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Chapter AUDIT OF
1 BANKS
Q-1 Name the laws which are applicable on a Banking Company.

Ans:- The laws applicable on Banking Company are as follows:

 Banking Regulation Act, 1948
 Companies Act, 2013
 State Bank of India Act, 1955
 State Bank of India (Subsidiary Banks) Act, 1959
 Regional Rural Banks Act, 1976
 IT Act, 2000
 Prevention of Money Laundering Act, 2002
 Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

Q-2 Explain types of Banks/Banking Institutions prevailing in India.

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.
Examples are :- State Bank of India, Axis Bank, HDFC Bank, etc.

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 etc.

3. Co-operative Banks function like Commercial Banks only but are set up on the basis of Cooperative
Principles and registered under the Cooperative Societies Act of the respective state or the Multistate
Cooperative Societies Act and usually cater to the needs of the agricultural and rural sectors.
Examples are :- The Gujarat State Co-operative Bank 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 of ATM cum Debit cards , Internet-banking & Mobilebanking.
Examples are :- Airtel Payments Bank , India Post Payments Bank, Paytm Payments Bank , etc.

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5. Development Banks had been conceptualized to provide funds for infrastructural facilities important for the
economic growth of the country.
Examples are:- Industrial Finance Corporation of India (IFCI), Industrial Development Bank of
India (IDBI), Small Industries Development Bank of India (SIDBI) , etc.

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

Q-3 What is the responsibility of Reserve Bank of India (RBI)?

Ans:- RBI is responsible for :-

1. development and supervision of the constituents of the Indian financial system (which comprises banks
and non-banking financial institutions)
2. determining, in conjunction with the Central Government, the monetary and credit policies keeping in with
the need of the hour.
3. regulating the activities of commercial and other banks

Q-4 What are the important functions of Reserve Bank of India (RBI)?

Ans:- The Important Functions of RBI are as follows

1. issuance of currency;
2. regulation of currency issue
3. acting as banker to the central and state governments; and
4. 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.
5. No bank can commence the business of banking or open new branches without obtaining license from RBI.
The RBI also has the power to inspect any bank.

Q-5 What are the peculiarities involved in Bank?

Ans:- The peculiarities involved in Bank are as follows:

1. Huge volumes and complexity of transactions;
2. Wide geographical spread of banks’ network;
3. Large range of products and services offered;
4. Extensive use of technology;
5. Strict vigilance by the banking regulator etc.

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Q-6 On the basis of Computerization, State the types of Banks involved.

Answer: Banks may be divided into three board categorises based on the level of computerisation:
1. Non-computerised banks :- Transactions can be done only at bank branches during working hours using
paper and pen.
2. Partially computerised banks :- Some transactions are computerised while major are non-computerised.
3. Fully computerised banks:- Core banking allows inter-connectivity between branches of the same bank
and with CBS , customers can operate their accounts as well as avail banking services from any branch of
the bank over the network

Q-7 What is the difference between Computerized and Non-

Computerized Banks?

Computerized Banks Non-Computerized Banks

All Banking activities are done through Computer Banking System done manually
system
Transaction-anywhere, anytime Transaction during business hours only
Will take less time for Banking Process Will consume a lot of time in Banking process
More Productive Less productive

Q-8 Explain Bank Audit Approach in detail

1. Drawing an Audit Plan:- An audit plan should be drawn up based on :-

(a) the nature and level of operations,
(b) nature of adverse features,
(c) level of compliance based on previous reports and
(d) audit risks based on inadequacy in or breach of internal controls and the familiarization exercise
carried out,
2. Questions on Internal Control
(a) Who performs the Control?
(b) What evidence is generated that Internal control is Performed?
(c) When and with what frequency is the control performed?
(d) Where is the evidence that proves Control is Performed?
(e) Why is the control being Performed?
(f) How is the Control Performed?
3. Engagement Team Discussions
 Nature of Discussions
(a) Error that may occur

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(b) Errors that have been occurred in Past Years
(c) Method by which can be conducted by Bank personnel
(d) Audit response to identified risk
(e) Need to maintain Professional Skepticism

 Benefits of Discussions
(a) An opportunity for experienced team members to share their viewpoints
(b) An understanding among team members to exchange information about Banking risks.

