CHAPTER-13 Sree Avonr— Aor oF Bayne Companies oucTion iginally He Oni udit 8 10 € 0 ye emphasis W' a yank. ioni ie a shift in focus of the functioning of the banks, Theit social Televance was given There saker sections of society and for the pur i es joney to We: Purpose of revival of sick unites. uth also got altered from adequacy of security to viabiliy of boomers fo nes ioning of a bank are regulated by Banking ies Regular; tdi ‘ Was coiiaabies ‘Act, 1956, They should Fat come out Reston Aa, Be ghee was he Provisions of both enactments reenses eA ate of accounts and records by the bank. tarding king company May engage in any or more of the following in addition to normal sag business of accepting deposits and lending loans and advances, ii) Borrowing and lending money / (2). Actas the agent of Government/ocal authority or any other person. (3) Deal with negotiable and quasi negotiable instruments, (4) Undertaking and executing of trusts. (5) Act as an administrator of estates. (6) Provide safe deposit vaults, (7) Canying and transacting every kind of guarantee and indemnity business, Doing all other things which are invidental or conducive to the promotion ot advancement in the interest of the organization, The important Provisions of Banking Company Regulation Act, 1949 are : \N) Forms of business in a banking company may engage 2) Prohinition of trading, buying, selling or bartering of woods. 3) Disposal of non-banking assets, 4) Requirements regarding minimum paid-up capital and Reserves. ; petulation of Paid-up and authorised capital. striction on Commission, brokerage, discounts on sale of shares. Prohibition Of charge on unpaid capital. Restrictions as to payments of dividends. main focus of bank audit centred round the following : ensure the solvency of the banking companies as it a 4 -als with as on the verification and adequacy of securities far advances mete fade by210/ Essentials of Auditing (9) Reserve fund and cash Reserve (10) Restrictions on the nature of subsidiary companies: (11) Restrictions on loans and advances (12) Maintenance of a percentage of assets. (13) Accounts and Balance Sheet. (14) Audit. Banking companies Reguat companies Business : (1) A banking company car section 6 (1) of the Act. (2) As per section 8 of the act a any trading business. (3) No banking company can up share capital of the company oF ever is less. (4) Abanking company is prodibited from forming. subsidiary company. The ex in this connection are : ‘EmpLions (i) from a subsidiary for providing safe deposit vaults. (ii) administration of estates of trustees (5) Banking Company is prohibited from paying brokerage or remuneration forthe shares exceeding 242% sale op (6) Without permission from R.B.1. abanking company is prohibited from paying brokerage tion Act, 1949 has placed the following restictions on in sn not engage in a business other than those prescrip, : ed ung ls bank is prohibited from carrying on directly or ing iret hold shares of other companies exceeding 30% of 30% of its own paid-up capital and reserves ; wv remuneration. : (7) No banking company can make loans/advances on the security of its owi sia grant unsecured-foans or advances to its directors or to companies in which its ry n | are directly or indirectly interested. 3 sts (8) No banking company is allowed to hold any immovable property for a period exceed Seven years except for its own use. 22 ~ The Banking companies Regulation Act, 1949, has laid down the procedure for th maintenance of the accounts and records of a. bank and their audit : There are four importa : features of bank accounts : = (a) A large number of transactions to be recorded in a very short period. {b) Normally banks were using slip system of accounting. Now they make use of computers. (c) Final accounts are prepared immediately after the close of the year. (d)_ Banks have a very strong system of internal check/ internal audit for their daily transactions. These features forces the banks to have : (a) an internal audit staff or employ the auditor to carry out continuous audit. (b) For every bank an efficient and reliable internal check is a must. This must be designed and decided by the bank in consultation with the auditor if necessary. In case of new auiditor he has to determine the extent of his work atthe time of ul of final accounts he has to anlyse the strength and weaknesses of internal check. Due to large number of transactions itis practically possible to have a detailed aut inthe assis of effective internal chgck. So the auditor can easily undertake a detailed Balance Sheet audit. (2) Bank Aupit PROGRAMME ture of In designing an audit programme an auditor must take into