Bank Audit

Identification of Non-Performing Assets by the Branch is a very crucial area where the Central Statutory auditors heavily depend upon the Branch Auditors. The Memorandum of Changes (MOCs) issued by the Branch Auditors are closely looked into by the Central Statutory Auditors. Appropriate notes and reports should accompany such MOCs, which will help the Central Statutory Auditors to take up the case appropriately with the management of the Bank for necessary provisions. Branch Auditors should know that there is neither time nor inclination on the part of the Bank Management to go back to the branch or circle or the Branch Auditor for further explanations in this respect. While looking into advances the Branch Auditors should identify weakness in the accounts, see drawing power calculations, non-regularisation of adhoc limit and genuineness of recoveries resulting into up-gradation of accounts. In a nut-shell, the Branch Auditors should be very vigilant where subjective judgment is required. Statutory Branch auditors should read Concurrent Audit Reports, Inspection Reports, Information System Review Reports, etc., to point out major weaknesses in internal controls so as to help Central Statutory Auditors to draft their LFAR. All this requires proper planning of audit and its meticulous execution. The Branch Auditors should always discuss the qualifications in various audit reports (Statutory, Tax, LFAR, Certificates) with the Branch Management so as to take a considered view into account before making such qualifications. However, Central Statutory Auditors expect the Branch Auditors to be completely impartial and not prone to any pressures while reporting their free and frank opinion.

Challenges before Central Statutory Auditors

The challenges before Central Statutory Auditors relating to Branch Audits are many. The first and the foremost is the quarterly limited review being done without any branch audit requirements. At the year end when the branches are under audit, as per the current policy of the RBI, the branch audit is necessary for those branches having advances of? 20 crore and above, only l/5th of the remaining branches

The role of the Branch Auditors is not only to do the
halance sheet audit of the branches allotted to them.

The Branch Auditors should understand the relevant
internal controls in the branch especially software
controls and manual controls.

and the business to be covered is to the extent of 90%. This virtually leaves 60% of the branches un-audited. Another problem faced is the Branch Auditors do not complete their work in time. Some of the Branch Auditors have very casual approach to the audit and therefore, quality of overall financial statements of the bank suffers. It is found in several cases that MOCs issued by the Branch Auditor are not well supported by facts and evidences. The Branch Auditors do not give proper explanations for MOCs given. The Branch Auditors do not write detailed explanation about their qualifications in various parts of reports and certificates. Branch Auditors do complain in private but do not contact their Central Statutory Auditors for difficulties faced by them during audit such as-MOC not allowed to be passed, data not available, no sitting arrangements, key staff on leave, statements not prepared and figures not available for completion of Tax Audit Report and LFAR, etc. ICAI has started the facility of answering online queries within 24 hours during the statutory audit period i.e. from 25th of March to 10th of April every year. However, most of the Branch Auditors do not take advantage of such a support system, thereby struggling in completion of their audit in time. Generally, no discussion is held with the Central Statutory Auditor by the Branch Auditors also for their very serious findings such as frauds. Many auditors do not write their observations in the Statutory Audit Report but state them only in LFAR or Tax Audit Report. The Central Statutory Auditors expects that all these pitfalls need to be avoided by the Statutory Branch Auditors while performing their duties.

Conclusion

There are huge expectations by the Regulator (RBI) from the Auditing Fraternity. The Branch Auditors are expected to work hand in hand with Central Statutory Auditors in completion of the task with the stamp of quality expected of the members of the Institute of Chartered Accountants. Therefore, it is imperative for all the Central Statutory and Branch Auditors to work in tandem for keeping the flag of ICAI flying high. ■

 

Bank Audit

Conducting Bank Branch Audit in CBS Environment

Bank branch audits are one of the significant segments of chartered accountants’ audit practice. The increased technology adoption by the banks during last decades has created both challenges and opportunities for the auditors. While the branch auditor cannot be expected to be an IT’s maestro, ignorance to the existence of IT system cannot be afforded too. To obtain understanding of bank’s IT system and controls, the auditor seeks assistance from system experts and designated bank officials. Then, he is also required to use computer assisted auditing tools to conduct the audit function efficiently. Further, computerised processing, although highly dependable and reliable, cannot be always considered as an assurance to accuracy. Auditor shall have to perform sufficient audit procedures and use his professional judgments for qualitative discharge of his professional duties. As the bank branch audits are approaching soon, the author, through this article aims to provide the reader an insight to the basic understanding of core banking system, the challenges before the auditor and the critical areas of focus while performing audit under CBS environment.