Q-9 Explain provisions w.r.t. Auditor (Qualifications, Disqualifications

& Appointment) of a Banking Company.

Answer:-
Qualification:-Same as provided under Section 141(1) (2) of Companies Act, 2013
Disqualifications:-Same as provided under Section 141(3) of Companies Act, 2013
Powers:-Same as of Company’s Auditor
Remuneration:-As provided under Section 142 of Companies Act, 2013.
Appointment:-
 Nationalised Banks:-Board of Directors in consultation with RBI
 Other Banks:-Members in consultation with RBI
 SBI:-C&AG in consultation with CG
 Subsidiary of SBI:-State Bank of India
 Regional Rural Bank:-Board of Directors in consultation with CG

Q-10 Explain provisions w.r.t. Auditor’s Report of a Banking Company.

Answer:-
Legal Requirements:- Report to CG (Nationalised Bank):-Contents:-
1. Standards of Auditing:-SA 700, 705, 706 1. That Balance Sheet present True and fair view of
2. Companies Act, 2013:-Section 143(3) Banking Affairs
3. Long Form Audit Report:-Prescribed by RBI 2. That transactions are within the powers of the
4. Circular:-issued by RBI Board.
3. That returns submitted by Branch is adequate
CARO, 2020 is not applicable on Banking Company 4. That P&L presents actual situation of profit or loss
5. Any other matter which is necessary
LFAR
1. 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).

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2. 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.
3. The LFAR is to be submitted before 30th June every year.
4. To ensure timely submission of LFAR, proper planning for completion of the LFAR is required.
5. 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 of Fraud:-Same as provided u/s 143(12) of Companies Act, 2013
Circular by RBI:-Circular states that if an Accounting Professional whether in the course of internal or
external audit finds anything susceptible to be
 Fraud
 Fraudulent Activity
 Act of excess of Power
 Smell any foul play in any transaction
He should refer the matter to the regulator (RBI). Any deliberate failure on the part of the Auditor should
render himself for action.

As per the above requirement, the member shall be required to report the kind of matters stated in the
circular to RBI.
1. Auditor should also consider the provisions of SA 250, “Consideration of Laws and Regulations in an
Audit of Financial Statements”. The said Standard explains that the duty of confidentiality is over-ridden
by statute, law or courts.
2. SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements“ states that
an auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance
that the financial statements taken as a whole are free from material misstatement, whether caused by
fraud or error.
3. It must be noted that auditor is not expected to look into each and every transaction but to evaluate the
system as a whole. Therefore, if the auditor while performing his normal duties comes across any
instance, he should report the matter to the RBI in addition to Chairman/Managing Director/Chief
Executive of the concerned bank.

Q-11 Explain the stages involved in Bank Audit.

Answer:-The stages are as follows:-

STAGE 1:-Initial consideration by the Statutory Auditor
(a) Obtain Status of Indebtness from Bank.
(b) Statutory Auditor should not be involved in Internal Assignments of Bank
(c) Develop an Audit Plan:-In compliance of SA 300
(d) Communication with the Previous Auditor
(e) Fix the terms of Engagement:-In Compliance of SA 210
(f) Perform Audit Procedures in Initial Audit Engagement:-In compliance of SA 510

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(g) Assessment of Engagement Risk
(h) Establish the Engagement Team

STAGE 2:-Identify and assess the risk of Material Mis-statement

STAGE 3:-Understand the Bank and its environment including Internal Control

STAGE 4:-Understand Bank’s Accounting Process

STAGE 5:-Understand Risk Management Process performed by Bank

(a) Oversight and involvement in control process by TCWG
(b) Identification, measurement of risks
(c) Control Activities:-A Bank should have proper control to overcome IR and CR
(d) Monitoring Activities:-The Control system should be regularly monitored

STAGE 6:-Engagement Team Discussion

STAGE 7:-Establish overall audit strategy

STAGE 8:-Establish Audit Plan

STAGE 9:-Determine Audit Materiality

STAGE 10:-Consider going concern

Q-12 Explain the types of Loans.

