PROF.

CA TEJAS SHAH PDLC

CHAPTER 10 AUDIT OF BANKS

 CHAPTER OVERVIEW

 TYPES OF BANKS
1. Commercial banks are the most wide spread banking institutions in India, that provide a
number of products and services to general public and other segments of economy. Two of
its main functions are:-
(a) accepting deposits and
(b) granting advances.
2. Regional Rural Banks known as RRBs are the banks that have been set up in rural areas in
different states of the country to cater to the basic banking and financial needs of the rural
communities. Examples are :- Punjab Gramin Bank , Tripura Gramin Bank , Allahabad UP
Gramin Bank , Andhra Pradesh Grameen Vikas Bank, etc.
3. Co-operative Banks function like Commercial Banks only but are set up on the basis of
Cooperative Principles and registered under the Cooperative Societies Act of the respective
state or the Multistate Cooperative Societies Act and usually cater to the needsof the
agricultural and rural sectors. Examples are :- The Gujarat State Co- operativeBank Ltd. ,
Chhatisgarh Rajya Sahakari Bank Maryadit , etc.
4. Payments Banks are a new type of banks which have been recently introduced by RBI. They
are allowed to accept restricted deposits but they cannot issue loans and credit cards. However
, customers can open Current & Savings accounts and also avail the facility ofATM cum
Debit cards , Internet-banking & Mobilebanking. Examples are :- Airtel Payments Bank ,
India Post Payments Bank, Paytm Payments Bank , etc.
5. Development Banks had been conceptualized to provide funds for infrastructural facilities
important for the economic growth of the country. Examples are:- Industrial Finance
Corporation of India (IFCI), Industrial Development Bank of India (IDBI), Small Industries
Development Bank of India (SIDBI) , etc.

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6. Small Finance Banks have been set up by RBI to make available basic financial andbanking
facilities to the unserved and unorganised sectors like small marginal farmers, small & micro
business units, etc. Examples are:- Equitas Small Finance Bank , AU Small Finance Bank ,
etc.

RBI is responsible for :-

• development and supervision of the constituents of the Indian financial system (which
comprises banks and non-banking financial 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 functions of RBI are :-
• issuance of currency;
• regulation of currency issue;
• 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.
Banking Operations - Conducted only at Branches
Banking operations are conducted only at the branches, while other offices act as controlling
authorities or administrative offices that lay down policies, systems and internal control procedures
for conduct of business, in compliance with the statutory/ regulatory impositions and in compliance
of accepted accounting principles and practices that cover all transactions and economicevents. These
controlling/ administrative offices also stipulate the delegation of powers and fix responsibilities and
accountability and these are involved generally in effective supervision, monitoring and control over
the business activities and operations, including seeking faithful compliance of the bank’s laid down
policies/ procedures/controls and deal with deviations therefrom.

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Regulatory Framework

Banking Regulation Act, 1949. State Bank of India Act, 1955.

Companies Act, 2013. State Bank of India (Subsidiary Banks) Act
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.
Regional Rural Banks Act, 1976.
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980.
Information Technology Act, Prevention of Money Laundering Act, 2002.
Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002.
Credit Information Companies Regulation Act, 2005.
Payment and Settlement Systems Act, 2007.
Besides, the above enactments, the provisions of the Reserve Bank of India Act, 1934, (RBI Act)
also affect the functioning of banks. The RBI Act gives wide powers to the RBI to give directions to
banks which also have considerable effect on the functioning of banks.

Peculiarities
involved:

Huge volumes Wide geographical Large range of Extensive use of Strict vigilance
and spread of banks’ products and technology by the banking
complexity of network services regulator etc
transactions offered

Types of Bank Audit Reports to be issued (generally):

Presently, the Statutory Central Auditors (SCAs) have to furnish the following reports in
addition to their main audit report:

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FoRTI2S-L

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1. UNDERSTANDING OF ACCOUNTING SYSTEM IN BANKS

• From the time that customers had to physically visit and deal with a bank, there is 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.
• 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.