Introduction
Most of the banks have moved to CBS environment. What was earlier the prerogative of the private sector banks and large public sector banks is filtered down to the large co-operative banks, district level co-operative banks and small co-operative banks. Sometimes mere payment clearing system of the clearing house becomes a trigger move to a CBS environment to ensure that electronic transfer by the clearing house automatically reaches the account holder. All persons exposed to the branch like its depositors, borrowers

Expectations of Central Statutory Auditors from Bank Branch Auditors

Audit of Banks is a very challenging taskfor Chartered Accountants. Banks in India also work in a vastly controlled environment where the Reserve Bank of India (RBI) is managing the Banking Sector through Notifications and Circulars. In the past, many banks used to have the meeting of Central Statutory Auditors with Branch Auditors of various Regions. Ihe quality of reporting by the branch auditors was expected to be substantially improved by this exercise based on which the Long Form Audit Report was issued by the Central Statutory Auditors regarding their impression on the overall working of the bank. There are huge expectations by the Regulator (RBI) from the Auditing Fraternity. The Branch Auditors are expected to work hand in hand with Central Statutory Auditors in completion of the task with the stamp of quality expected of the members of the Institute of Chartered Accountants (ICAI). Therefore, it is imperative for all the Central Statutory and Branch auditors to work in tandem for keeping the flag of ICAIflying high.

Introduction

Audit of Banks is a very challenging task for Chartered Accountants. The Banks work with highly technology driven platform such as Core Banking Solutions. Banks in India also work in vastly controlled environment where the Reserve Bank of India is managing the Banking Sector through

CA. Shriniwas Y. Joshi

(The author is a member of the Institute. He can be reached at syjoshi@cvk-ca.com).

Notifications and Circulars. RBI is micromanaging not only procedures and practices of the banks’ business, but even their profitability by directing the minimum provisioning to be made against the stressed assets. The RBI micromanages banking in India not only by stating what is to be done, but by also insisting on how it is to be done.

Every auditor should know its customer as per the requirement of Auditing Standards. Currently, the banks have challenges in keeping the cost of operation low (which is done by increase in current account and saving account balances i.e., CASA), to keep the Non-performing assets in limit (which is done by way of Debt Restructuring), to check

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1 Readers are invited to send their comments on the selection of cases and their utility at eboard@icai.in. For fall judgment, write to eboard@icai.in 74 THE CHARTERED ACCOUNTANT MARCH 2015                                                                                                                                                                                                                                               www.icai.org

 

Presentation of Write-Back of Provisions No Longer Required in the Statement of Profit And Loss

 

Facts of the Case

  1. A public sector company under the Ministry of Steel, Government of India, is primarily engaged in rendering design & engineering, technical consultancy, and project management services for various clients in India and abroad. The company is also executing Engineering, Procurement and Construction (EPC)/turnkey projects involving supply of equipment, erection, commissioning etc. for various clients/projects. As a part of financial and business restructuring, the core business activities of the company have been divided into four Strategic Business Units (SBUs), namely metal, power, oil & gas and infrastructure. These four segments have been disclosed as primary business segments as per the requirements of Accounting Standard (AS) 17, ‘Segment Reporting! The primary objectives of these SBUs are to focus on procurement and execution of jobs in the above fields. The nature of activities of the company is diverse and flexible depending upon various factors like global business scenario, economic policy of the Government, investment decision, and corporate strategy.
  2. The querist has stated that as per revised Schedule VI to the Companies Act, 1956, in the statement of profit and loss, total revenue is divided under two heads, e., ‘Revenue from Operations’ and ‘Other Income! In respect of a company other than a finance company, revenue from operations is sub-divided into three heads namely sale of products, sale of services and other operating revenue. Other income is sub-divided into interest income, dividend income, net gain/loss on sale of investment and other non-operating income. It is important to understand the meaning of the term ‘other operating revenue’ and which items should be classified under this head vis-a-vis under the head ‘other income! The Guidance Note on the Revised Schedule VI to the Companies Act, 1956, issued by the Institute of Chartered Accountants of India (ICAI), inter alia, states that the term ‘other operating revenue’ is not defined. However,
    these include revenues arising from the company’s operating activities. Whether a particular income constitutes ‘other operating revenue’ or ‘other income’ is to be decided based on the facts of each case and detailed understanding of the company’s activities (emphasis supplied by the querist).
  3. The querist has also reproduced the relevant extracts of accounting policy of the company as follows (refer Note 32 of the financial statements of the company for the year 2012-13):

