CA (Dr.) S S SHARMA

(M) – 9810295443

E-MAIL: sssharmafca@yahoo.com

Presentation

BANK AUDIT- A Practical Approach

Banking is a dynamic activity. Therefore banks are different from most other commercial enterprises. Now a days banking has constantly been undergoing a change. Chartered Accountants are expected to carry out the bank branch audit in the shortest possible time. The responsibilities have increased manifold after prudential norms, Anti Money Laundering norms, Basel II norms, increase in certification, increased use of Information Technology and CBS etc.

Over the period due to increase in NPAs in the banking system, RBI has been taking a stricter cognizance of the divergences.

Work to be done in Bank audit being divided into four parts.

• Statutory Audit as per Banking Regulation Act.
• Long Form Audit Report
• Certification
• Tax Audit

Hence it becomes imperative to plan the audit in systematic manner to enable completion of all the important area leaving no room for any material misstatement.

What is basically needed for effective execution of the job is error free documentation and effective preparation of related working papers. 

Audit Planning

A systematic and meticulous planning and programming will help the auditors to ensure that he performs the audit as per the required Auditing Standards.

• Communication with previous Auditor: The incoming auditor must communicate with the previous auditor. The incoming auditor should primarily find out whether there are any professional or other reasons why he should not accept the appointment.

• Acceptance:  A careful reading of appointment letter is must before accepting the audit. Ensure that your audit firm is other wise eligible for conducting the audit. The appointment letter consist procedural requirements to be complied by audit firm such as submission of various declaration etc. 
• Engagement: As required by SA 210, the auditor should send an engagement letter, preferably before the commencement of the engagement, to help avoid any misunderstanding with respect to the engagement. It is suggested that before commencement the engagement, the branch auditor should send an audit engagement letter to the appointing authority. A specimen of Engagement Letter is annexed as Annexure I

The institute had issued a general clarification on SA 210, which clarifies that audit of public sector bank is audit under statute and auditors obligation are laid down in statue, therefore it shall be sufficient compliance with the requirements related to sending the audit engagement letter, if an engagement letter is appropriately delivered to the client and auditor retains the evidence for such delivery.

• Audit Program: The auditor should prepare a written audit programme setting fort the procedures that are needed to implement. The programme should define the scope of audit, significant audit areas, set materiality level, lay down an overall time schedule. The programme should have sufficient details to serve as a set of instructions to the assistants. A specimen of areas to be covered in audit programme is annexed as Annexure II.

• Communication with Branch: For smooth and timely completion of audit it is advisable that branch auditor should send a formal communication to branch specifying the time schedule, books, records, analysis and other information’s required in the course of audit. A specimen of letter is annexed as Annexure III.

• Banks guidelines for Closing and Audit: Every bank is preparing a booklet, which contains the procedure of account closing by the branch, statements and certificates to be prepared by the branch and to be audited by the auditors. These guidelines also suggested the work not to be done at branches such as provisioning, depreciation etc. It is advisable to read the booklet and make proper notes of it.

• Accounting Policy of The bank: A complete understanding of accounting policy will help smoothly and timely completion of audit.

• Access to System: Ensure that audit team must have access to computers of the branch.

A Check list for Branch Overview and Internal Control is annexed as Annexure IV

Audit Procedure

Statutory Audit

• As per Banking Regulation Act
• Balance Sheet
• Profit & Loss A/C
• Other Annexure
• True & Fair view

• Balance Sheet and Profit and Loss Account: The balance sheet and profit and loss account of the bank are drawn up in Forms “A” & “B” respectively of the third schedule of the banking regulation act, 1949.

Assets Side

Cash and Balances  with RBI,  Balances with Bank and Money at call, Investments,  Advances, Fixed Assets and  Other Assets.

Liabilities Side

 Capital, Reserve and Surplus, Deposits, Borrowings, Other Liabilities and Provisions

Verified all the items in the balance sheet for the figures mentioned therein from the General Ledger. and in Profit and Loss account with Income and Expenditure Ledger. Important items of verification of expenditure are interest expended, Salaries and allowances, Rent, Printing and Stationery etc.

Expenses

• Interest Expended
• Establishment Expenses ( Salary & Allowances)
•  Rent
• Printing & Stationery

Income

• Interest Earned on Advances
• Commission

• Income: Interest earned on advances is major income of the branch. Auditor should, on sample basis, check the interest rates, its application on large advances etc. Auditor should made cross checks/ analytical review regarding the figures of interest income/ other income on a comparative basis.