2. BANK AUDIT APPROACH

1. Drawing an Audit Plan :- An audit plan should be drawn up based on :-
• the nature and level of operations,
• 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 Environment at the Bank :- 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.
The following are certain common questions /steps, which have to be kept in mind while
undertaking/ performing control activitie

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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 demonstrate/prove that the control
is performed?
When • When and with what frequency is the control performed?
• 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 bypassed?
• Can th bypass, if any, be detected?
• How are exceptions/deviations resolved on identification?
• What is the time frame for resolving the exceptions?

3. Engagement Team Discussions : All personnel performing an engagement, including any

experts contracted by the firm in connection with that engagement are known to 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:
• Errors that may be more likely to occur;
• Errors which have been identified in prior years;
• Audit responses to Engagement Risk, Pervasive Risks, and Specific Risks;
• Need to maintain professional skepticism throughout the audit engagement;
• 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).

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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.

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9. APPOINTMENT OF
AUDITOR

The auditor of a The auditor of a The auditors of The auditors of The auditors of
banking nationalised the State Bank the subsidiaries regional rural
company is to bank is to be of India are to of the State Bank banks are to be
be appointed at appointed by the be appointed by of India are to be appointed by
the annual bank concerned the Comptroller appointed by the the bank
general meeting acting through and Auditor State Bank of concerned with
of the its Board of General of India India. the approval of
shareholders & Directors. & in consultation the Central
with the prior with the prior with the Central Government.
approval of RBI. approval of Government.
RBI.
SH+RBI BoD+RBI C&AG+CG SBI Bank+CG
10. AUDITOR’S REPORT
In the case of a nationalised bank, the auditor is required to make a report to the Central
Government in which he has to state the following:

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(NOTE: 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.)

Format of Report
• The auditors, central as well as branch, should also ensure that the audit report issued by them
complies with the requirements of Standards on Auditing discussed in Chapter 8 on Audit Report.
• 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.
• Such disclosure in the audit report is not only in accordance with the best international trends but
also provides useful information to users of financial statements.
• It may be noted that, in addition to the aforesaid, 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, it is pertinent to mention that the reporting requirements relating to the Companies
(Auditor’s Report) Order, 2020 is not applicable to a banking company, as defined in clause (c) of
Section 5 of the Banking Regulation Act, 1949.

Long Form Audit Report

• Besides the audit report as per the statutory requirements discussed above, the terms
of 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
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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.

Reporting to RBI
• The RBI issued a Circular relating to implementation of recommendations of Committee on
Legal Aspects of Bank Frauds applicable to all scheduled accounting and auditing profession,
the said circular provided as under:
“If an accounting professional, whether in the course of internal or external audit or in
the process of institutional audit finds anything susceptible to befraud or fraudulent
activity or act of excess power or smell any foul play in any transaction, he should refer
the matter to the regulator. Any deliberate failure on the part of the auditor should render
himself liable for action”.
As per the above requirement, the member shall be required to report the kind of mattersstated in the circular
to RBI.
• Auditor should also consider the provisions of SA 250, “Consideration of Laws and
Regulations in an Audit of Financial Statements”. The said Standard explains thatthe duty of
confidentiality is over-ridden by statute, law or courts.
• SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of FinancialStatements“
states that an auditor conducting an audit in accordance with SAs is responsible for obtaining
reasonable assurance that the financial statements taken as a whole are free from material
misstatement, whether caused by fraud or error.

11. CONDUCTING AN AUDIT

1. Initial consideration by the statutory auditor

2. Identifying and Assessing the Risks of Material Misstatements (SA 315)

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3. Understanding the Bank and Its Environment including Internal Control