consideration the nati’ ries of bank accounting, its pectuar nomenclature, the special la applicable to the bank and vag"Specia "Pecial Audit —Audit of Banking Companies /211 baking sector. The review of the intemal co FO system of bank is to concentrate on the following 38M is also very (a) Review of internal Control and'p (b) Examine of Routine transactions US (6) Nerifieation of Balance Sheet hem, (©) Checking of the Profit and Lone, m (#) Review of internal Control an, essential. An audit programme " 'd Procedures Auditor should remember that a bank ers Jot of * lot of scoy Auditor to study internal controls ang PE for fr c md procedure’ frauds as it deals with cash loopholes and leakages with the object ot arene bank to identify the chances for slips, enrich its potentials by interviews, i veh arther by a systematic enquiry, Fe he has consider are : Manuals. The main porns aian (1) Arrangement of tasks, duties and Fesponsibi 7 onsibi levels are to be transferred from one branche another period frequently without notice. The work isto te Periodically from the same time the work of one person 1 seuanged using di ti must b ivision of of authority and responsibi checked by another. The shes hhe employees at various One position to another labour principle and at ld be proper definition subsequent follow up. Bank's brane Any discrepancies are locate (b) Examination of routine transact Auditor is to review the internal control sys hag to identify its weakness andexpress his opinion on its reliability and it should be recorded. The audie Programme is to be designed accordingly. 2 Auditor can select certain items on a random basi interest calculations, balances, nature of security, tverall routine to have a better understanding of degree of its reliability. (Verification of Balance SKeet ‘stem in operation. He is and examine thoroughly to verify existing margins. A detailed examination of the actual form of internal control and the ltthe internal control is solid and sound, its reliability is greater then the auditor need not check the arithmetical accuracy of various original vouchers. So the auditor is to check the Balance Sheet in greater detail. (@) Checking of the Profit and Loss account Fist the auditor is to check the effectiveness and reliability of internal check. Auditor ‘ld conduct routine as well as overall checking of various items of receipt and payments ‘Feting in Profit and Loss accounts.2: Essentials of Auditing Auoit of BANKING COMPANIES Every banking company incorporated in India is to prepare Balance Sheet Loss account in the format specified by the Act. Schedule I to 16 deal with these gant accounts at the end of each financial yeat. The accounts are to be audited by a pers, etails oft bean auditor under law. Incase of banking companies incorporated outside India cpg ® by aperson qualified under the law of the county to which the company is incorpgr 2° shall have the powers, furtctions, duties and liabilities of the company auditop. "4 Auge! Nationalised Banks are regulated by the Provisions of Banking companies ™ and Transfer of under takings) Act, 1970. Some of the Provisions of the Banki Accu, Act, 1949 are also applicable to nationalised banks. These banks shall carry ¢n® ®t! business as per the provisions of 5 (b) of Banking Regulation Act. They may alyy nag forms of business specified in section 6 (1) of the Act. Each nationalised eae or, Tore books of accounts on 31st March every year. They have to appoint auditors to andy i accounts with the prior approval of the Reserve Bank of India. The auditor can appojn Ihe bookc op or other persons to assist him in the audit work. But the expenses are to be ee tan nationalised banks. Auditor's remuneration is fixed by the bank in consultation wras? eh Government. He has the right to examine the books of accounts and other documents Er and officials ofthe bank may be required as per the requirements of audit. Auditor ion oS his report to the central Government and copy of such report to the R.B.I. and tothe oStht bank. COnCeMeg Liabilities Side : The items which appear on the liabilities side of the Balance Sheet are : (1) Capital (2) Reserves (3) Customer’s deposits (4) Borrowings (5) current labile, Capital The Banking companies Regulation Acthas specified the minimum Capital. The subse capital must be half of the authorised capital and the paid-up capital must be half of the abate capital. A banking company is prohibited from paying brokerage or remuneration on thes shares at a rate exceeding 24% of the paid-up value of Shares. at Reserves Every banking company before declaring dividend shall transfer 20% of its profits oa reserve called statutory reserve. This