RBI has prescribed income recognition norms for Interest on NPAs. Accordingly interests on NPAs are recognized only on receipt basis. Further in respect of newly identified NPAs, unrealized interest of last two years should be reversed. This will apply to Government guaranteed accounts also. 

·         Appropriation of Recovery in NPAs

Recovery in NPA accounts should be appropriated in accordance with bank policy if there is no clear agreement between bank and borrower, generally first towards interest and then towards principal

• Advances: Audit of the advances covers major part of audit of branch. The first step towards audit of advances is to verify the procedure and documentation compliance with respect to the sanction and disbursement of the advances. The following points needs to be covered.

v  Whether sanction has been made as per the banks policies.

v  Credit appraisal reports contains adequate information’s

v  Check whether the terms of sanction have been complied with?

v  Check whether all the documentation formalities have been complied with before release of facilities by the branch?

v  Check whether in the cases of corporate borrowers due charges have been registered with the Registrar of Companies?

v  Stock Audit Report

v  Rating by External Agencies.

A detailed checklist for audit of large advance is Annexed as Annexure V.

• Asset Classification: The second step towards audit of advances is to verify the classification of advances. There are four types of classification of Advances for balance sheet purpose.

1. 1.    Facility Wise: Cash CreditOverdraft, Term Loan Demand Loan and Bills Purchased Bill Discounted.
2. 2.    Sector Wise: Priority Sector, SSI and Others
3. 3.    Security Wise: Secured, Guaranteed and Un Secured
4. 4.    Health wise: Performing Assets (Standard assets) or Non Performing assets (NPAs). ( Sub Standard, Doubtful and Loss)

The RBI norms for classification into Performing and Non Performing are based on record of recovery and period for which the asset has remained nonperforming and the realisability of dues.

Every year in the month of July, Reserve Bank of India is issuing master circular for IRAC Norms. This circular is available on RBI website www.rbi.org.in. The circular provides prudential norms applicable for the current year in great details.

• Advances under consortium: Asset classification of account under consortium should be based on the record of recovery of the individual member banks. There is no relevance of classification of account in lead bank or in other member bank.

• Agriculture Advances: Classifications of Agriculture Advances are based on overdue crop season. The length of crop season is not defined in RBI circular. The length of crop season would be determined by SLBC in each state. There are lot of misunderstanding at branch level, regarding commencement and closure of crop season. Part C of Master circular July 2013, has clarified the norms, which deals with the NPA Norms for agriculture finance.

• According to these norms, 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.

• The term overdue means 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.

• Rabi season (planted October-November and harvested in March-April).

• Kharif season (planted May- June and harvested in October- November).

• Based on the clarifications given by RBI, and Crop Season defined by various SLBCs, following broad guidelines will explain the date of NPA in Agriculture Advances.

            First Crop Season after due date:

            Second  Crop Season after due date:

            Accordingly any disbursement in  Agriculture loanKCC up to 30.09.2011 ( i.e. Rabi season 2010-2011 and Kharif Season 2011) is not realised, the account will be NPA as on 31.03.2014.

• Accounts regularized near about balance sheet date: The asset classification of accounts where few credits are recorded should be examined thoroughly without scope for subjectivity. Where the account indicates inherent weakness on the basis of data available, the account should be deemed as a NPA.

• Asset classification to be borrower-wise not facility-wise

• Accounts where there is erosion in value of security: In respect of accounts where there are potential threats for recovery on account of erosion in the value of security or non-availability of security and existence of other factors such as frauds committed by borrowers it will not be prudent that such accounts should go through various stages of asset classification. In cases of such serious credit impairment the asset should be straightaway classified as doubtful or loss asset as appropriate.

-      value of security erodes by 50% or more as compared to previous valuation, such accounts may be classified under the doubtful category.

-      Value of security erodes to less than 10% of O/S amount; such accounts may classify as loss asset.

• Restructuring of advances: RBI has harmonies the norms across all categories of Debt restructuring mechanism except those are restructuring on account of natural calamities. These norms are applicable to all restructuring including those under CDR mechanism.

GENERAL PRINCIPLE AND PRUDENTIAL NORMS FOR RESTRUCTURED ADVANCES  

(i)            Banks may restructure the accounts classified under ‘standard’,’ sub-standard’ and ‘doubtful’ categories.

