LFAR and Other Important Aspects of Bank Audit

LFAR and Other Important Aspects of Bank Audit

Mayur SwadiaChartered Accountant

Contents

Shifting role of the Auditor. Audit Programme. Profit and Loss Account. Basics of LFAR Posers LFAR Para-wise Ghosh and Gilani Committee Reports

04/21/23 CA Mayur Swadia 2

Bank Branch Audit is like an IPL – a very short game in which we have to bat like ‘Yusuf Pathan’ and WIN

High quality output in a short period of time


Shifting role of the Auditor

Challenge to do quality audit in a limited time frame.

Proper audit planning critical. Quality of audit and value addition –

key issues. All of us must strive to do our best

in the larger interest of our profession.

Audit Programme

No planning, is planning to fail. Go through last year’s Profit and

Loss Account and Balance Sheet. Carry out comparative analysis. Find out major variations. Probe for major reasons.

Audit Programme

Go through last inspection, internal audit, concurrent audit, revenue reports and compliance by the branch.

Identify key risk areas for special focus.

Prepare work schedule on the basis of the overall analysis with special focus on identified key areas.


Profit and Loss Accounts Existence of system to compute

discrepancies in interest / discount income as well as interest expenditure & timely adjustment thereof.

Discrepancies if material to be reported (MOC to be issued) Existence of system Discrepancies to be checked by branch Findings of Concurrent Audit/Revenue Audit.

Audit of Profit and Loss Account

Test Check interest calculations. Verify rates of interest and changes

therein. Check interest charge on NPA

accounts Analysis of yield on advances. Test check commission income etc.

– whether as per revenue recognition norms.

Audit of Profit and Loss Account

Check provisions for expenses. Check depreciation charged correctly. General ledger scrutiny and

reconciliation with subsidiary ledgers. Compare expenses with previous year. Test check major/exceptional expenses. Check the powers of the branch to incur

expenses.


Profit and Loss Accounts (Cont’d)

Compliance with Income Recognition Norms.

System of estimation and provision of Interest on overdue / matured term deposits.

Divergent trends in major items of P & L A/c if not satisfactorily explained.


Basics of LFAR Why ‘LFAR’? Should it be ‘BCAR’? LFAR is an internal control evaluation

questionnaire. Comprehensive in scope and coverage.

Where as MAOCARO is not so comprehensive

Covers both Balance Sheet and Profit & Loss Account.

Serves as an important check list for audit planning. Make LFAR part of the audit programme.


Must Do’s Study the Questionnaire thoroughly. Each answer should be precise. Avoid vague or general comment. Give specific instances of

weakness/shortcomings. Main Audit Report and LFAR are two

separate reports. Qualificatory remarks MUST be part of

the main report.


Must Do’s

Main Report is a self contained document and should not contain any references to LFAR.

Should be sufficiently detailed and quantified to enable expeditious consolidation.

Do not make current year’s LFAR a replica of previous year.


LFAR is of utmost importance to the management as well as the Central Auditors.

Finalize Statutory Report and LFAR simultaneously.

Should be well drafted. Scope of work carried out should be

clearly specified. Should create an impact on the bank

management about the quality of work carried out.

Must Do’s


Mr. CA has taken a housing loan from Bank of NAMO.

Monthly installment (principle + Interest) due on 31st December, 2013 not paid by 31st March, 2014. Whether the account is NPA?

Would it make any difference if the said installment was due on 30/12/2013 or 1/1/2014?

Refreshers…….


Term Loans (Posers???) Mr. FCA has taken a term loan from bank

of Italy. Installment for the October-December

quarter debited on 30th December, 2013 Rs. 1 lac (Incl. int. of Rs. 25,000/-

Amount paid by 31st March, 2014 against the same Rs. 95,000/-. Branch Manager has classified the account as a Performing Asset. Your audit assistant has approved the same. Do you have any counter view?


Term Loans

Mr. Article has taken a housing loan from a bank. Equated Installments (principal + interest) are payable on a monthly basis. Mr. Article is generally regular in repayment. However, installments for the months of October and November, 2013 could not be paid by 31/3/2014? All the other installments are paid for the year ended 31/3/2014.

Is he OUT??? or NOT OUT???