is compulsory for every banking company registaned a India. For banking companies registered outside India shall transfer 20% of its profits eamed in India and this is to be deposited with Reserve Bank of India. The R.B.1. may exempt a banking company from such transfer for a stipulated period only when the balance in reserve fund ard share premium is not less than its paid-up capital. Cash reserves Regarding the cash reserves to be maintained with the R.B.I the act has prescribed following conditions: (a) Every scheduled Bank is required to maintain cash reserve an average daily balance at least 3% of its total time liabilities and demand liabilities. This percentage may be raise 15% based on the economic conditions. (b) A non-scheduled Bank is to maintain cash reserve with R.B.I. or S.B.I. or any 0! bank notified by the central Government in this behalf a sum equal to 3% of total time demand liabilities. The bank is to submit to R.B.I. before 15th day of every month showing| amount so held on friday of each week f the proceeding month with details time and demas liabilities in India. A banking company is to maintain in India cash, gold or unenambord secuSpecial Audit Audit of | Banking Compar mies a price not exceeding the current market eb a Vail cet 23 rice the amount not less than 250 of its tora i" roweR’s DEPOSITS us i the bal itor isto compare the balances of al deposit ledgers A edget He hast see that interest ae Sth the balances that appear in : i 8" west 7 ‘used on Sand duty provided for. He has to conduct rane POSS have bey ne ; 10 conduct test check en correctly ay those of which whose pas books availble withthe pei eM Ceasar ee owings gor" itor is go though the : tr tler9UOW He is dca wet carina me tee gins the secured I ws veep is uncalled capital otherness “A banking company is nox alowed eens saat ir charge shall a shi andheyhaveto ify tha sucha char Permission is obtained from ‘Snot detrimental tothe interest ofthe depositors uanenT LIABILITIES Auditor they are properly cleared and recorded, Conti Silt % Ie ined and disclosed inte Be ne lilies ofthe bank ave ben dy Auditor to verify that entries for contra items like Bills for collection. ‘on behalf of customers and Acceptances and endorsements and other obligations on behalf of customers has been property adjusted in the books of accounts of the bank. Auditors are to carefully watch the secret reserves as not misused as bank are allowed maintain them, Assets SIDE (On the asset side of Balance Sheet the schedules 6 to 10 specify the particular. They are cash in and Balances with other Banks, Investments, Loans and advances other assets and fixed assets. Non-banking asses acquired in satisfaction of claims. ‘Cash in Hand and with other Banks On the last day of the financial year auditor will attend personally and verify the available cash in hand or bullion by actual counting or weighing, The balances of the cash Book is compared! with the day Book. Balances with R.B.1 and with other Banks shall be verified with the help of confirmation certificates from them, Money at call and short Notice ean be verified with the help of call deposit receipts in possession of the bank. InvesTMENTS ‘Auaitor should obtain a schedule of investments. He has to verify these investments atthe «dof the year by caeying out an inspection ofthe securities and other documentary evidences aoc ih the bank. Care must be taken by the auditor to see that : Fa ame investments are not shown twice. Jaks own investments is to be distinguished by the bank against loams and advances aa safe custody ofthe bank, a ai) ee(iii) Bank’s might handed over investments to some other banks as secu certificate must be obtained from them Hi for liv) Compare Investment account in the General ledger with Inv cs 214 / Essentials of Auditing este, investment schedule. Gold is shown under investments. MEM edge Auditor should check that bank has not invested indulged in any invesy ‘ang prohibited by Banking companies Regulation Act. * investmen, ‘A banking Company has been prohibited from holding shares in any com, of pledge, mortgage or absolute owner of an amount exceeding 30% of paid usar) that company oF 30% of its own paid-up share capital and reserves which ever n° form any subsidiary company. Auditor to see that all interests and dividends ae? received on investments have been taken into account See tha the investments acca and scrutinise their valuation. In the Balance Sheet investments must be proget®® Ppa along with their mode of valuation PStly iscong Loans Ano Apvances : (1) Auditor is to obtain a schedule of all loans and advances, cash credits ang from the bank. He has to verify them with