“Use of Estimates

In preparing the financial statements in conformity with accounting principles generally accepted in India, the company makes best estimates and assumptions that may affect the reported amount of assets and liabilities and the disclosure of contingent liabilities as at the reporting date and the amount of revenue and expenses during the reporting period. Actual result in some cases may differ from those estimates. Any revision of such estimates is recognised during the period in which the same is determined.”

“Provision for Contractual Obligations/LD, etc.

  • Provisions for estimated liabilities on account of guarantees & warranties in respect of Engineering & Consultancy Services and Turnkey Contracts are made by the company after assessment of risk and consequential probable liabilities on case to case basis.
  • Provisions for liquidated damages are made as and when these are deducted and/or considered deductible by the client as per contract.
  • Suppliers’/contractors’ claims for price escalation, additional or extra claims, are accounted for to the extent such claims are accepted by the company.”
  1. Accounting treatment/ practice followed by the company has been stated by the querist as follows:

♦ Each and every job being distinct and

 

Opinion

different in nature is allotted a specific work item number (chargeable) from the date of commencement of job. Each and every job being executed for client is part and parcel of the company’s operating activities and source of revenue. The company has divided revenue from operations into three items namely revenue from consultancy services, revenue from construction contracts and other operating revenues (refer Note 23). Revenue from consultancy services and revenue from construction contracts are recognised as per the accounting policy of the company. In the course of execution of jobs/operating activities of the company, the company is making various provisions for expenditures out of contractual obligations as per the requirement of contracts with various sub-contractors/vendors/clients etc. Further, the company is also making provisions as per the requirement of applicable Accounting Standards /accounting practices as the case may be.

Broadly, the company has classified the expenditure as ‘operating expenditure’ and ‘non-operating expenditure! Accordingly, expenses incurred in relation to work items (chargeable) are treated as operating expenses and expenses incurred not in relation to any work item (chargeable) are treated as non-operating expenses keeping in mind the nature of activities of the company. However, the revised Schedule VI has not categorically classified any expenditure as either ‘operating expenditure’ or ‘non- operating expenditure!

Provisions for contractual               obligations/

expenses and other provisions, which are related to work items (chargeable) and which are related to operating activities, are part of operating expenses (Refer Note 25 and Note 30 of the financial statements of the company for the financial year (F.Y.) 2012- 13). Provisions for contractual obligations/ expenses, provisions for bad & doubtful debts, provisions for liquidated damages recovered by clients, provisions for claims recoverable from clients, provisions for advances recoverable from clients etc., which are related to work items (chargeable) and which are related to operating activities, are reviewed periodically and reversed in the
accounts on case to case basis as and when these provisions are no longer required to be carried in the balance sheet. Therefore, such provisions no longer required and written back which are related to work items and related to operating activities are treated as part of ‘other operating revenues’ considering the nature of activities of the company and also in the ordinary course of business of the company. For instance, trade receivable is essentially recognised as amount to be realised from goods sold or services provided to the particular client in the normal course of operation. Hence, writing back of provision against trade receivable with specific work item number is also shown as ‘other operating revenues! Considering the nature of activities/business profile of the company, same logic is applied for similar items of provisions written back which are related to work items and related to operating activities and, therefore, are shown under ‘other operating revenues’ as a matter of prudent accounting practice consistently followed by the company.

Provisions for salary and wages, provision for employee related expenses, provision for various administrative and office expenses of general nature which are not related to any work item (chargeable) are treated as non­operating expenses (Refer Note 27 and Note 30). Such provisions which are not related to work items (chargeable) are reviewed periodically and reversed in the accounts on case to case basis as and when these provisions are no longer required to be carried in the balance sheet. Therefore, such provisions no longer required and written back which are not related to work items are shown as ‘other non-operating income’ under the head ‘other income’ (refer Note 24) as a matter of prudent accounting practice consistently followed by the company.