Term Loans

Any loan account where the monthly/quarterly/half yearly/annual installment (principle + Interest) falls due on or before 30th December, 2013 and if the same is not FULLY paid by 31st March, 2014, the account would have to be classified as an NPA for the financial year ending 31st March, 2014.


Posers??? A Ltd. Has availed Cash Credit facilities.

Interest for the quarter October-December, 2013 is Rs. 2,50,000/-. Credit during the quarter Rs. 2,45,000/-.

Interest for the quarter January-March, 2014 is Rs. 2,80,000/-.

Credits during the period January-March, 2014 are Rs. 2,79,000/-.

The Branch Manager requests for your valued opinion?


Cash Credit

Y Ltd has taken Cash Credit from a bank. Interest debited during the quarter January-March, 2014 is Rs. 50,000/-. No credits in the account for last quarter except one credit entry for reversal for excess charge of commission in the past for Rs. 51,000/-.

HOWZZZTHAT?????


Posers??? B Ltd. has a Cash Credit facility (based on

hypothecation of inventory and debtors). The sanctioned limit is Rs. 10 lacs. Drawing power is Rs. 7.5 lacs. Outstanding balance in the account is around Rs. 7 lacs for January-March, 2007. Your assistant has noticed that inventory statement includes dead stock of Rs. 3 lacs and statement of debtors includes non-realizable debtors of Rs. 2 lacs. Hence the actual DP is only Rs. 4.5 lacs. How would you classify the account?


Posers???

C Ltd. has CC facilities. The account is healthy and there are no outstanding overdue as at 31/3/2014. On verifying DP calculation, you notice that DP is worked out based on last available stock statement of August, 2013. The account is classified as a Performing Asset. Is it OK?


Posers??

D Ltd. again has CC facilities. It is a blue-chip company with strong Balance Sheet. The account is healthy with no overdue outstandings. The limit was due for review on October 1, 2013. However, the same could not be reviewed by 31/3/2014? The account is classified as a PA. How say you?


Posers???

Y Ltd. Is a chemical manufacturing concern. The unit is not in operation for 6 months. Inventory of Rs. 20 lacs is carried forward for last six months. Outstanding dues in CC account are Rs. 10 lacs. Account is fully serviced as at the Balance Sheet date. You have noticed that inventory of Rs. 15 lacs had expiry period of 120 days. How would you classify the account?


Posers???

H Ltd. Has CC facility of Rs. 100 lacs. The account is healthy. There is overdrawing in the account in the month of January by Rs. 10 lacs for 10 days. In the month of March the account is overdrawn by Rs. 15 lacs for the period 25th March, 2013 to 3rd April, 2014. How would you classify the account?


Posers??? Ram Ltd. and Laxman Ltd. are

sister(brother??) concerns. The account of Ram Ltd. has become NPA. The other account is Standard. Laxman Ltd. was sanctioned additional facilities as at the year end. Laxman Ltd. gave a loan to Ram Ltd. Out of the same, Ram Ltd. cleared its outstanding dues of the bank at the year end. Ram Ltd. is classified as Performing asset at the year end. Is it correct?


Posers???

M Ltd. is a healthy manufacturing unit with no overdue outstanding in either CC/TL/BPBD account. Fire takes place on 31/3/2024 and all the assets are destroyed. There is no insurance cover. Bank has classified the account as a Standard asset based on the norms. As an auditor, what is your call?


Posers??

In the case referred to in the previous slide, assume that the fire takes place on April 1, 2014. Would there be any change in your opinion with respect to classification of the said account as at 31st March, 2014?

What is the date on which the account would become NPA?


Bills Purchased/Discounted

X Ltd. Has facilities from Metro Bank Ltd. Cash Credit and Term loans are serviced regularly. Bills account is also regular except for one bill due on 29th December, 2013, which is overdue. How would you classify the various facilities of X Ltd?


Posers???

Bank of Vadodara is a listed bank. You are the branch auditor of the bank.

Borrower X has obtained loan against pledge of shares.

The list of shares pledged includes shares of Bank of Vadodara.

Is there any audit objection?


Posers???

Robert Ltd. Has availed loan from PQR bank. You are the auditor of the bank.

On scrutiny of the account of Robert Ltd., you notice that wife of the director of the bank has 26% stake in the company. However, she is neither director or employee of the company.