(ii)          Banks can not reschedule/ restructure/ renegotiate borrowal accounts with retrospective effect. While a restructuring proposal is under consideration the usual asset classification norms would continue to apply.

(iii)         In case there is undue delay in sanctioning a restructuring package and in the mean time the asset classification status of the account undergoes deterioration, it would be a matter of supervisory concern

(iv)         No account will be taken up for restructuring by the banks unless the financial viability is established and there is a reasonable certainty of repayment from the borrower, as per the terms of restructuring package. 

(v)          BIFR cases are not eligible for restructuring without their express approval. CDR core group in case of advances restructured under CDR mechanism/ the Lead bank in case of SME Debt restructuring and the individual in other cases after ensuring all the formalities in seeking the approval from BIFR are completed before implementing the package.

As per the circular the account classified as ‘standard’ should be immediately re-classified as ‘sub-standard asset’ upon restructuring. However in case of advances other than Consumer and personal advances and Advances classified as capital market exposures may be retained in standard assets if the fulfill the following conditions. (Special Regulatory Treatment)

(i)            The dues to the bank are fully secured. The condition of being fully secured by tangible security will not be applicable in the following cases

a)    SSI borrowers where the outstanding is upto Rs.25 Lakhs.

b)    Infrastructure projects provided the cash flows generated from these projects are adequate for repayment of the advance.

(ii)          The unit becomes viable in 8 years, if it is engaged In infrastructure activities, and in 5 years in case of other units.

(iii)         The repayment period of the restructured advance including the moratorium period, if any, dose not exceed 15 years in case of infrastructure advances and 10 years in case of other advances.

(iv)         Promoter’s sacrifice and additional funds brought by them should be a minimum of 15% of banks sacrifice.

(v)          Personal guarantee is offered by the promoter except when the unit is affected by external factors pertaining to the economy & Industry.

(vi)         The restructuring under consideration is not a repeated restructuring.

• Advances where repayment mode is by an EMI: EMI accounts needs special attention as EMIs are determined on certain assumptions, specially that:

a.)  EMI should be paid on stipulated time.

b.)  Principal and Interest component of EMI is clearly defined.

c.)   Delayed payment interest should be recovered separately.

d.)  EMI or Tenure being revised at every instance of rate increase.

It has been observed that in most of the cases EMI are paid at irregular intervals and interest on delayed payments are not collected, Rate of interest being changed but EMI are not revised, EMIs are calculated without considering interest of moratorium period etc. Therefore there are certain amounts of overdue interest or principle in the account but the same is not noticed apparently. To ensure proper classification of these advances, obtain the breakup of EMI in to principal and interest and compare the present outstanding with the outstanding as per schedule. Alternatively examine that remaining installments are enough to square off the loan on stipulated time.

• Compliance with Accounting Standards: Branch auditor should ensure that branch should comply with the all applicable Accounting Standards. Some of the Accounting Standards are complied at branch level and some are complied at bank as a whole. A suitable reporting should be made in respect of non compliance and compliance to be done at Head office level. Usually following Accounting Standards are being complied at Head office level:

• AS-3 Cash Flow statement
• AS-15 Employee Benefits
• AS-17 Segment Reporting
• AS-18 Related party Disclosure
• AS-22 Accounting for taxes on Income

• Fixed Assets: In past few years banks are spending lot on computreisation, furniture and fixture etc. It was observed that most of the time amount is lying in advances and capitalization entries not passed for wants of certain testing reports etc.

• Other Important items:

• Sundry Liability, Sundry Asset of Suspense Account.
• Transaction in dormant account
• Large Value transaction in newly opened account
• Debit balance in savings account
• Reversal of Misc. Charges
• Overdue term deposits
• Credit Card Tranactions
• System Testing
• Bank Guarantee
• Letter of Credits
• Frauds
• Claims not acknowledge as debts

• Provisioning on Advances: AS per RBI guidelines provisions on advances to be made as following:

Provision for Standard Advances

The rate of provisioning for standard assets is as follows:-

 Provisioning for Sub-Standard Advances

Provision for Doubtful Advances

Provision for Loss Advances

In most of the banks, provisions on advances been made at Zonal or Head office level. Branch Auditors are required to verify the classification only.

• Reporting:

• Auditors Report: As required by banking regulation act, auditor of the bank should state the following in his report.

v    Balance Sheet and Profit and Loss Account have been drawn up in the forms ‘A’ and ‘B’ respectively of the third schedule of banking regulation act.

v    He had called for the informations and explanations and same have been given and considered satisfactory.

v    Transactions of the bank, which have came to his notice, have been within the powers of the bank.

v    The returns received from the offices and branches of the banks have been found adequate for the purpose of his audit.