the balances of respectiv. Overdrafs a /e leds will be compared and checked up with respective total accounts maine A general ledger. ed in the (2) The Board of Directors resolution for sanctioning of the loan at the time of ay smoney to be checked. Similarly they may grant extension for repayment af tt Which ase the Board of directors resolution must be checked. Further audian review loans not paid regularly and see that the loan gets time bared, mS (3) Auditor is to check and examine the documents executed by the borrow. documents are current and the borrower is legally bound to pay the } commits and default the bank shall have the right to sell the security an proceeds towards recovery of loan. (4) Auditor is to ascertain the extent to which loans and debts are secured, He isto chy the title of the borrower to securities offered in connection with loan is clear marketable. In case of advances secured by personal guarantee of some person auditor is to examine the adequacy of the margin kept in the value of the secu Further the auditor is to examine the letter of guarantee he shall try to ascertain d financial position of the guarantor. He will see it the guarantor is able to fulfil his promise incase of default by the deby ‘The confidential report of the borrows regarding his financial position is o be look into by the auditor. Banks are not to disclose bad debts and provision for bad debs the Balance Sheet as only the net debtors are to be presented. In the Profit and Li account provision against bad debts and bad debts are to be deducted from gross incor interest and bank charges and only the net income is presented. (5) Auditor is to examine that the company has not made any loans/advances onthe secu of its own shares. no advances or unsecured loans have been sanctioned to any o directors or to firms ot to companies in which any’ of its directors interested i partner or holds any position connected with management. (6) Auditor is ascertain that interest accured on the debts of the bank have been cole regularly and properly accounted. He is to check that there is proper classification presentation in the Balance Sheet is complete. Loans, overdrafts, cash credits! Purchased and discounted are to be classified as inside and outside the count. (7) Loans and advances are classified and presented on the basis of their security: (i) Debts considered good in respect of which the banking company is fully = ii) Debts considered good for which banking company holds no other sesu"ty than debtor's personal security. er. See that th loan. In case id adjust the sa> © » Deby Spectal Audit — Audit of Banking Companies 215 ty, Ser pide sod fr which the bank asthe personal sz ets which if Addition to the debtor. ©) Dey ich es due fa considered doubtful or bad and have not been provided for £ ( Degll) with any Lifectors/officers of the bank or any of them either severally or Pats due fron’ Other person \ "ersoneu® fom those (il) Maxim, O°°4Pying Pe in which directors of the bank are interested as OF the bar Unt advance Positions Mavinnath OF any or mance sive including temporary advances total amour ny ithe jointly or severally during the year advances made to associated companies at any time officer (iii) (ix) Debre ane ap AND Dou: B STFUL De, The main function of a jways a probability for the oecy it iS lending al Ie Occurren, Ng Money and earning interest. In lending there is ide for in the and provi the rig counts Will not reflect the time BTS ce of in the rc So banks are to identify correctly bad debts i accounts. If this is not done the books of Bad debts sh he financial Position in the books of accounts. to the knowin be adequate and to the satisfaction of the ige of the management to increase it failing s ties in cy ten cherie ‘onnection with verifi a aN Pete fei! Tegarding the aipeee “oun af lesan and advances is ts nds of advances. They {2) Advances against stockein- Taga ot aNd Securities of joint sek compass 7 Advances against Properties, =. 