Audit of Banks, NBFCs and Public Sector Undertakings — Practice

Question 1

A bank's loan account becomes overdue for more than 90 days on 1 April 2025, triggering NPA classification. Determine the classification of this asset (sub-standard or doubtful) as at 31 March 2026 and as at 31 March 2027, explaining the sequential logic involved.

Accepted Answer

The asset becomes an NPA on 1 April 2025 and is initially classified as sub-standard, since a sub-standard asset is one that has remained an NPA for a period not exceeding 12 months from the date it was first classified as an NPA; as at 31 March 2026, exactly 12 months (or just under) from the NPA classification date, the asset remains classified as sub-standard, since this period has not yet exceeded 12 months. As at 31 March 2027, the asset has now remained in NPA status for 24 months since 1 April 2025, meaning it has been in the sub-standard category for a period exceeding 12 months (specifically, having crossed the 12-month sub-standard threshold on 1 April 2026, it has now been sub-standard, and beyond, for a further 12 months), triggering reclassification to doubtful; the key sequential point is that doubtful classification is defined and measured from the date the asset first became sub-standard (1 April 2026, when the 12-month sub-standard period was crossed), not directly and independently from the original NPA classification date, meaning the asset must genuinely pass through, and remain in, the sub-standard category before it can become doubtful, rather than the two thresholds being computed as two independent, parallel countdowns from the same original NPA date.

Question 2

A bank has three advances: Advance A, standard, outstanding ₹500 lakh; Advance B, sub-standard, outstanding ₹80 lakh (unsecured); Advance C, loss asset, outstanding ₹30 lakh. Assuming illustrative provisioning rates of 0.4% for standard assets, 15% for unsecured sub-standard assets, and 100% for loss assets, compute the total provision required, and explain the underlying rationale for the sharply rising provisioning percentage across these categories.

Accepted Answer

Provision on Advance A (standard) = 0.4% × ₹500 lakh = ₹2 lakh. Provision on Advance B (sub-standard, unsecured) = 15% × ₹80 lakh = ₹12 lakh. Provision on Advance C (loss asset) = 100% × ₹30 lakh = ₹30 lakh. Total provision required = ₹2 lakh + ₹12 lakh + ₹30 lakh = ₹44 lakh. The sharply rising provisioning percentage across these categories, from a modest 0.4% for standard assets up to a full 100% for loss assets, directly reflects the prudence principle applied progressively as evidence of impairment accumulates and strengthens: a standard asset carries only the normal, general credit risk inherent in any lending book, warranting only a small general provision; a sub-standard asset has already demonstrated an actual payment default persisting long enough to be classified as an NPA, warranting a materially higher provision reflecting the genuinely elevated, demonstrated risk of loss; and a loss asset has been specifically identified, whether by the bank itself or by auditors or regulatory inspection, as one where recovery is considered virtually impossible with little realisable value remaining, warranting full provisioning reflecting that the asset's value is regarded as effectively already lost rather than merely at elevated risk.

Question 3

A bank advance had accrued but uncollected interest income of ₹6 lakh recognised in its books before the advance was reclassified as an NPA during the current financial year. Explain the two distinct accounting actions the bank must take once this reclassification occurs, and the underlying reasoning connecting both actions to the same principle.

Accepted Answer

First, the bank must reverse the ₹6 lakh of interest income that was already accrued and recognised on this advance before it became an NPA, removing this amount from income recognised in the current period (or, if it was recognised in an earlier period, through an appropriate adjustment), since this income, though correctly accrued at the time based on the information then available, is no longer considered reasonably certain of collection now that the underlying advance has demonstrated an actual payment default sufficient to trigger NPA classification. Second, the bank must cease any further accrual of interest income on this advance going forward from the date of NPA classification, recognising future interest income, if any is ever actually received, only on a cash (received) basis rather than an accrual basis. Both actions connect to the same underlying principle: once an advance is classified as an NPA, the very fact of that classification is itself strong evidence that future interest income on the advance is not reasonably certain of collection, and prudent, reliable financial reporting requires both that no further income be accrued on this now-uncertain basis, and that any already-accrued but still-uncollected income recognised under the earlier, more optimistic assumption be reversed, since continuing to report that already-accrued income as a genuine asset (in the form of accrued interest receivable) would overstate the bank's reported income and assets relative to what can now genuinely be expected to be collected.