• Adherences of SA ( Standard of Auditing)

As you know, SAs are our performance benchmark and we all are following the same. In this regard we desired your response on following SA.

• SA- 700, 705 and 706: These SA defines the manner of reporting in auditor’s report and inclusion of qualifications and matter of emphasis in auditor’s report.

Illustrative format given in Guidance Note on Audit of Banks issued by ICAI also suggest that auditor should comment that financial statements comply with the applicable Accounting Standards.

Branch Auditors also report on the above matters in his report.

• SA- 260 and 265

SA 260 deals with the auditor’s responsibility to communicate with those charged with governance in relation to an audit of financial statements. In addition, SA 265 establishes specific requirements regarding the communication of significant deficiencies in internal control the auditor has identified during the audit to those charged with governance.

Every CSA are reported these matters to ACB and Board, Therefore branch Auditors must send these issues to respective CSA through separate letter. 

• Memorandum Of Changes: Banks have unique system for recording the changes suggested by the auditors during the course of the audit.

Long Form Audit Report

This is a detailed questionnaire formulated by RBI contains the matters required to be reported by Branch Auditors on system and controls. This form has one main questioner which is applicable to all branches and other is additional questioner for specialized branches and also one annexure in respect of large/ irregular/ critical advances.

The main questioner has four parts viz Assets, Liabilities, Profit and Loss Account and General informations.

All adverse remarks and comments must be with the instances.

A detailed checklist for LFAR is Annexed as Annexure VI.

Certification

• Statement of Cash & Bank Balances on 12 specified Dates for compliance in respect of SLRCRR. 
• Certificate relating to DICGC transactions
• Certificate in respect of Subsidy claim under PMRY Scheme
• Certificate of 2% Interest Subsidy claim of Agricultural Advances
• Certification in respect of bank’s claim relating to interest subvention in respect of rupee export credit.
• Certification for  the correctness of the data furnished by the Branches in the Returns prescribed for computation of Insurance Premium to be payable to DICGC
• Certificate in respect of implementation of GHOSH COMMITTEE/JILANI COMMITTEE RECOMMENDATIONS at the branch level
• Breakup in respect of segment reporting
• Capital adequacy- Basel II

Tax Audit

• To comply with the Sec. 44AB of the Income Tax Act, 1961 and reporting in form 3CA and 3CD.

Audit Evidence

The Auditor should document matters, which are important in providing evidences that audit were carried out in accordance with the basic principles. Working papers will come to the rescue, whenever, at a later date if there is query about any matter or issue relating to the work performed by the auditor.

On completion of audit, all working papers must be organized in a file in a proper sequence and must be reviewed by a partner other than the one who conducted the audit of the branch.

THANKS  

ANNEXURE I

SPECIMEN LETTER OF ENGAGEMENT

To,

The official who has signed your appointment letter

___________Bank

You have requested that we audit the Balance sheet of _______Branches of your Bank as 31^st March 2014 and the related Profit and Loss account for the year ended on that date. We are please to confirm our acceptance and our understanding of this engagement by means of this letter. Our audit will be conducted with the objective of our expressing the opinion on the financial statement.

We will conduct our audit in accordance with auditing standard generally accepted in India and with requirements as per your terms in your appointment letter. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principals used and significant estimates made by management, as well as evaluating the overall financial statements presentation.

However, having regard to the test nature of an audit, persuasive rather than conclusive nature of audit evidence together with inherent limitations of any accounting and internal control system, there is an unavoidable risk that even some material misstatements of financial statements, resulting from fraud, and to a lesser extent error, if either exists, may remain undetected.

In addition to our report on the financial statements, we expect to provide you a Long Form Audit Report (LFAR) containing any material weaknesses in accounting and internal control system and other procedures of the bank, which might come to our notice.

The responsibility for the preparation of financial statements on a going concern basis is that of the management. The management is also responsible for selection and consistent application of appropriate accounting policies, including implementation of applicable accounting standards along with proper explanations relating to any material departures from those accounting standards. The management is also responsible for making judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the entity at the end of the financial year and of the Profit or Loss of the entity for that period.

We also wish to invite your attention to the fact that our audit process is subject to “peer review” under the Chartered Accountants Act, 1949. The reviewer may examine our working papers including those relating to your bank during the course of Peer review.

