II.

AUDITING PRACTICES

TYPES OF AUDITING DONE IN A LARGE BRANCH

Introduction A well-organized and efficient banking system is a pre-requisite for economic growth. Banks play an important role in the functioning of organized money markets. Presently, there are four types of banking institutions in India. These are:

Commercial banks Regional rural banks Co-operative banks Development banks (more commonly known as term-lending institutions)

What Is An Audit? Audit is an independent examination of financial statements of an entity that enables an auditor to express An opinion whether the financial statements are prepared (in all material respects) in accordance with an identified and acceptable financial reporting framework. (E.g. international or local accounting standards and national legislations)

Why Is There A Need For An Audit? The problem that has always existed at the time when the manager reports to the owners is that: whether the owners will believe the report or not? This is because the reports may: a) b) c) d) e) f) Contain errors Not disclose fraud C. Be inadvertently misleading be deliberately misleading Fail to disclose relevant information Fail to conform to regulations

Objectives of Auditing There are two main objectives of auditing. The primary objective and the secondary or incidental objective are :

a) Primary objective as per Section 227 of the Companies Act 1956, the primary duty (objective) of the auditor is to report to the owners whether the balance sheet gives a true and fair view of the Companys state of affairs and the profit and loss A/c gives a correct figure of profit of loss for the financial year. b) Secondary objective it is also called the incidental objective as it is incidental to the satisfaction of the main objective. The incidental objective of auditing are: 1. Detection and prevention of Frauds, and 2. Detection and prevention of Errors.

The International Auditing Practices Committee (IAPC) of the International Federation of Accountants (IFAC) issues standards (ISAs) on generally accepted auditing practices and on related services and on the form and content of the auditors reports. These standards are intended to improve the degree of uniformity of auditing practices and related services throughout the world. The purpose of this Statement is to provide additional guidance to auditors by amplifying and interpreting these standards in the context of the audit of international commercial banks. It is not, however, intended to be an exhaustive listing of the procedures and practices to be used in such an audit. Banking System is the backbone for the development of any country. Well developed and organized banking system provides suitable system for the development of organized money markets. Banks act as vehicle for mobilizing funds on one hand and distributing the same to productive channels on the other hand. Types of Bank Audit: Normally there are five types of bank audits. i. ii. Statutory Audit Revenue Audit / Income and Expenditure Audit

iii. iv. v.

Internal Audit / Inspection RBI Audit Concurrent Audit

Statutory Audit: A statutory audit is essentially a balance sheet audit. It is annual audit as determined by the statute. It is conducted within a month of the end of the financial year. Briefly the statutory audit involves the following functions: To ensure correct placement of various items in the balance sheet. To certify that the classification of assets has been done as per the guidelines issued by the Reserve Bank of India from time to time Preparation of long form audit report and other reports as required by RBI. Ghosh & Jilani Committee Recommendation are Implemented Scope of Statutory Audit i. Branch Level:

Normally banking business is carried out at branch level. Banking business means receiving deposits and granting advances. Branch auditors are required to verify the balance sheet, profit and loss account and all other transactions. Branch auditors are required to submit their report to the Central Auditors. In case of branches whose financial statements are not subject to audit, all the financial statements are to be sent to the head office for the purposes of consolidation at the head office level. ii. Head Office:

At the head office level, generally administrative functions are carried out and policy matters are framed. Branch balance sheet, profit and loss account, etc., are consolidated into head office

accounts at the head office level. Central Statutory Auditors are required to verify consolidation of branch accounts and their incorporation in the head office accounts. iii. Revenue Audit:

In the revenue audit the auditors job is confined to the checking of the Income & Expenditure accounts of the branch with a view to ensure that there is no revenue leakage, or incurring of extra expenses or any loss of revenue has been caused to the bank because of excess payment of interest, etc. Under payment or short payment of interest is also a disservice to bank's customers and should not be encouraged in the staff, as such the same is also equally important to be reported. Briefly Revenue Audit involves the following functions:

Checking of Interest on Advances: The main source of revenue of a bank is income from interest on loans and advances. A revenue auditor should check the interest calculation in depth while leaving a smaller margin for selective checking. Following areas should be checked while checking interest. The auditor should ensure that interest is charged in accordance with the circulars issued by the Head Office. Normally, product sheets are generated by computer systems. Auditor should check the products of few accounts manually with the products generated by the computer system. The auditor should ensure that Penal Interest has been properly charged to the borrower accounts where there are irregularities. Penal Interest is charged by the banks for the following irregularities: i. Non / late submission of stock statements, Quarterly Information Statement, Monthly Select Operational Data (MSOD), Audited Balance sheet. ii. iii. iv. Non submission of details for review / renewed of accounts. Overdue Installments and Overdrawn accounts. For Violation of other terms and conditions.