TYPES OF LOANS
1. Funded loans are those loans where there is an actual transfer of funds from the bank to the borrower.
Examples of funded loans are Term loans, Cash credits, Overdrafts, Demand Loans, Bills Discounted and
Purchased, Participation on Risk Sharing basis, Interest-bearing Staff Loans
2. Non-funded facilities are those which do not involve such transfer.
Examples of non-funded loans are Letters of credit, Bank guarantees, etc.

Q-13 Explain the types of Advances

CLASSIFICATION OF ADVANCES
SECTOR WISE

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RBI issues common guidelines for lending to Priority Sector which banks are required to follow. These
guidelines cover rate of interest; service charges, receipt, sanction, rejection, disbursement Register; issue
of Loan Application Acknowledgement. RBI also issues targets for banks for lending to Priority Sector.
Examples of Priority Sectors are Agriculture , MSME , Education , Housing , etc.
SECURITY WISE
Banks ask Security or Collateral while lending to assure that the Borrower will return the money to bank in
prescribed time else the Banks have legal authority to sell the collateral to recover its money.
AS PER PRUDENTIAL NORMS
STANDARD LOANS NPA LOANS
(a) Standard Regular (a) Sub-Standard
(b) Special Mention Accounts (b) Doubtful (D1/D2/D3)
(I) SMA 0 (Accounts Showing Stress Signals) (c) Loss
(II) SMA 1 (Overdue between 31 to 60 days)
(III) SMA 2 (Overdue between 61 to 90 days)

Q-14 Explain the nature of Security in case of advance provided by

Bank

Answer:-There are two types of security provided by the borrower:-

 Primary Security:-It refers to the security offered by the Borrower for Bank Finance or the one against
which credit has been extended by the Bank

 Collateral Security:-It is an additional security which is kept the borrower in addition to the primary
security.

Q-15 Explain modes of creation of Security.

Answer:-
Mortgage:-Usually on an Immovable Property. Its types are as follows:-
Registered Mortgage:-Mortgage Deed is prepared between Lender and Borrower.
Equitable Mortgage:-Mere delivery of title deeds to create Security

Pledge:-
 It is a kind of Bailment
 Movable goods are kept as Security
 Ownership remains with the pawnor while pawnee will have interest on it

Hypothecation:-
Here, proper agreement is created between both the parties.

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Physical possession of the security is with the borrower.
Currently, Bank has neither the ownership nor the possession of the Security.
In case of default, Bank can seize the Security

Assignment:-It means transfer of rights by borrower to Bank. Only Actionable Claims such as Books debts
and Insurance Policies are transferred.

Set-Off:-
 In this case, Borrower will have two accounts i.e. Deposit account and Loan account.
 Bank can adjust the amount of loan from Balance credited in deposit account.

Q-16 Explain Prudential norms on Income Recognition.

Answer:-
Non-Performing Asset:-An asset becomes NPA when it ceases to generate income for the Bank.
Where any loan/Advance
A) Interest and/or instalment overdue for a period of 90 days in term loan
B) The account remains ‘out of order’ in respect of OD/CC Limit
C) The Bill remains overdue for a period of more than 90 days.

Out of Order:-An account shall be treated as ‘out of order’ if:-

 Outstanding Balance is in excess of the limits
 Balance is within the limit but there are no credits since 90 days

Overdue:-An account due to the bank which is not paid on due date will be termed overdue.

Q-17 Explain categories of NPA along with Provision required.

CATEGORIES PROVISION
1) SUB-STANDARD ASSETS 15%
(Remained NPA for 12 months or less)
2) DOUBTFUL ASSETS Secured Insecured
Doubtful upto one year (D1) 25% 100%
Doubtful 1 to 3 years (D2) 40% 100%
Doubtful more than 3 years (D3 100% 100%
3) LOSS ASSETS
Would be one, where loss has been been
identified by the Bank/Internal Auditor/External 100%
Auditor/RBI

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Q-18 Explain Government Guaranteed Advances.