We look forward to full co-operation with your staff and we trust that they will make available to us whatever records, documentation and other information are requested in connection with our audit.

This letter will be effective for future years unless it is terminated, amended or superseded.

Please sign and return the attached copy of this letter to indicate that it is in accordance with your understanding of the arrangements for our audit of the financial statements.

For_______________

Chartered Accountants

(Signature)

(Name of the Member)

(Designation)

Acknowledge on behalf of

_______Bank /Branch by

Name and Designation

(Signature)

ANNEXURE II

AREAS TO BE COVERED IN AUDIT PROGRAM ON BANK AUDIT

ANNEXURE III

SPECIMEN LETTER OF REQUIREMENTS

Dated : _____________

To,

_________Bank                   

_________Branch

_________Address

Sub:    Statutory Audit of your Branch for the year ending on __________

Dear Sir,

With reference to the above we have to inform you that we have been appointed as statutory auditor for conducting the audit of your branch for the year ending on________. As discuss with central accounts department, we will commence the audit from -----. We are confident that you will make available the branch returns on arrival of our team.

In order to enable us to finalize and furnish our report on the audit of the accounts of your branch, may we request you to get ready the information/clarifications as detailed below and make the same available to our team on its arrival to your branch: -

1.         For our scrutiny the following latest reports on Branch Accounts and compliance by the Branch on the observations contained therein: -

a)            Branch Audit Report of Previous Year

 b)        Internal Inspection Report

 c)        All concurrent Audit Reports of the year

 d)        RBI Inspection Report, if such inspection took place

 e)        Limited review reports

  f)        LFAR of Previous Year

2.         Please provide us a list of consortium advances. Also provide us the minutes of consortium meetings held during the year.

3.         Please confirm the basis of valuation of stock of stationery in hand as at the year end and whether this is based on physical verification of stationery items. In case physical verification is conducted before the year-end, a statement may be prepared showing reconciliation thereof with the balance as at the year-end after considering further additions/deductions.

4.         Please confirm whether other than for advances, there are any matters involving the Branch in any claims, in litigation, arbitration or other disputes in which there may be some financial implications, including for staff claims, municipal taxes, local levies etc. if so, they may be listed for our verification.

5.         Advances

     (a) Please provide us a list of advances the limits of which are pending for renewal as on the date.

     (b) Please provide us a list of settlement and compromises entered into with the borrowers during the year by the branch. 

     (c)   Please also provide us a list of advances accounts of which are closed during the year otherwise than in normal course of business. 

(d)  Please also provide us a list of advances rescheduled during the period, along with the sacrifice made by the branch in reschedulement.

(e)  Large advances where documentation is pending.

(f)   List of accounts where valuation is older than 3 years.

6.         Details of Fraud cases observed or reported to higher authorities during last three years.

7.         Please provide us a list of advances covered by Govt. guarantee, along with the date of invocation, if any.

8.         Please provide us a list of advances classified as substandard and accounts upgraded as standard during the year.

10.       Please provide us a list of suit filed and decreed account during the year along with list of Decrees remained unexecuted.

11.       Please provide us a list of advances Re-scheduled or Re-negotiated after commencement of Commercial Production during the year along with complete scheme and approval of the board for the same.

12.       Please provide us a list of Investments held by the branch on the behalf of the Head office. Further if the investments are in the dematerialized form, a certificate from depositary participant should annex.

13.       Please keep ready the information’s required in LFAR along with annexure.

14.       Please also keep ready all information required for tax audit & certificate.  

15.       Please provide us circulars issued by RBI/Head Office during the year particular relating to advances.

16.       Please provide us a list of claims not acknowledge as debts.

We are sure that you will keep ready the point-to-point reply of this letter well before arrival of our team at your branch. However, in case you require any clarification then please write to us or contact at phone No.____________ or communicate at  fax No. _______.

We are sure that you will be ready in all respect by the time our team reaches to get your accounts audited.  Please also confirm us about your readiness at the earliest.

For_______________

Chartered Accountants

(Signature)

(Name of the Member)

(Designation)

                                                                                                ANNEXURE IV

Check list for Branch Overview:

Checklist on General Internal Control

ANNEXURE V

CHECK LIST FOR VERIFICATION OF LARGE ADVANCES

BRANCH:……………                                                                     PERIOD:…………..

ANNEXURE VI

CHECK LIST OF LFAR

BRANCH:……………….                                                    PERIOD:…………….