Branch can waive the penal interest by taking appropriate approval from the higher authorities.

 Checking of Interest on Deposits: i. ii. Ensure that interest rate on deposits is as per the circulars issued by Head Office. Ensure that computer system properly calculates the monthly products in case of saving account. iii. In case of pre-matured term deposits ensure that rate of interest is properly calculated and penal interest is deducted as per the rules of Head Office. iv. Excess/short payment of interest are to be reported. Allowing of concessional or higher rate of interest to the Staff: The allowing of concession in charges or interest or higher rate of interest in Deposit to the staff should be properly checked to ensure that the staff is paid or charged interest for which they are entitled according to the policy of the bank. Discrepancy should be reported. Checking of Commission/charges: Another source of revenue to a bank is commission. The auditor should verify the following commission/charges and ensure that they are being collected as per the latest circular issued by the Bank. Different sources of Commission / charges are as follows: i. ii. iii. iv. v. vi. vii. viii. ix. x. xi. xii. xiii. xiv. Demand Draft Commission Pay Order Commission Demand Draft Cancellation charges Cheque Book Issue charges Cheque Return charges Commission on Outward Bills for Collection. Account close charges in case of SB and Current A/c. Minimum balance charges Ledger fees Bank Guarantee commission L/C commission Process charges Agreement charges Visit fees

Any other charges / commission as required by the Head Office Circular should also be checked and reported. Any refund of interest, commission and charges needs approval of higher authorities. Checking of Expenses: During verification of expenses auditor should comment on the following points: The auditor should ensure that all the expenses incurred have been properly authorised. The authority sanctioning should have proper discretionary power. Timely payment of expenses Test checking of calculation of Overtime salaries paid. Reimbursement of expenses is properly supported by vouchers / bills. Procedure laid down by the bank is followed i.e. obtaining quotations for rates, etc. All other expenses which are unusual in nature should be vouched and verified along with the sanction of the controlling authority. iii. Internal Audit / Inspection: Internal audit / inspection is done either by the staff of the audit department or by the office of the bank higher than the unit / branch audited or by Chartered Accountants reporting to the audit department. However, the responsibility is that of audit department. To ensure relative security of the assets of the bank, the RBI recommends a high frequency of internal inspection and this act of the banks is reviewed by RBI. The highest coverage of audit is under this category. The responsibility of revenue audit lies with the internal auditor and test check of revenue calculation is not uncommon even if the same was earlier covered by a revenue auditor. Safety of advances is the other main function of internal auditor. Every bank has its own scope and formats for verification and Reporting. iv. Reserve Bank of India Audit (RBI Audit): Section 35 empowers RBI to inspect books and accounts of a banking company. For inspection of banks, the Central Bank sends its own auditors. The thrust and emphasis of RBI audit is a bit different. The aim of the audit is to assess the overall position of the assets and liabilities of a

bank to ensure that its financial position is satisfactory and it is in a position to pay its depositors in full as and when their claims accrue and it has sufficient cushion of owned funds to safeguard the interests of depositors in the event of loss. Policies and procedures of the bank are also assessed to ensure that they are sound; they are on approved lines and are in conformity with socio-economic objectives. Effectiveness of the management to safeguard the interests of the depositor and control and supervision of the Head office over the branches is also assessed. v. Concurrent Audit: Concurrent Audit means checking of day to day transactions. The concurrent auditor's main task is to check the correctness and accuracy of the voucher and documentation. Functions of the concurrent auditor: Functions to be performed by the concurrent auditors are stated in the guidelines / scope issued by the bank. Scope or guidelines are of two types i.e. Specific Scope: In case of specific scope the auditor will have to strictly follow the format and cover the areas as required by the scope. However the auditor can report on the areas which are not required by the scope if they are material in nature. General Scope: In case of general scope the auditor is required to cover all the areas. He has to report on the irregularities observed by him during the course of audit. Following are the areas, which are commonly found in the scope/guidelines issued by almost all the banks: i. Cash Verification: Surprise verification of Cash Bundles of the cash should be properly stitched Cash Retention Limit All the Registers relating to cash should be properly maintained.