Is there any irregularity on the part of the bank?


Posers???

Loan granted against 10% Government of India security. Interest and installments of last two quarters not paid.

Manager has classified the account as NPA.

Interest has been accounted on cash basis.


Posers???

X has taken loan against his term deposits?/NSC’s/IVP’s/KVP’s and life insurance policies. Interest has remained overdue for 120 days as 31/3/2014. The branch has recognized the interest income on accrual basis. Is it correct? What would be the asset classification?


Posers???

Z Ltd. Is an NPA account (outs principle Rs. 50 lacs + Outs interest Rs. 25 lacs) It has paid Rs. 5 lacs during the year against its overdue loan. Bank has accounted the same as income for the year. Z Ltd. Had requested to settle the same against outstanding principle amount. What is your call?


Posers??

A Ltd. Has a CC facility with bank against inventory. Facility is for Rs. 50 lacs. Inventory is Rs. 100 lacs. Sundry creditors against goods are Rs. 50 lacs. Margin specified is 25%. What would be the DP?


Coverage Cash and Bank Balances. Money at call and Short Notice. Investments. Advances Other assets. Deposits and other liabilities. Profit and Loss Account. General. Specialized Branches.


Cash balance which vary significantly from the limit fixed by controlling authorities.

Excess balance reported to the controlling authorities.

Adequate Insurance Cover. Joint custody. Refer Instructions, Key Movement Register. Periodic checking of cash balance. Ascertain procedure and observe during

audit General scrutiny of cash book.

Cash


Balance confirmation. Report differences. Observations on differences.• Cash transactions remaining

unresponded (very serious observation).• Revenue items requiring adjustment /

write offs. (issue MOC / Qualify report)• Old outstanding balances remaining

unexplained and age wise analysis.

Balance with RBI, SBI and other Banks


Item requiring special attention of management.

Reconciliation not done / procedure not followed.

Material amount unadjusted for a long time.

Items affecting financial statements may be reported in the Statutory Report.

Balance with RBI, SBI and other Banks (cont’d)


Money at call and Short Notice

Report even if a single transaction. Confirm that the transaction is as

per the instructions/guidelines. Unauthorized deposits and excess

of authorized deposits to be reported.

Normally not applicable to branches.


Investments

Physical verification on behalf of H.O. Ensure that income earned on such

Investments is not accounted by Branch. Matured or overdue investments not

encashed. Guidelines of RBI for transaction and

valuation followed. Examine evidence of securities not in

possession of the branch. Generally not maintained at branch level.


Advances

Examination of all large advances and a test check of other advances

Questionnaire in four Broad categories Credit Appraisal Sanctioning / Disbursement Documentation Review / Monitoring / Supervision

Higher of advances exceeding Rs. 2 crores or 5% of the advances of the branch needs to be individually audited.


Credit Appraisal Opinion is sought on compliance of

Procedure / Instruction of controlling authorities

Whether loan application in prescribed format.

Whether intelligent appraisal done by competent person.

Adequate appraisal documentation. As per the old format required to report

on major shortcomings in credit appraisal.


Sanctioning / Disbursement

Credit facilities beyond the delegated authorities.

Are such cases promptly reported to higher authorities?

Verify control returns. Advances disbursed without compliance

of terms of sanction (give details) eg: Necessary funds not brought in by the

borrower.


Sanctioning / Disbursement (Cont’d)

Net worth of the guarantor not furnished.

Unit not inspected. End use of the funds not verified. Borrower continuing to have

operations with other Banks.


Documentation Instances of credit facilities released

without execution of all the necessary documents? Verify legal status. Government recognized status. Type of Loan. Securities.

Instances of deficiencies in documentation, non registration of charge etc., (give details)


Documentation (Cont’d) Some instances of deficiencies

Documents left blank. Overwriting in documents, change in hand

writing, incomplete documents. Joint documentation in case of consortium

advance. Documents inadequately stamped. Documents time bared.

Additional reporting requirement on advances against lien of deposits.


Review / Monitoring / Supervision

Periodic review of advances including balance confirmation / acknowledgement of debts etc. Analysis of such accounts overdue for review.