Answer:-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.
The situation would be different if the advance is guaranteed by State Government, where advance is to be
considered NPA if it remains overdue for more than 90 days for both Provisioning and Income recognition
purposes.

Q-19 Explain Advances under Consortium.

Answer:-
1. 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.
2. Consortium advances should be based on the record of recovery of the respective individual member
banks and other aspects having a bearing on the recoverability of the advances.
3. 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.
4. The banks participating in the consortium, therefore, need to arrange to get their share of recovery
transferred from the lead bank or to get an express consent from the lead bank for the transfer of their
share of recovery, to ensure proper asset classification in their respective books.

Q-20 Explain the Accounts in which there is erosion in value of

Security.

Answer:-
Value of Security reduces to less than 50% of its value:-DOUBTFUL ASSET
Value of Security reduces to less than 10% of O/S Loan:-LOSS ASSET

Q-21 Explain Agricultural Advances

Answer:-
LONG DURATION CROPS SHORT DURATION CROPS
MEANING: The “long duration” crops would be MEANING: crops, which are not “long duration”
crops with crop season longer than one year crops would be treated as “short duration” crops.

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The crop season for each crop, which means the period up to harvesting of the crops raised, would be as
determined by the State Level Bankers’ Committee in each State.
NPA: will be treated as NPA if instalment/interest NPA: will be treated as NPA if instalment/interest
remains overdue for one crop season. remains overdue for two crop seasons.

Q-22 Explain Advances to Staff

1. 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 staff members where interest is payable after
recovery of principal, interest need not be considered as overdue from the first quarter onwards.
2. 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.
3. 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.

Q-23 As an Auditor, how will you obtain evidence about advances made
by the Bank.

1. Amounts included in balance sheet in respect of advances which are outstanding at the date of the
balance sheet.
2. Advances represent amount due to the bank.
3. Amounts due to the bank are appropriately supported by loan documents and other documents as
applicable to the nature of advances.
4. There are no unrecorded advances.
5. The stated basis of valuation of advances is appropriate and properly applied and the recoverability of
advances is recognised in their valuation.
6. The advances are disclosed, classified and described in accordance with recognised accounting policies
and practices and relevant statutory and regulatory requirements.

Q-24 As an Auditor, how will you verify the internal control over
advances made by the Bank.

Answer:-
 The Bank should make an advance after satisfying with the credit worthiness of the Borrower.
 All the necessary documents have been prepared
 Ensure that the bank has complied with the Sanctioned limit.
 Drawing Power should be updated every month.
 All Accounts have been kept within drawing powers
 All the Accounts which exceed the Sanctioning limit or drawing power should be brought in notice.

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 The operation of each Advance Account shall be reviewed atleast once in a year.
 Sufficient margin should be kept against securities so as to cover for any decline in value of Security.

Q-25 As an Auditor, how will you obtain S&A evidence about evaluation
of Internal Controls relating to advances?

Answer: The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation
of internal controls relating to advances, and by:
1. examining the validity of the recorded amounts;
2. examining loan documentation;
3. reviewing the operation of the accounts;
4. examining the existence, enforceability and valuation of the security;
5. checking compliance with RBI norms including appropriate classification and provisioning; and
6. carrying out appropriate analytical procedures

Q-26 How drawing power is computed?

1. Meaning :- Drawing Power generally addressed as “DP” is an important concept for Cash Credit (CC)
facility availed from banks and financial institutions. Drawing power is the limit up to which a firm or
company can withdraw from the working capital limit sanctioned.

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

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

4. Bank’s Duties:- Banks should ensure that drawings in the working capital account are covered by the
adequacy of the current assets. Drawing power is required to be arrived at based on current stock
statement. However, considering the difficulties of large borrowers, stock statements relied upon by the
banks for determining drawing power should not be older than three months. The outstanding in the
account based on drawing power calculated from stock statements older than three months is deemed as
irregular.

5. Auditor’s Concern:- The stock statements, quarterly returns and other statements submitted by the
borrower to the bank should be scrutinized in detail. The audited Annual Report submitted by the
borrower should be scrutinized properly. The monthly stock statement of the month for which the audited

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accounts are prepared and submitted should be compared and the reasons for deviations, if any, should
be ascertained.