Question 4

A bank's existing loan to a borrower is on the verge of being classified as an NPA due to non-payment. Just before this classification would occur, the bank sanctions a new loan to the same borrower, the proceeds of which are used to fully repay the existing, troubled loan, and the new loan is classified as 'standard.' Explain why an auditor should treat this pattern with heightened professional scepticism, and the audit procedures that would help determine whether genuine evergreening has occurred.

Accepted Answer

This pattern, a fresh loan sanctioned specifically to repay an existing loan on the verge of NPA classification, is a classic evergreening pattern, and the auditor should treat it with heightened scepticism because, in economic substance, the borrower's underlying financial distress and inability to service the original loan have not genuinely been resolved at all; the bank has simply substituted a new credit exposure for the old one, using the new loan's proceeds to disguise what remains, in reality, the same continuing, troubled credit relationship, while resetting the NPA classification clock and avoiding the provisioning consequences the original loan's genuine, ongoing distress would otherwise require. To determine whether genuine evergreening has occurred, the auditor should examine whether the new loan's own underwriting was performed on a genuinely independent basis reflecting the borrower's current, actual creditworthiness (as opposed to being sanctioned essentially automatically to facilitate repayment of the old loan regardless of the borrower's genuine ability to service new debt), whether the borrower's underlying financial position and cash flow genuinely support the new loan's serviceability independent of the old loan being repaid from its proceeds, whether the timing and terms of the new loan (sanctioned suspiciously close to when the old loan would otherwise have become overdue past the NPA threshold) suggest a pattern specifically designed to avoid classification consequences rather than reflecting a genuine, independently justified new lending decision, and whether similar patterns exist across other borrowers at the bank, which, if found repeatedly, would suggest a systemic practice rather than an isolated, genuinely justified transaction; if the auditor concludes genuine evergreening has occurred, the new loan should, in substance, continue to be assessed against the same NPA classification and provisioning framework the original, troubled loan was subject to, rather than being accepted at face value as a fresh, standard asset.

Question 5

Explain why the NPA classification threshold is based on a fixed number of days overdue (generally 90 days) rather than left to each bank's own subjective judgement about when a borrower's payment delay becomes genuinely concerning.

Accepted Answer

A fixed, objective day-count threshold, such as 90 days overdue, provides a consistent, verifiable, and comparable basis for classifying advances across all banks and all borrowers, removing the subjectivity and potential for inconsistent or self-serving judgement that would exist if each bank were left to determine, based on its own subjective assessment, when a particular payment delay becomes 'genuinely concerning' enough to warrant classification and its associated provisioning consequences; a bank facing pressure to minimise reported NPAs and provisioning charges would have an obvious incentive to apply a more lenient, self-serving threshold if given full subjective discretion, understating its true credit risk and overstating its reported asset quality and profitability relative to a bank applying a more conservative, genuinely concerned threshold. A fixed, regulator-mandated threshold ensures uniform, comparable treatment across the entire banking sector, allows regulators, auditors, and users of financial statements to compare asset quality meaningfully across different banks using a common, objective standard, and removes the specific incentive-driven risk of banks systematically understating problem loans that a purely subjective, bank-specific classification approach would create.

Question 6

Explain why the underlying discipline of asset classification and provisioning transfers directly from banks to NBFCs, even though NBFCs operate under a distinct regulatory framework with their own specific thresholds and categories.

Accepted Answer

Both banks and NBFCs undertake fundamentally similar financial activities in substance, extending credit and bearing the risk that borrowers may fail to repay, and the same underlying prudential concern, ensuring that a lender's reported asset values and profitability genuinely reflect the increasing likelihood of loss as a loan account demonstrates actual payment difficulty, applies equally to both types of institution regardless of the specific regulatory label attached to each; the classification-by-overdue-period and graduated-provisioning discipline exists specifically to address this shared underlying risk, credit risk crystallising into demonstrated non-payment over time, which is present in NBFC lending exactly as it is present in bank lending. What differs between the two frameworks is the specific regulatory detail, the exact day-count thresholds, the exact provisioning percentages, and certain category definitions, which are set by the specific regulatory framework each type of institution is subject to and can differ in their precise calibration even while sharing the identical underlying conceptual structure; an auditor should therefore apply the same general classification-and-provisioning mindset developed for banks when auditing an NBFC, while specifically verifying and applying the NBFC-specific regulatory thresholds and rates that actually govern the entity being audited, rather than assuming the bank framework's specific numbers transfer identically without needing separate, sector-specific verification.