3 (4) Advances against Life Insurance Poy (5) Advances against bank's fixed ge 6) Advances against bullion es (7) Unsecured advances to limited Companies and partnership nership firms, jes of Joint Stock (1) Advances against Government Securities and See u Companies: i Auditor is to examine the adequacy of margin by ascertaining their market values. He (a) has to check and see that only those sec ‘ z os pean hae Deer nde eutes which included nthe acceptable lending (b) Auditor is to see that the security pledged is accompanied by a blank transfer form duly signed by the borrower. (c)_ Ifthe securities pledged are in the name of a person other than the borrower audi . Sans be S ver auditor must examine the letter of authority in favour of the borrower giving him the right to pledge those securities. (d) Auditor is to verify the securities pledged against advances and ascertain that they have been properly enclosed in favour of the bank ° (e) The Letter of pledge duly signed by the borrower is to be checked by the auditor to know the terms and condition of the pledge. (Auditor is to be vary careful with advances against partly paid shares, unquated shares, and shares of private companies, he has to take special care to see that the bank has not sanctioned any advance which is either ultra vires o the provisions of the Banking Regulation Act or any of the internal regulation of the bank. (2) Advances against Stock-In-Trade : (a) Auditor to check and verify all the details of these of transactions by going through the letter of pledge or hypothecation deed.216 / Essentials of Auditing (b) (Co) d) (e) 3) Advances against Properti (a) (b) () @ (4) Advances against insurance Policies : (a) (b) (c) id) (5) Advances against bank’s fixed Deposit Receipts: (a) (b) (e) (6) Advances against Bullion f@) (b) (7) Unsecured Advances to limited companies and partnership firms (@) rc) } In case of thee advances bank should employ inspectors for the purpose ‘Verification of stocks so pledged. Auditor isto carry out a complete examiny. records and reports of these inspectors. : ‘Auditor isto compare the stock statement received from the borrower the beepers records with the register maintained by the bank He is to check thatthe stocks and the godown are duly insured against ox In case of slow moving stock and slow tumover of stock auditors to beg. to see that these accounts have not become bad as the scope for itis move “My snr ‘bank, £44, ‘Auditor is to examine the title deeds of the properties mortgaged and the » the mort gager thority of Regarding legal mortagages auditor is to examine the mortgage deed. Incase of mortgage the memorandum of deposit is to be checked, 4itable For the valuation ofthe property mortgaged auditor isto examine the architec’ Further he has to check that the properties mortgaged are insured against a men losses. Possibe For properties owned by companies subject to mortgage the auditor is to che, ‘mortgage has been properly authorised and Registered wit the Registrar ofer under the provisions of companies Act. “OMpanies Auditor iso examine the insurance policy/policies lodged by the debtor shou assigned in favour of the-bank by the borrower, The assignment must be tt with the insurance company. sisleed {Auditor isto check thatthe bank before advancing money should have obi surrender certiicate fom the insurance company and the advance made othe ba must be less than the surrender value of the policy ‘The age of the insured has been admitted by the insurance compan, Last premium receipts to examined to make sue thatthe policy infor and has lapsed. Auditor to verify the fixed deposit receipt. ‘The receipts should be duly discharged by the borrower in favour ofthe bank By accepting the F.D. receipt as a security a lien of the receipt is created. ‘Auditor to verify the physical existence, weight and value of billion held by the bank asa security against its advances. He may get the weight, purty of contents and the values certified by an independent jeweller of high repute. ‘Auditor to examine and ascertain the partnership dead to know the partners power to borrow. For companies the powers of directors to burrow is to be checked snd examined with the help of M/A and A/A. For partnership firms permission note is executed by all partners. This i to bechesked and it should be presented in the Balance Sheet asa lability Incase of companies, auditor isto examine the Board of Director's resolution to bur ‘Any charge so created is duly registered with the Registrar of compaties. Auditor examine the Balance Sheet of the borrowing company to know its eval finan position. This is to be done with the object of releasing the loan.Special 4 Malt Audit of Banking Companies 317 2 perFORMING Assets. (NPA) 10 cecbosomes non-performing when te ssn ied ct nap Income forthe bank, cog fora specific period of time “ 6st ransparency 90 da overdue ny oe oso Heietion oF NPAs vas se om Mach 31,2004 rr 4 no performing a8et shall bea loan or an advance where in case of term loan interest and installn 1) yore than 90 days. "ent of principal remain overdue fora period ® Resins aha and cash credit the account remains out of order for a period more os wi ris overdue fora period of more than 90 days in ease of bills purchased and o aac ‘8 7 ‘eceived remains overdue fra period of mor than 90, days regarding (a) Aloan granted for short