6. Computation of DP:- It needs to be ensured that the drawing power is calculated as per the extant
guidelines formulated by the Board of Directors of the respective bank and agreed upon by the concerned
statutory auditors. Special consideration should be given to proper reporting of sundry creditors for the
purposes of calculating drawing power.

7. Stock Audit:- The stock audit should be carried out by the bank for all accounts having funded exposure of
more than 5 crores. Auditors can also advise for stock audit in other cases if the situation warrants the
same. Branches should obtain the stock audit reports from lead bank in the cases where the Bank is not
leader of the consortium of working capital. The report submitted by the stock auditors should be
reviewed during the course of the audit and special focus should be given to the comments made by the
stock auditors on valuation of security and calculation of drawing power.

SUMMARY
 Bank should ensure that Accounts shall be kept within Sanctioned Limits.
 The accounts which exceed the sanctioned limit or drawing power should be brought to the notice of
the Management/Head Office regularly.
 Bank should ensure that drawings in working capital are covered by Current Assets
 Stock Statements, Quarterly returns submitted by borrower shall be issued
 The Audited Annual Report provided by borrower shall be scrutinized.
 Stock statements relied upon by the banks for determining drawing power should not be older than
three months.
 The outstanding in the account based on drawing power calculated from stock statements older than
three months is deemed as irregular.
 It needs to be ensured that the drawing power is calculated as per the guidelines formulated by the
Board of Directors of the respective bank and agreed upon by the concerned statutory auditors
 In case of Construction Business, the drawing power is to be examined carefully w.r.t. WIP
 The stock audit should be carried out by the bank for all accounts having funded exposure of more than
5 crores. Auditors can also advise for stock audit in other cases if the situation warrants the same.

Q-27 Computation of drawing Power

Q-Calculate the drawing power of the borrower on the basis of the following information
Stock 80000
Debtors 60000
(including debtor of Rs. 10000 for an invoice dated 16.10.2021)
Sundry Creditors 20000
Sanctioned Limit 60000
Margin on Stock is 20% and on debtors is 50%

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Note:-Debtors Older than 3 months are ineligible for calculation of DP

(A) STOCK
Stock at realizable value 80000
(-) Unpaid Stock
Creditors (20000)
Paid for Stocks 60000
Margin @ 20% (12000)
48000

(B) DEBTORS
Total Debtors 60000
(-) Ineligible Debtors (10000)
Eligible Debtors 50000
(-) Margin on Debtors @ 50% 25000
25000

TOTAL DRAWING POWER 73000

Q-28 Explain Sources of Income to a Banking Company

INTEREST EARNED OTHER INCOME

1. Interest/ Discount 1. Commission, Exchange and Brokerage: This item comprises of the following:
on Advances/ Bills: a) Commission on bills for collection.
2. Interest Income on b) Commission/exchange on remittances and transfers, e.g. demand
Investments: drafts, NEFT, RTGS, etc.
3. Interest on c) Commission on letters of credit and guarantees, letter of comforts.
Balances with RBI d) Loan processing, arranger and syndication fees.
and Other Inter– e) Mobile banking fees.
bank Funds: f) Credit/Debit card fee income including annual fee income, merchant
4. Others: This acquiring income, interchange fees, etc.
includes any other g) Rent from letting out of lockers
interest/discount h) Commission on Government business.
income not i) Commission on other permitted agency business including consultancy and
included in the other services.
above heads j) Brokerage on securities.
k) Fee on insurance referral.
l) Commission on referral of mutual fund clients.
m) Service/transaction banking charges including charges levied for
transaction at other branches.
n) Income from rendering other services like custodian, demat,

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2. Profit on Sale of Investments
3. Profit/Loss on Revaluation of Investments
4. Profit on sale of Land, Buildings and Other Assets:
5. Profit/Loss on Revaluation of Fixed Assets
6. Profit on exchange transactions: This includes revaluation gains/losses on
forward exchange contracts and other derivative contracts, premium
income/expenses on options, etc.
7. Income earned by way of dividends, etc., from subsidiaries and joint ventures
abroad/in India.
8. Miscellaneous income.