As per the annual accounts of the company, Note 25 ‘Purchase of Equipments and Direct Expenses’ represent operating expenses only, Note 27 ‘Employee Benefit Expenses’ represent non-operating expenses only and Note 30 ‘Other Expenses’ represent operating expenses and non-operating expenses both. As per Note 30, provision for bad & doubtful

 

 

 

 

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Opinion

 

 

 

 

debts, provision for liquidated damages recovered by clients, provision for claims recoverable from clients, provision for advances recoverable from clients, provision for doubtful deposits etc. which are related to work items (chargeable) and related to operating activities of the company are items of operating expenses. On the other hand, rent, rates & taxes, repairs & maintenance, audit fees, advertisement & publicity, legal & professional fees, postage & telephone, power & fuel etc. which are not related to any work item (chargeable) are items of non­operating expenses.

  • To sum up, in compliance with the requirements of revised Schedule VI, provisions written back related to work items (chargeable) are shown as ‘other operating revenues’ under the head ‘revenue from operations’ and provisions written back not related to work items (chargeable) are shown as ‘other non-operating income’ under the head ‘other income’ in the statement of profit and loss as a matter of prudent accounting practice consistently followed by the company.
  1. Query
  2. The querist has sought the opinion of the Expert

Advisory Committee of the ICAI on the following

issues:

  • Considering the nature of activities of the company, whether the company is correct to present and disclose provisions no longer required and written back which are related to work item numbers (chargeable) and related to operating activities as ‘other operating revenues’ under the head ‘revenue from operations’.
  • Considering the nature of activities of the company whether the company is correct to present and disclose provisions no longer required and written back which are not related to work item numbers as ‘other non­operating income’ under the head ‘other income!
  • Whether the company can continue to follow the above accounting treatment and the above presentation and disclosure as required under revised Schedule VI to the Companies Act, 1956 or Schedule III to the Companies Act, 2013 as applicable.
  • If not, what alternative accounting entry should be passed in the accounts and what presentation and disclosure should be made by the company as required under the Companies Act and Accounting Standards as applicable.
  1. Points considered by the Committee
  2. The Committee notes that the basic issue raised by the querist relates to the presentation and disclosure of write back of provisions no longer required in the financial statements. The Committee has, therefore, considered only this issue and has not examined any other issue that may arise from the Facts of the Case, such as, propriety of classification of expenses including provisions into operating and non-operating, whether accounting policies of the company with regard to use of estimates and recognition of provisions are in conformity with Accounting Standards, The Committee while expressing its opinion has dealt only with the broad principles regarding presentation of write back of provisions and has not gone into the presentation of each provision being recognised by the company.
  3. The Committee notes the following paragraphs of Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’ and Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’:

AS 29

“10.1 A provision is a liability which can be measured only by using a substantial degree of estimation?

“Measurement Best Estimate

  1. The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date…?

“Changes in Provisions 52. Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision should be reversed?

 

Opinion

AS 5

“Changes in Accounting Estimates

  1. As a result of the uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. The estimation process involves judgments based on the latest information available. Estimates may be required, for example, of bad debts, inventory obsolescence or the useful lives of depreciable assets. The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability.
  2. An estimate may have to be revised if changes occur regarding the circumstances on which the estimate was based, or as a result of new information, more experience or subsequent developments. The revision of the estimate, by its nature, does not bring the adjustment within the definitions of an extraordinary item or a prior period item.”

“25. The effect of a change in an accounting estimate should be classified using the same classification in the statement of profit and loss as was used previously for the estimate.

  1. To ensure the comparability of financial statements of different periods, the effect of a change in an accounting estimate which was previously included in the profit or loss from ordinary activities is included in that component of net profit or loss. The effect of a change in an accounting estimate that was previously included as an extraordinary item is reported as an extraordinary item.”
  2. From the above, the Committee notes that the provisions are measured at the best estimate of the expenditure which may be required to settle the present obligation at the balance sheet date and the same should be reviewed at each balance sheet date and adjusted to reflect the current best estimates. Accordingly, any change in the amount of the provision including write-back of earlier provision no longer required is a change in estimate, which should be treated in accordance with the requirements of AS 5. With regard to classification of the effect of change in accounting estimates, AS 5 prescribes that the effect of a change in an accounting estimate which was previously included in the profit or loss from ordinary activities is included in that component of net profit or loss.