Question 7

A public sector undertaking correctly records and discloses a large expenditure on a foreign business-class travel programme for its senior executives, fully compliant with the applicable accounting standards and properly authorised under its own internal delegation of authority policy. Explain why this expenditure could nonetheless attract adverse comment under a propriety audit, even though it passes both a financial fairness test and an internal authorisation test.

Accepted Answer

A propriety audit examines a dimension distinct from, and beyond, both financial statement fairness (is the expenditure correctly recorded and disclosed, which it is here) and internal procedural compliance (was the expenditure properly authorised under the entity's own delegation of authority, which it also is here); propriety audit specifically asks whether the expenditure reflects due regard to economy, efficiency and effectiveness in the use of public funds, and whether the expenditure is consistent with the standards of financial propriety expected of a public sector entity spending funds that are, ultimately, public money entrusted to it for specific public purposes, not merely whether it was correctly recorded and internally authorised according to the entity's own, potentially overly permissive, internal policies. A lavish, business-class foreign travel programme for senior executives, even if fully compliant with accounting standards and internally authorised, could reasonably be judged, under a propriety lens, as inconsistent with the standard of prudent, economical use of public funds a public sector undertaking is expected to observe, particularly if a more economical alternative (such as premium economy travel, or a smaller delegation) could have achieved the same underlying business purpose at materially lower cost to the public exchequer; this illustrates precisely why propriety audit exists as a genuinely distinct dimension from financial fairness and internal procedural compliance, since an expenditure can pass both of those tests entirely while still failing a propriety standard focused on the prudent, economical, and effective use of public resources specifically.

Question 8

A government-funded rural electrification scheme reports that it spent its entire allocated budget and all expenditure was properly recorded and authorised, but three years after the scheme's completion, only 40% of the targeted villages have actually received reliable electricity access. Explain how a performance audit would evaluate this scheme differently from a financial or propriety audit.

Accepted Answer

A financial audit of this scheme would focus on whether the expenditure was accurately recorded and the financial statements or utilisation certificates fairly present how the allocated budget was actually spent; a propriety audit would focus on whether the specific expenditures incurred (contracts awarded, procurement conducted, individual payments made) reflected due economy, efficiency and adherence to proper financial standards in how the money was actually disbursed. A performance audit asks a fundamentally different, outcome-oriented question: did this scheme actually achieve its intended objective, reliable electricity access for the targeted rural villages, and did it use its resources efficiently and effectively in pursuing that objective; here, despite full budget utilisation and properly recorded, authorised expenditure (which might satisfy both a financial and even a propriety audit reasonably well), the scheme's actual outcome, only 40% of targeted villages having received reliable electricity access three years after completion, reveals a genuine performance failure that neither a financial audit nor a propriety audit, each focused on how money was recorded and spent rather than on what was actually achieved with it, would necessarily surface at all; a performance audit would investigate the specific reasons for this shortfall, whether flawed implementation planning, inadequate contractor oversight, or unrealistic original targets, providing a genuinely different, outcome-focused form of accountability that complements, rather than duplicates, the financial and propriety dimensions.

Question 9

Explain why a bank's contingent liabilities (letters of credit, guarantees, derivative exposures) are typically far more significant, both in absolute scale and relative to the bank's own balance sheet, than the contingent liabilities of a typical non-financial commercial company, and why this matters for audit emphasis.

Accepted Answer

A bank's core business function includes providing exactly these kinds of credit-substitute and risk-management instruments to its customers as a fundamental part of its commercial banking services, issuing letters of credit and guarantees to facilitate customers' own trade and commercial activities, and entering derivative contracts both for its own risk management and as a service offered to customers, meaning these instruments are not incidental, occasional exposures the way they typically are for a non-financial commercial company, but a core, high-volume line of the bank's own ordinary business activity conducted at a scale commensurate with the bank's overall size and customer base. This matters significantly for audit emphasis because the scale of these off-balance-sheet, contingent exposures for a bank can genuinely rival or even exceed the bank's own on-balance-sheet assets in notional terms, meaning a failure to properly assess, classify, or provide for potential losses on this contingent exposure could have a materially significant effect on the bank's true financial position, even though these items, by their contingent nature, do not appear as recognised liabilities on the balance sheet in the same way an ordinary loan does; auditors of banks must therefore devote proportionately greater attention to understanding, testing, and evaluating disclosure of this contingent liability portfolio than would typically be warranted for a non-financial commercial company, where such exposures are usually a much smaller, more incidental part of the overall audit.