Q-29 Explain Audit Approach to verify Income of a Banking Company

Auditor’s Concern :- In carrying out audit of income, the auditor is primarily concerned with obtaining
reasonable assurance that the recorded income arose from transactions, which took place during the
relevant period and pertained to the bank, there is no unrecorded income and the income is recorded at
appropriate amount.
RBI’s Directions:-RBI has advised that in respect of any income which exceeds one percent of the total
income of the bank if the income is reckoned on a gross basis or one percent of the net profit before taxes if
the income is reckoned net of costs, should be considered on accrual as per Accounting Standard 9.
Materiality:-If any item of income is not considered to be material as per the above norms, it may be
recognised when received and the auditors need not qualify their report in that situation.
Revenue Certainty:-Banks recognise income (such as interest, fees and commission) on accrual basis, i.e., as
it is earned. It is an essential condition for accrual of income that it should not be unreasonable to expect
its ultimate collection.
Revenue Uncertainty:- In view of the significant uncertainty regarding ultimate collection of income arising
in respect of non-performing assets, the guidelines require that banks should not recognize income on non-
performing assets until it is actually realised. When a credit facility is classified as non-performing for the
first time, interest accrued and credited to the income account in the corresponding previous year which
has not been realized should be reversed or provided for. This will apply to Government guaranteed
accounts also.
Advances against Securities :- Interest on advances against Term Deposits, National Savings Certificates
(NSCs), Indira Vikas Patras (IVPs), Kisan Vikas Patras (KVPs) and Life policies may be taken to income
account on the due date, provided adequate margin is available in the accounts.
Bills Purchased:- In the case of bills purchased outstanding at the close of the year the discount received
thereon should be properly apportioned between the two years. [The Unexpired discount/ rebate on bills
discounted i.e., where part of receipt comprising discount charges on bills purchased relate to the period
beyond the year-end, should be recorded as “Other Liabilities”].
Bills for Collection:-In the case of bills for collection, the auditor should also examine the procedure for
crediting the party on whose behalf the bill has been collected. The procedure is usually such that the
customer’s account is credited only after the bill has actually been collected from the drawee either by the

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bank itself or through its agents, etc. This procedure is in consonance with the nature of obligations of the
bank in respect of bills for collection. The commission of the branch becomes due only when the bill has
been collected
Renegotiations :-Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of
outstanding debts should be recognised on an accrual basis over the period of time covered by the re-
negotiated or rescheduled extension of credit. Test check the interest earned by the banks for the sample
selected. Test check the fees and commissions earned by the banks made for commission on bills for
collection, letters of credit and bank guarantees.
On leased assets: The component of finance income (as defined in AS 19 – Leases) on the leased asset
which was accrued and credited to the income account before the asset became non-performing and
remaining unrealised, should be reversed or provided for in the current accounting period.
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. Broken period interest paid on
securities purchased and amortisation of premium on SLR investments is net off from the interest income
on investments.
Profit on Sale of Investments: Investments are dealt in the course of banking activity and hence the net
profit or loss on sale of investments is taken to profit and loss account.
Profit/Loss on Revaluation of Investments: In terms of guidelines issued by the RBI, investments are to be
valued at periodical intervals and depreciation or appreciation in valuation should be recognised and taken
to profit and loss account.

Q-30 Explain Take out Finance

On Take-out finance: A takeout loan is a method of financing whereby a loan that is procured later is used to
replace the initial loan. More specifically, a takeout loan, or takeout financing, is long-term financing that the
lender promises to provide at a particular date or when particular criteria for completion of a project are met.
Takeout loans are commonly used in property development
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)

Objectives of Take-out Finance:-

1. To expand sources of finance for infrastructure projects by facilitating participation of new entities
2. To address sectoral/group/entity exposure issues and asset liability mismatch concerns of lenders

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3. To boost the availability of longer tenor debt finance for projects

Q-31 Explain partial Recoveries of NPA

1. 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.
2. The appropriate policy to be followed is to recognise income as per AS 9 when certainty attaches to
realisation and accordingly amount reversed/derecognised or not recognised in the past should be
accounted
3. Interest partly/fully realised in NPAs can be taken to income. However, it should be ensured that the
credits towards interest in the relevant accounts are not out of fresh/additional credit facilities
sanctioned to the borrowers concerned.

