cash credit and overdraft. In contrast, drawing power is the specific amount calculated on a
given date, considering primary security less margin, indicating the maximum funds a client
can withdraw within the sanctioned limit.

2. Considerations for Accounts: It is imperative to ensure that all accounts consistently

adhere to both the drawing power and sanctioned limit. Any accounts surpassing these
limits, being contrary to approved securities, or displaying irregularities must be promptly

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reported to the Management/Head Office on a regular basis for necessary attention and
corrective action.

3. Bank's Duties: Banks bear the responsibility of aligning working capital account drawings
with the sufficiency of current assets. Drawing power is determined based on the current
stock statement; however, for large borrowers, banks should not rely on stock statements
older than three months to account for potential difficulties. Any outstanding amounts
based on drawing power from stock statements older than three months are considered
irregular.

4. Auditor’s Concern: Auditors must meticulously scrutinize the borrower's stock

statements, quarterly returns, and other submissions to the bank. Thorough examination of
the borrower's audited Annual Report is essential, including a detailed comparison of the
monthly stock statement with the audited accounts, aiming to identify and understand any
deviations in order to ensure financial accuracy and compliance.

5. Computation of DP: The computation of Drawing Power (DP) should strictly adhere to
the existing guidelines set by the Board of Directors of the bank and mutually agreed upon
by the statutory auditors. Additionally, particular attention should be directed towards
accurately reporting sundry creditors, ensuring their proper inclusion for the precise
calculation of drawing power.

6. Stock Audit: Stock audits are mandatory for accounts with funded exposure exceeding 5
crores. Auditors may recommend stock audits in other cases as needed. Branches not
leading a working capital consortium should obtain stock audit reports from the lead bank.
During the audit, special attention should be paid to the comments made by stock auditors
on security valuation and drawing power calculation.

Particulars of current assets DP

(A) Stocks
Stocks at realizable value 1000

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 Less: Unpaid stocks:
 Sundry creditors 300
 Acceptances/LCs etc. 300 600

 Paid for stocks 400

 Margin @ 25% 100 300
(B) Debtors
Total Debtors 1000
Less: Ineligible debtors 200
Eligible debtors 800
Margin @ 40% 320 480

Total DP 780

AUDIT OF ADVANCES

Advances typically form a substantial portion of the bank's assets, and a diverse range of
borrowers are granted various types of advances. Given the significant role advances play in
the bank's portfolio, the audit of advances demands primary focus and attention from
auditors.

In carrying out audit of advances, the auditor is primarily concerned with obtaining
evidence about the following:

(a) Verifying amounts in the balance sheet for outstanding advances.

(b) Confirming that advances represent amounts owed to the bank.

(c) Ensuring proper documentation supports amounts due, aligned with the nature of
advances.

(d) Confirming the absence of unrecorded advances.

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(e) Validating the appropriateness and application of the stated valuation basis for
advances, recognizing their recoverability.

(f) Verifying disclosure, classification, and description of advances in compliance with

accounting policies, statutory, and regulatory requirements.

(g) Assessing provision adequacy for advances in accordance with RBI norms, Accounting
Standards, and accepted accounting practices.

INCOME

Interest Earned Other Income

 Interest/ Discount on Advances/ Bills: Commission, Exchange and Brokerage: This
 Interest Income on Investments: item comprises of the following:
 Interest on Balances with RBI and Other (a) Commission on bills for collection.

 Inter–bank Funds: (b) Commission/exchange on remittances

 Others: This includes any other and transfers, e.g. demand drafts, NEFT,
interest/discount income not included in RTGS, etc.
the above heads (c) Commission on letters of credit and
guarantees, letter of comforts.
(d) Loan processing, arranger and
syndication fees.
(e) Mobile banking fees.
(f) Credit/Debit card fee income including
annual fee income, merchant acquiring
income, interchange fees, etc.
(g) Rent from letting out of lockers
(h) Commission on Government business.
(i) Commission on other permitted agency
business including consultancy and other
services.
(j) Brokerage on securities.
(k) Fee on insurance referral.
(l) Commission on referral of mutual fund

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 clients.
(m) Service/transaction banking charges
including charges levied for transaction at
other branches.
(n) Income from rendering other services
like custodian, demat, investment advisory,
cash management and other fee based
services.
 Profit on Sale of Investments
 Profit/Loss on Revaluation of Investments
 Profit on sale of Land, Buildings and Other
 Assets:
 Profit/Loss on Revaluation of Fixed Assets
 Profit on exchange transactions: This
includes revaluation gains/losses on
forward exchange contracts and other
derivative contracts, premium
income/expenses on options, etc.
 Income earned by way of dividends, etc.,
from subsidiaries and joint ventures
abroad/in India.
 Miscellaneous income.

AUDIT APPROACH AND PROCEDURES

a. Revenue Uncertainty: Due to substantial uncertainty surrounding the ultimate collection

of income from non-performing assets, banking guidelines mandate that banks refrain from
recognizing income on such assets until it is actually realized. When a credit facility is initially
classified as non-performing, any interest previously accrued and credited to the income

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account in the corresponding prior year, yet unrealized, must be reversed or provided for.
This protocol also applies to Government-guaranteed accounts.

b. Advances against Securities: Interest on advances against securities such as Term

Deposits, National Savings Certificates (NSCs), Indira Vikas Patras (IVPs), Kisan Vikas Patras
(KVPs), and Life policies can be recognized in the income account on the due date, given
there is an adequate margin available in the accounts. This practice aligns with the
assurance of repayment and sufficient collateral value associated with these secured
advances.

c. Bills Purchased: For bills purchased outstanding at the year-end, the discount received
should be appropriately allocated between two years. Unexpired discount on bills extending
beyond the year-end is recorded as "Other Liabilities." Additionally, the interest component
paid on the rediscount of bills from other financial institutions is not netted off from the
discount earned on bills purchased.

d. Bills for Collection: In the context of bills for collection, the auditor scrutinizes the
process of crediting the party for whom the bill is collected. Typically, the customer's
account is credited after the bill is collected from the drawee, either by the bank or its
agents. This aligns with the bank's obligation regarding bills for collection, and the branch's
commission becomes due only upon successful bill collection.

e. Renegotiations: Fees and commissions resulting from the renegotiation or rescheduling

of outstanding debts should be recognized on an accrual basis over the duration of the
renegotiated or rescheduled credit extension. The auditor verifies the interest earned and
tests the fees and commissions earned by the banks, specifically examining those related to
bills for collection, letters of credit, and bank guarantees.

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