Accordingly, in the extant case, the Committee is of the view that where, in an accounting period, there is any write-back of the earlier recognised provision for a liability and a provision for the same item is also being recognised in that accounting period, the write-back should be adjusted in arriving at the amount of that provision, i.e., only the net amount after adjustment of the write-back should be charged/credited to the statement of profit and loss. However, where, in an accounting period, there is only write-back of the earlier recognised provision and no provision is being recognised, the write-back should be recognised as income in the statement of profit and loss using the same classification as was used previously. For example, reversal on account of provision for warranties created during the earlier years is ?20 and ? 100 is required for providing for warranties in respect of sales effected in the current year on account of provision for warranties. In such a case, write­back of ?20 should be adjusted to ? 100 and ?80 (? 100-^20) should be recognised as provision for warranties in the statement of profit and loss for the current year. Where no provision is required to be recognised for the current year on account of provision for warranties, write-back of ?20 should be recognised as income. The Committee notes from ‘Note No. 36.9- Particulars of Provision’ to the financial statements of the company for the F.Y. 2012-13 that in respect of provisions, for example, in respect of ‘provision for claims recoverable) the company is not adjusting the write-back of provisions in the amount of provisions recognised in the statement of profit and loss for the current period. Accordingly, the Committee is of the view that the company’s presentation policy to that extent is not correct.

  1. The Committee further notes that although revised Schedule VI to the Companies Act, 1956, requires incomes to be classified into operating and non-operating, such an explicit classification is not specified for expenses. Accordingly, the Committee is of the view that if the provision was earlier classified as ‘other expense’, the reversal should be classified as other operating income or non-operating income keeping in view the fact that whether the provision pertains to an item which is operating in nature or non-operating in nature considering the business and nature of the activities of the company.
  2. With regard to the disclosure of write-back of the excess provisions no longer required,

 

[Opinion

 

 

 

 

1 The Opinion is only that of the Expert Advisory Committee and does not necessarily represent the Opinion of the Council of the Institute.
2 The Opinion is based on the facts supplied and in the specific circumstances of the querist. The Committee finalised the Opinion on May 1,2014. The Opinion must, therefore, be read in the light of any amendments and/or other developments subsequent to the issuance of Opinion by the Committee.
3 The Compendium of Opinions containing the Opinions of Expert Advisory Committee has been published in thirty two volumes. A CD of Compendium of Opinions containing thirty two volumes has also been released by the Committee. These are available for sale at the Institute’s office at New Delhi and its regional council offices at Mumbai, Chennai, Kolkata and Kanpur.
4 Recent opinions of the Committee are available on the website of the Institute under the head ‘Resources!
5 Opinions can be obtained from EAC as per its Advisory Service Rules which are available on the website of the ICAI, under the head ‘Resources! For further information, write to eac@icai.in.

 

the Committee notes the following paragraph of AS 29:

“Disclosure

  1. For each class of provision, an

enterprise should disclose:

  • the carrying amount at the beginning and end of the period;
  • additional provisions made in the period, including increases to existing provisions;
  • amounts used (i.e. incurred and charged against the provision) during the period; and
  • unused amounts reversed during the period.

n

The Committee further notes Clause (b) of Note 5(v) of the ‘General Instructions for Preparation of Statement of Profit and Loss! of revised Schedule VI to the Companies Act, 1956, as well as, Schedule III to the Companies Act, 2013, which is reproduced as below:

“5. Additional Information A Company shall disclose by way of notes additional information regarding aggregate expenditure and income on the following items:-

  • (a)…

(b) The aggregate, if material, of the amounts withdrawn from such provisions, as no longer required.”

On the basis of the above, the Committee notes that in addition to the presentation requirements discussed in paragraphs 8 and 9 above, the company should give disclosures as per paragraph 66 of AS 29 and above reproduced requirements of revised Schedule VI to the Companies Act, 1956, or Schedule III to the Companies Act, 2013, as applicable.

  1. Opinion
  2. The Committee is of the following opinion on the issues raised by the querist:

(i) & (ii) The Committee is of the view that where, in an accounting period, there is any write-back of the earlier recognised provision for a liability and a provision for the same item is also being recognised in that accounting period, the write-back should be adjusted in arriving at the amount of that provision, i.e., only the net amount after adjustment of the write-back should be charged/credited to the statement of profit and loss.