Q-32 Explain Reversal of Income

1. 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.
2. 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.
3. Further, in case of banks which have wrongly recognised income in the past should reverse the interest if
it was recognised as income during the current year or make a provision for an equivalent amount if it was
recognized as income in the previous year(s).
4. Furthermore, the auditor should enquire if there are any large debits in the Interest Income account that
have not been explained. It should be enquired whether there are any communications from borrowers
pointing out differences in interest charge and whether appropriate action has been taken in this regard.

Q-33 Explain where Banking Company will make the expenditure.

INTEREST EXPENSE OPERATING EXPENSES PROVISIONS

1. Interest on Deposits 1. Payments to and Provisions for 1. Provisions made in respect of
2. Interest on Reserve Employees the Non- performing assets.
Bank of India/Inter– 2. Rent, Taxes and Lighting 2. Provisions for Taxation
Bank Borrowings 3. Printing and Stationery 3. Provisions for Diminution in
3. Others 4. Advertisement and Publicity the value of
5. Depreciation on Bank’s Property 4. investments
6. Directors’ Fees, 5. Provisions for contingencies
7. Allowances and Expenses

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8. Auditors’ Fees and Expenses &
Legal expenses
9. Postage, Telegrams, Telephones,
etc.
10. Repairs and Maintenance
11. Insurance
12. Marketing Expenses
13. Other Expenses

Q-34 Explain Audit Approach with respect to Interest Expense of a

Banking Company.

 In carrying out an audit of Interest expended, the auditor is primarily concerned with assessing the overall
reasonableness of the amount of interest expense
 The auditor should also compare the average rate of interest paid on the relevant deposits with the
corresponding figures for the previous years and analyse any material differences.
 The auditor should, on a test check basis, verify the calculation of interest and satisfy himself that:
(a) Interest rates are in accordance with the bank’s internal regulations, of the RBI directives, and
agreements with the respective depositors;
(b) In case of Fixed Deposits it should be examined whether the Interest Rate in the accounting system
are in accordance with the Interest Rate mentioned in the Fixed Deposit Receipt/Certificate.
(c) Interest on Savings Account should be checked on a test check basis in accordance with the rules
framed by the bank in this behalf.
(d) Interest on inter–branch balances has been provided at the rates prescribed by the head office.
 The auditor should ascertain whether there are any changes in interest rate on saving accounts and term
deposits during the period.
 The auditor should examine the completeness that interest has been accrued on the entire borrowing
portfolio and the same should agree with the general ledgers.
 The auditor should re-compute the interest accrual i.e., by referring to the parameters like frequency of
payment of interest amount, rate of interest, period elapsed till the date of balance sheet, etc. from the
term sheet, deal ticket, agreements, etc. and ensure that the recomputed amount is tallying with the
amount as per books of accounts without any significant difference.

Q-35 Explain Audit Approach with respect to Operating Expense of a

Banking Company.

For audit of operating expenses,

1. 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.
2. The auditor should examine whether there are any divergent trends in respect of major items of
expenses.

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3. 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.
4. The auditor should also verify expenses with reference to supporting documents and
5. check the calculations wherever required.

Q-36 Explain Audit Approach for Audit of Provisions and

Contingencies.

1. 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.
2. The auditor should obtain an understanding as to how the bank computes provision on standard assets
and non-performing assets.
3. It will primarily include checking the basis of classification of loans and receivables into standard, sub-
standard, doubtful, loss and non- performing assets. The auditor may verify the loan classification on a
sample basis.
4. The auditor should obtain the detailed break up of standard loans, non- performing loans and agree the
outstanding balances with the general ledger.
5. 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.
6. 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.

Q-37 How the prior period items are treated in Financials of the
Banking Company

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 disclosure of the impact of prior period items on
the current year’s profit and loss, such disclosures, wherever warranted, may be given.

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