4. Understanding the Bank’s Accounting Process

5. Understanding the Risk Management Process

(a) Oversight (b) (c) Control (d) (e) Reliable

and involvement Identification, activities Monitoring information
in the control measurement activities systems
process by those and monitoring
charged with of risks
governance:
6. Engagement Team Discussions
7. Establish the Overall Audit Strategy (SA 300)
8. Develop the Audit Plan ( SA 300)
9. Audit Planning Memorandum
10. Determine Audit Materiality
11. Consider Going Concern (SA 570)
12. Assess the Risk of Fraud including Money Laundering ( SA 240)
13. Assess Specific Risks:
14. Risk Associated with Outsourcing of Activities
15. Response to the Assessed Risks (SA 330)
16. Stress Testing : Stress testing is a software testing activity that determines the robustness
of software by testing beyond the limits of normal operation. 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.
17.
BASEL III framework: Basel norms or accords are the International Banking regulations issued
by the BCBS. The Basel Committee on Banking Supervision (BCBS) and the Financial Stability
Board (FSB) has undertaken an extensive review of the regulatory framework in the wake of the
sub-prime crisis. In the document titled ‘Basel III: A global regulatory framework for more
resilient banks and banking systems’, released by the BCBSin December 2010, it has inter alia
proposed certain minimum set of criteria for inclusion of instruments in the new definition of
regulatory capital. The set of agreement by the BCBS, which mainly focuses on risks to banks and
the financial system are called Basel accord.
18. Reliance on / review of other reports: The auditor should take into account the adverse
comments, if any, on advances appearing in the following

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12. ADVANCES
TYPES OF ADVANCES

12,1 What do ADVANCES comprise:

Advances comprise of funded amounts by way of:
• Term loans
• Cash credits, Overdrafts, Demand Loans
• Bills Discounted and Purchased
• Participation on Risk Sharing basis
• Interest-bearing Staff Loans
12.2 Legal requirements of Disclosure in the Balance Sheet:
A. (i) Bills purchased and discounted
(ii) Cash credits, Overdrafts and loans repayable on demand
(iii) Term Loans
B. (i) Secured by tangible assets
(ii) Covered by Bank/Government guarantees
(iii) Unsecured
C. I. Advances in India:
(i) Priority sectors (ii) Public sector
(iii) Banks (iv) Others

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C. II. Advances outside India:

(i) Due from Banks
(ii) Due from Others:
(a) Bills Purchased and discounted
(b) Syndicated loans
(c) Others

12.3 Mode of Creation of Security

(i) Mortgage: Mortgage are of several kinds but the most important are the Registered
Mortgage and the Equitable 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 interests in the goods. The pledge of goods constitutes a specific (or fixed)
charge.
(iii) Hypothecation: The hypothecation is the creation of an equitable charge (i.e., a 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.

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(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.

12,4 Prudential norms on Income Recognition, Asset Classification and Provisioning

pertaining to Advances:

(i) Non-performing Assets: An asset becomes NPA when it ceases to generate income for the
Bank.

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A non-performing asset (NPA) is a loan or an advance where –

• interest and/ or installment 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.
(ii) 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’.
(iii) 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
Substandard Assets:
Would be one, which has remained NPA for a 90 15%
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 months.
Sub-categories: (Secured + Unsecured)
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:
Would be one, where loss has been identified by
the bank or internal or external auditors or the RBI 100%
inspection but the amount has not been written off
wholly.
Classification as NPA should be based on the record of recovery. Availability of security or net
worth of borrower/guarantor is not to be taken into account for purpose of treating an advance
as NPA or otherwise. Asset classification would be borrower-wise and not facility-wise. All
facilities including investments in securities would be termed as NPA.
(iv) Accounts regularized near the Balance Sheet Date: The asset classification of borrower
accounts where a solitary or a few credits are recorded before the balance sheet should be
handled with care and without scope for subjectivity. Where the account indicates inherent
weakness on the basis of the data available, the account should be deemed asNPA. 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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(v) Advances under Consortium: Consortium advances mean advancing loans to a borrower
by two or more Banks jointly by forming a Consortium. Joint appraisal, control and
monitoring will facilitate for exchange of valuable information among the Banks. Usually, a
Bank with a higher share will lead the consortium. Consortium advances should be based on
the record ofrecovery of the respective individual member banks and other aspects having a
bearing on the recoverability of the advances. Where the remittances by the borrower under
consortium lending arrangements are pooled with one bank and/ or where the bank receiving
remittances is not parting with the share of other member banks, the account should be treated
as not serviced in the books of the other member banks and therefore, an NPA. The banks
participating in the consortium, therefore, need to arrange to get their share of recovery
transferred from the lead bank or to get an express consent from the lead bank for thetransfer of
their share of recovery, to ensure proper asset classification in their respective books.
(vi) Drawing Power Allocation in case of Cash Credit Account: The Lead Bank would be
responsible for computing the drawing power (DP) of the borrower and allocate the same to
member banks. In certain special circumstances, at the request of the Borrower, the Lead Bank
may allot a higher or lower share of drawing power to the member bank, as against their
share of advances. The proforma DP Allocation Letter is presented here under for reference:
(Rs. in Crores)
BANKS Share % LIMIT/D.P.
State Bank of India 32.25 500.00
Bank of Baroda 2.58 40.00
Bank of India 6.45 100.00
Canara Bank 5.16 80.00
Standard Chartered Bank 9.03 140.00
Union Bank of India 6.45 100.00
HSBC 13.87 215.00
Citi Bank 6.45 100.00
Bank of America 1.29 20.00
BNP Paribas 1.94 30.00
Punjab National Bank 6.45 100.00
ICICI Bank 4.84 75.00
IDBI Bank 3.23 50.00
Unallocated
TOTAL 100.00 1550.00