 Procedure of exchanging and disposing of mutilated notes should be followed. Other Details such as Minimum balance, Maximum balance, Average balance, range of fluctuation, etc. ii. Tokens: Physical Verification Token register properly maintained. Correspondence of tokens received from Head Office Missing Tokens Intimation to Head office and it is prominently displayed in cashiers cabin. iii. Postage Stamps and Stamped Documents/Adhesive Stamps: Physical Verification Unusable or under stamped/torn stamps. Stale Stamped Documents should also be reported. Safe custody. iv. Sensitive Stock (DD stock, pay order, cheque book stock, F.D. receipt, etc.): Physical Verification. Instruments should be kept in lock and key. Periodical verification should be carried out by the bank officials. Non usable stock should be reported. v. Security Alarm:

Verify that security alarm is properly working or not Opening of and operations in Deposit Accounts: i. Know your customer (KYC) & prevention of Money Laundering Act (PMLA) norms are fulfilled. ii. Account Opening forms: 100 % checking of account opening forms. Proper Account opening forms are used for appropriate accounts. Form should be completely filled up. Photograph of the Depositor. Photo ID Proof of operator

 Residential proof. Proper Introduction. Partnership Firm - Partnership deed. Companies - MOA, AOA, Resolution. Resolution in bank's format. Specimen signature - scanned and proper maintenance. Authentication by Bank Official. Copy of P.A.N. card or Declaration in Form No. 60/61. iii. Operation in deposit accounts: Operation in newly opened accounts to be verified for large deposits and withdrawals. iv. Debit balances in savings and current accounts: Reasons for debit balance. Payment of statutory dues. Payment of LIC, Telephone, Electricity, Credit Cards etc. in the accounts should be properly authorized. v. Issue of Cheque Books: Proper procedure is followed for issue. Proper charges collected. Registers maintained. Necessary precautions for delivery of cheque book to third persons. Stocks are kept in Lock and key. vi. Nomination: Appropriate Nomination forms for Deposits, Lockers etc. is to be verified. Nomination registers is maintained and updated. Signature of person making nomination to be verified. vii. Stop Payment Instructions: Instructions to be received in bank's format Letters are properly filed and duly authenticated. Signature is duly verified.

 Stop payment register is maintained and updated. Proper charges are collected.

viii.

Cheque return register: Cheque return register is maintained and updated. Collection of charges.

ix.

Voucher Verification:

All vouchers are properly prepared and authorized. Daily summary sheets are verified with vouchers. Daily Summary sheets are signed by the officer verifying the same with vouchers. Vouchers are stitched, bundled, and properly stored. Printed flap at the top of the bundle containing details like Date, no. of debit vouchers, no. of credit vouchers along with signature of the person scrutinizing the vouchers is done. Missing vouchers are identified and entered in the missing voucher register. Missing vouchers should be traced or duplicate vouchers are prepared. Details of the same should be entered in the missing voucher register. x. Safe Deposit Lockers: Locker application are properly obtained and stamped as required. Branch maintains access visit register. Letters for surrender of locker are properly verified. Changing of locks when lockers are surrendered and reissued. Locker rent register for rent dues are properly maintained. Deposit amounts are obtained as per Head Office circulars. Notices are affixed on lockers and hirer should not be given access to locker if the locker rent are in arrears. Advances: Verification of advances is an important area during the course of audit. All pre-sanction and post sanction formalities issued by Head Office are properly followed. Following are the general points to be verified: Pre-sanction Formalities:

 Loan application is properly filled up. Photograph, Address Proof, Latest Income Proof of the Borrower and Guarantor is obtained. Income of the Borrower and Guarantor is adequate as per the laid down norms. Documents obtained are verified from originals. Bank Account statements for last six months are obtained. MOA/AOA in case of Companies and Partnership Deed in case of Partnership Firms are obtained. Credit Reports from Borrowers Bank is obtained. Sanctioning and Disbursement: Sanction Note is on record. Sanction Note contains factual information as contained in the supporting documents Observations of the auditor mentioned in the Audit Report and Notes on Accounts affecting credit decision is brought on record. Ratification of sanctioned loan is obtained from appropriate authority. Adhoc limits are ratified by the higher authorities. Stamped receipt in original is held on record. Computer Master Printouts are generated, checked and held on record.

xi.

Rate of Interest applied is as per sanction.

xii.