duration crops willbe itthei , or interest them remains overdue for two ie eas neni (b)- For loan granted to long duration crops will be treated as NPA if the installment of principal or interest thereon remains overdue forall crop season, {c) For agricultural loans other than those specified above and term loans given to non- agriculturists, identification of NPAs would be done on the same basis as non-agricultural advances (90 days norm) (d)__ The point to be noted that while granting loans and advances to agricultursts realistic repayment schedules are fixed on the basis of cash flow/fluidity with borrowers. The system of identification of NPAS is done on an on going basis. Doubts in asset classification due to any reason is to be settled though specified internal channels. Within one month form the date on which the account have been classified as NPA as per prescribed norms Provisions for NPA s isto be made on a quarterly basis to have an accurate provision for NPA. Bits Discounted AND PURCHASED Discounting of Bills and Purchase of bill i performed bythe bank for mostly outstation parties, Bills are sent to various branches or agents fr eoleton, So physical verification of rare nsagtions isnot possible forthe auditor. He can perform the following: Se est the bil withthe help of Reser of bills discounted and confirmation certificate Sbtained from branches which process them, (2) Limits tse o parties should not be exceeded. 12) Carnpae tetas ofthe Bil discountedin the lege withthe balances ofthe contol ewount in the General ledger. 4) Sonthat al oustanding bill are included (4) Seen the date of maturity ofeach il inorder to verify the amount of overdue bills (5) Exar the adequacy of security available with the bank (6) asco undertake surprise test checking ofthe Register of Bills discounted and the (7) aden accompanying the ils have been properly enclosed and signed in favour of the bank, es ss218 / Essentials of Auditing | (8) He shall ascertain the adequacy of provision for dishonored bills and cay, in payment and the action taken by the bank is to be checked. SES fog (9) Advise the management fo enhance the provision for doubtful debs, necessary, hee (10) Check the calculations for rebate on bill discounted and ascertain that g proportion of debate on bil discounted on bill ue after the close of tah, year has been carried forward to the subsent year. . Finan ‘Contra Accounts These relate to the following: (1) Bills for collection (2) Acceptances, endorsements, guarantees letters of credit opened for custo appear as an asset as well a liability. So their debits must be equal to credig They Auditor to take the following steps: (1) Bills on hand for collection is to be examined physically (2) The books of account are to be checked to know the extent of lability (3) He has to check thatthe contingent obligation assumed by the bank does n actual liability. becom (4). There should be adequate provision for Bad and Doubtful debts, (5) _ Entries of the subsequent period are to be checked to ascertain all those, the bank has failed to recover the from the customer, 3SE5 Where BRANCH ADJUSTMENTS: This refers the differences that arise due to inter branch transactions in connection transfer of various documents and advances between various branches, So the epee by the auditor are : ‘es (1) Branch statements received from various branches is to be looked into while reconciliation statements. (2) _Ascertain thatthe items appearing in branch reconilition statements were not op abnormal nature and were adjusted immediately after the close ofthe year (3) _ Entries remaining uncleaed fora longer duration iso be investigated bythe ud preparing Other Assets Include items like furniture and fixtures, stock of stationery and interest accured and ser on investment (1) Auditor is to check the title dead or other documentary evidences to satis that they are the assets of the bank on the date of the Balance Sheet. ° (2) The should really exist and properly valued, (3) _ Physical examination of same of the assets can be undertaken. (4) Amount of accured income is shown in the Balance Sheet. Non-banking assets acquired in satisfaction of claims. (sec y The Banking companies Regulation Act prohibits a bank from holding any immovable property for any period exceeding Seven years from the acanisition date, This isnot applicable in the case of assets acquired for its own use, The period of Seven years may be extended upio another five years by the R.B.L it it satisfied that such an extension will in the interest ofthe depositors of the banking company. Auditor's duty in connection with non-banking assets acquired in satisfaction of claims are