12,5 Accounts where there is erosion in the value of security / frauds committed by borrowers
Not prudent to follow stages of asset classification. It should be straight- awayclassified as
doubtful or loss asset as appropriate.
(i) Erosion in the value of security can be reckoned as significant when the realisable value
of the security is less than 50 per cent of the value assessed by the bank or accepted by
RBI at the time of last inspection, as the case may be. Such NPAs may be straight- away

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classified under doubtful category and provisioning should be made as applicable to

doubtful assets.

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(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 borrower 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.

12. 6 Advances Against Term Deposits, NSCs, KVPs / IVPs, etc.

Advances against Term Deposits, NSCs eligible for surrender, KVP/IVP and life policies need
not be treated as NPAs, provided adequate margin is available in the accounts.

12. 7 Agricultural Advances Affected by Natural Calamities

Master Circular issued by the RBI deals elaborately with the classification and income
recognition issues due to impairment caused by natural calamities. Banks may decide on
their own relief measures, viz., conversion of the short term production loan into a term loan
or re- schedulement of the repayment period and the sanctioning of fresh short term loan,
subject to the guidelines contained in RBI’s latest Master Circular on Prudential Norms on
Income Recognition, Asset Classification and provisioning pertain- ing to Advances. In such
cases, the NPA classification would be governed by such re- scheduled terms.
12.8 Advances to Staff
Interest-bearing staff advances as a banker should be included as part of advances portfolio
of the bank. In the case of housing loan or similar advances granted to staffmembers where
interest is payable after recovery of principal, interest need not be considered as overdue from
the first quarter onwards. 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.
12.9 Agricultural Advances
As per the guidelines, Agricultural Advances are of two types:
(1) Agricultural Advances for “long duration” crops;and
(2) Agricultural Advances for “short duration”crops.
The “long duration” crops would be crops with crop season longer than one year and crops,
which are not “long duration” crops would be treated as “short duration” crops. The crop season
for each crop, which means the period up to harvesting of the crops raised, would beas
determined by the State Level Bankers’ Committee in each State. 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 installment 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 installment of
principal or interest thereon remains overdue for one crop season.

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13. COMPUTATION OF DRAWING POWER

Particulars of Current asset DP
(A) Stock:
Stocks at realizable value 1000
Less: Unpaid stocks:
- Sundry creditors 300
- Acceptance/LCs etc. 300 600
Paid for stocks 400
Margin @ 25% 100 300

(B) Debtors:
Total Debtors 1000
Less: Intangible debtors 200
Eligible debtors 800
Margin @ 40% 320 480
Total DP 780