System of receipt of Stock / Book Debt and other statement and scrutiny thereof.

System of obtaining Stock Audit Report. Audited accounts as per RBI guidelines

from non corporate entities with limit beyond Rs.10.00 lacs.


Review / Monitoring / Supervision (Cont’d)

Physical verification of securities as per procedure laid down?

Deficiencies in value of securities, frequent / unauthorized drawings, inadequate insurance etc.

New clauses relating to lease finance activities and credit card dues.

Clauses relating to Prudential Norms. Clause relating to DICGC. (modified

formats)


Review / Monitoring / Supervision (Cont’d)

Compliance by Branch with Recovery Policy / in respect of Compromise / Settlements / Write off. Details of such cases where waiver / write

off >50 lacs.

Major deficiencies in credit review / monitoring / supervision.

New Clause relating to guarantee and letter of credit (clause 5 (e).


Other Assets

Stationery and Stamps. [Clause 6(a)] Comment on existence and

compliance with Internal control system over valued stationery with regard to issue and custody.

Instances of missing or lost items of stationery to be given (new clause).


Other Assets (Cont’d)

Suspense Accounts / Sundry Assets. Critically Scrutinize these accounts. Details and clarification in respect of old

unadjusted entries be obtained. Balances which in your opinion are not

recoverable. eg: Advance against travelling. Payment to merchant establishment. Legal expenses Dividend / Interest paid.


Other Assets (Cont’d)

Unusual items in these accounts be reportedeg: Cash in transit • Difference in balancing.• Difference in cash.


Deposits

Compliance with guidelines in respect of inoperative accounts.

Instances if not complied with the guidelines.

Seek clarification for unusual movements after balance sheet date.

Quantification of Overdue / Matured term deposits at the year end.


Bills Payable / Sundry Deposits / Contingent Liabilities

Details of old items to be reported. Unusual items and matured

withdrawals or debits to be reported along with their nature and amounts.

List of major items of contingent liabilities other than Guarantees, LCs, Endorsements, Acceptances etc.,


General

Proper maintenance of manual Books of Accounts.

In respect of Computerized Branches number of new areas prescribed.

Inquire about Banks policy Compliance of the policy Internal Control & Security measures. Backups and Disaster Recovery Plans


General (Cont’d)

Suggestions for the improvement in the system

Reconciliation of control and subsidiary records.


General (Cont’d)

Inter Branch Accounts, (Very Important area) Understand the system. Daily Communication to HO/Designated

cell statement of debit / credit transaction. Agreement between balance in HO

Account Branch Accounts. Old outstanding debits in the Head Office

Account.


General (Cont’d)

Expeditious compliance to communication from HO / Designated cell (Report unresponded entries).

Old / Large outstanding transaction at debits as at year end.

Audit and Inspection.


General (Cont’d)

Particulars of frauds discovered during the year together with your suggestions to minimize the same.

Window dressing to be reported eg. Large deposit at year end. Under utilised facilities converted

in Deposits. Unsecured loans shown as secured.


General (Cont’d)

Maintenance of Fixed Assets Records. Documents of title in relation to

branch Non compliance with Ghosh and

Jilani Committee recommendations.


GHOSH COMMITTEE RECOMMENDATIONS WERE FOR

Improvement in day to day administrative functions.

For ensuring safety of assets. Compliance with the let down policies

and procedures. Accuracy and completeness of

accounting and other records. Proper segregations of duties and

responsibilities of the staff. Timely prevention and detection of

frauds and malpractices.


Ghosh Committee Recommendations

Recommendations divided in to four groups

Group-A: Recommendations, which have to be implemented by the banks immediately.

Group-B: Recommendations requiring Reserve Bank of India’s approval.


Recommendations

Group-C: Recommendations requiring approval of Government of India.

Group-D: Recommendations requiring further examination in consultation with IBA.


JILANI COMMITTEE

Working group to review the internal control and inspection and audit system in banks.

Contains 25 questions and to indicate the answer as either “Implemented “ or Not Implemented”.


GILANI COMMITTEE RECOMMENDATIONS

Broadly divided into three categories Dealing with the EDP environment

in the banks. Dealing with the inspection/Internal

audit system in the bank. Dealing with other miscellaneous

aspects of functioning of a bank.

Thank you