In case of Project Loans, Periodic Investment done by the Promoters and certified by the chartered accountant/architects is obtained.

xiii.

Originals Bills/receipts in case of project loan disbursement is on record.

Documentation: All prescribed security Documents like Demand Promissory Note, Deed of Hypothecation, Letter of Guarantee, Mortgage Deeds etc. are obtained. All the documents are properly filled up.

 All the documents are duly signed by the Borrower. Letter of Guarantee is duly signed by the Guarantor. All the documents are properly stamped. Documents are verified by the officer of the Bank. In case of big advances the said documents are to be vetted by the legal department of the Bank or Banks empanelled advocates All the Documents obtained are entered in the Security Register. Documents required to be obtained along with the Recording Letter are obtained and held on record. (Equitable Mortgage) Mortgage is created for sanctioned amount. Creation of security: Equitable mortgage stipulated as principal security is created Equitable mortgage stipulated as Collateral security is created Stock and debtors statement is obtained and verified by the branch before making first disbursement Registration of Banks charge: Banks charge is registered with ROC within 30 days from the date of disbursement. Verification of Specific Loans and Advances: i. Clean Advance:

All the advances which are not secured by any legally enforceable tangible security or by of surety / sureties are classified as clean advances. Normally clean advances are not encouraged. Temporary overdraft in saving/current A/c. up to a certain limit can be allowed. Reasons for such overdrafts should be scrutinized and the account should be regularised. Personal Loans (Secured/Unsecured):

Purpose of such loans: House Repairs, Medical Expense, Marriage, Purchase of new house, Vehicle, computers, etc. Following points should be ensured while verifying Personal Loans: Details such as Name of the borrower, Sanctioned Limit, Facility, Sanctioning authority, Sanction Date, etc. are taken on records. Loan has been sanctioned by appropriate authority having the powers to sanction the same. Process fees and agreement charges are properly collected. Application Letter and Sanction letter are on records. Letter of Acceptance of terms and conditions is signed by the borrower/s and the guarantors. All the necessary documents (i.e. Drawing Power Note, Loan Agreement, Letter of Guarantee, etc.) are on records All the documents should be properly filled up, stamped, and signed. Stamp Receipt and Invoice are on records. Insurance for Prime security and collateral security is on record and the policy is assigned in favour of the bank. In case of Home Loan Visit Report, Title Report and Legal opinion report is on record. In case of Home Loan Equitable Mortgage is created and No Objection Certificate from the society for creating and registering charge is on record. Any other terms and conditions of the sanction is complied.

Term Loans: Term loans are sanctioned for the purchase of machinery, land and building, etc. and it may be sanctioned for a period of 3 years or 5 years or more. The repayment should be done in fixed installments already calculated at the time of sanction. Following points should be ensured while verifying Term Loan accounts: Details such as Name of the borrower, Sanctioned Limit, Facility, Sanctioning authority, Sanction Date, etc. are on records.

Loan has been sanctioned by the appropriate authority having the powers to sanction the same. Application Letter and Sanction letter is on record. Letter of Acceptance of terms and conditions is signed by the borrower/s and the guarantors. All the necessary documents (i.e. Drawing Power Note, Loan Agreement, Letter of Guarantee, etc.) are on records All the documents are properly filled up, stamped and signed. Process fees and agreement charges are collected

Industrial and Business loans: Cash Credit: Cash Credit limit is sanctioned for day to day business transactions. Following points should be ensured while verifying Cash Credit accounts: Details such as Name of the borrower, Sanctioned Limit, Facility, Sanctioning authority, Sanction Date, etc. is on records. Loan has been sanctioned by the appropriate authority having the powers to sanction the same. Application Letter and Sanction letter should is on records. Letter of Acceptance of terms and conditions is signed by the borrower/s and the guarantors. All the necessary documents (i.e. Drawing Power Note, Loan Agreement, Letter of Guarantee, etc.) are on record. All the documents are properly filled up, stamped and signed. Process fees and agreement charges are properly collected. Drawing Power is properly calculated. Value of Security.

Stock Statements: Received in time In banks format and completely filled up Bifurcation of Debtors above and below 90 days is given Old and obsolete items of stock are excluded. Penal interest is charged for non/late submission of stock statements. In case of Companies, Charge is created with the Registrar of companies (ROC) by filing Form No.8 and 13. Mortgage Deed is executed for properties obtained as collateral Securities. Periodical Visits are carried out by the bank officials. Any other terms and conditions of the sanction are complied.