1. Meaning :- Drawing Power generally 5. Auditor’s Concern:- The stock

addressed as “DP” is an important statements, quarterly returns and
concept for Cash Credit (CC) facility other statements submitted by the
availed from banks and financial borrower to the bank should be
institutions. Drawing power is the limit scrutinized in detail. The audited
up to which a firm or company can Annual Report submitted by the
withdraw from the working capital borrower should be scrutinized
limit sanctioned. properly. The monthly stock
2. Different from Sanctioned Limit :- statement of the month for whichthe
The Sanctioned limit is the total audited accounts are prepared and
exposure that a bank can take on a submitted should be compared and
particular client for facilities like cash the reasons for deviations, if any,
credit, overdraft, export packing credit, should be ascertained.
non-funded exposures etc. On the other 6. Computation of DP:- It needs tobe
hand, Drawing Power refers to the ensured that the drawing poweris
amount calculated based on primary calculated as per the extant guide-
security less margin as on a particular lines formulated by the Board of Di-
date. rectors of the respective bank and
3. Considerations:- All accounts shouldbe agreed upon by the concerned stat-
kept within both the drawing power and utoryauditors. Special consideration
the sanctioned limit at all times. The should be given to proper reporting
accounts which exceed the sanctioned of sundry creditors for the purposes
limit or drawing power or are against of calculating drawing power.
unapproved securities or are otherwise 7. Stock Audit:- The stock audit
irregular should be brought to the notice should be carried out by the bankfor
of the Management/Head Office all accounts having funded exposure
regularly. of more than Rs. 5 crores. Auditors
4. Bank’s Duties:- Banks should ensure can also advise for stock audit in
that drawings in the working capital other cases if
account are covered by the adequacy of
the current assets. Drawing power is

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required to be arrived at based on the situation warrants the same.

current stock statement. However, Branches should obtain the stock
considering the difficulties of large audit reports from lead bank in
borrowers, stock statements relied upon the cases where the Bank is not
by the banks for determining drawing leader of the consortium of
power should not be older than three working capital. The report
months. The outstanding in the account submitted by the stock auditors
based on drawing power calculated should be reviewed during the
from stock statements older than three course of the audit and special
months is deemed as irregular. focus.

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15. AUDIT OF REVENUE ITEMS

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✓ INCOME : AUDIT APPROACH AND PROCEDURES

✓ Reversal of Income:
• If any advance, including bills purchased and discounted, becomes NPA as at
the close of any year, the entire interest accrued and credited to income account in
the past periods, should be reversed or provided for if the same is not realised. This
will apply to Government guaranteed accounts also.
• In respect of NPAs, fees, commission and similar income that have accrued should
cease to accrue in the current period and should be reversed or provided for
with respect to past periods, if uncollected.
• Further, in case of banks which have wrongly recognised income in the past should
reverse the interest if it was recognised as income during the current year or make
a provision for an equivalent amount if it was recognized as incomein 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

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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 aparticular
date or when particular criteria for completion of a project are met. Takeout loans are
commonly used in property development. 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 recognize income as per AS 9 when
certainty attaches to realization and accordingly amount reversed/derecognized or
not recognized in the past should be accounted. Interest partly/fully realized 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.
✓ 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.
✓ 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. Brokenperiod 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 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.

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✓ EXPENSES : AUDIT APPROACH AND PROCEDURE

✓ 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 to the average quantum of
the respective liabilities during the year. In modern day banking, the entries for interest
expenses are automatically generated through a batch process in the CBS system.
✓ 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 obtain general ledger break-up for the interest expense
incurred on deposits (savings and term deposits) and borrowing each month/quarter. The
auditor should analyse month on month (or quarter on quarter) cost analysis and
document the reasons for the variances as per the benchmark stated. He should examine
whether the interest expense considered in the cost analysis agrees with the general
ledger. The auditor should understand the process of computation of the average balance
and re-compute the same on sample basis.
✓ 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.
(d) Interest on inter–branch balances has been provided at the rates prescribed by the
head office/RBI.
✓ 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
examine whether there are any divergent trends in respect of major items of expenses.
The auditor should perform substantive analytical procedures (proforma given below for
reference) 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. The auditor should also verify expenses with
reference to supporting documents and check the calculations wherever required.
✓ 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

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how the bank computes provision on standard assets and non-performing assets. Itwill
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, nonperforming loans
and agree the outstanding balances with the general ledger. The auditor should obtain the
tax provision computation from the bank’s management and verify the nature of items
debited and credited to profit and loss account to ascertain that the same are appropriately
considered in the tax provision computation. The other provisions for expenses should
be examined vis-a-vis the circumstances warranting the provisioning and the adequacy
of the same by discussing and obtaining the explanations from the bank’s management.
✓ 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 disclosureof
the impact of prior period items on the current year’s profit and loss, such disclosures, wherever
warranted, may be given.

“Stop calling it as a DREAM,

its time to call it as a PLAN”

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