Question 10

A large bank has 500 branches, of which the 20 largest branches together account for 60% of total advances, while the remaining 480 branches collectively account for the remaining 40%, spread thinly across many small branches. Explain how the bank's statutory audit would likely be structured to address this distribution, connecting this to the significance-driven approach developed for group audit components.

Accepted Answer

Consistent with the significance-driven scoping approach the group audits chapter developed, where component significance (whether by financial size or specific risk characteristics) determines the depth of audit work warranted, the 20 largest branches, together accounting for 60% of total advances, a clearly substantial and concentrated proportion of the bank's overall lending book, would likely be classified as significant and subject to full-scope statutory branch audit, with a designated branch auditor (or the central statutory auditor directly, for the very largest branches) performing detailed audit procedures on each. The remaining 480 branches, each individually modest in size and collectively representing a much smaller, more thinly spread 40% of total advances, would likely be subject to a more limited scope of audit work, potentially a sample-based selection of some of these branches for audit each year on a rotational basis, combined with analytical procedures and internal control reliance at the overall bank level for branches not individually selected in a given year, since dedicating full-scope audit resources equally to all 500 branches regardless of their individual significance would be a highly inefficient allocation of audit effort relative to where the bank's genuine credit risk concentration actually lies; the central statutory auditor is then responsible for consolidating the results of the significant branches' full-scope audits together with the more limited work and analytical procedures performed on the remaining branches, forming an overall opinion on the bank's financial statements as a whole, precisely mirroring the group engagement partner's consolidating role across significant and less significant components in an ordinary group audit.

Question 11

Explain why provisioning norms typically distinguish between secured and unsecured sub-standard assets, applying a higher provisioning rate to the unsecured portion, and how this connects to the fundamental concept of recoverability.

Accepted Answer

A secured sub-standard asset is backed by collateral or security that the bank can potentially realise to recover some or all of the outstanding amount even if the borrower does not repay in the ordinary course, meaning the bank's genuine expected loss on a secured sub-standard asset is typically lower than on an equivalent, otherwise identical unsecured asset, since the security provides a real, additional avenue of recovery beyond relying solely on the borrower's own ability and willingness to pay. An unsecured sub-standard asset, by contrast, offers the bank no such additional recovery avenue; if the borrower does not repay, the bank has no specific asset or collateral to fall back on to recover any portion of the outstanding amount, meaning the genuine expected loss, and therefore the appropriate provisioning percentage, should reasonably be higher to reflect this materially weaker recovery prospect. This distinction directly connects to the fundamental concept of recoverability underlying all provisioning: provisioning is meant to reflect a realistic, prudent estimate of expected loss, and since the presence or absence of security materially changes the realistic expectation of eventual recovery even for two loans that are otherwise identically overdue and classified in the same sub-standard category, applying a uniform provisioning rate regardless of security status would either overstate the true expected loss on secured assets or, more concerningly, understate the true expected loss on unsecured assets, which is precisely why the differentiated rate exists.

Question 12

A bank genuinely restructures a loan for a borrower experiencing temporary, demonstrable financial difficulty, extending the repayment period and reducing the interest rate, based on a credible assessment that the borrower's business will recover and can service the restructured terms. Explain why this genuine restructuring should be distinguished from evergreening, and what specific evidence would support treating it as a legitimate restructuring rather than a disguised continuation of distress.

Accepted Answer

A genuine restructuring, undertaken based on a credible, evidence-based assessment that the borrower's underlying business faces temporary, resolvable difficulty and can realistically service the new, restructured terms going forward, differs fundamentally from evergreening, where a fresh loan is used merely to repay an existing troubled loan with no genuine change to the underlying, ongoing difficulty or credible improvement in the borrower's ability to service debt; a genuine restructuring directly and transparently addresses the borrower's demonstrated difficulty by modifying the terms of the same, continuing loan relationship in a way credibly designed to make it serviceable, rather than disguising the underlying distress by substituting a superficially fresh, differently-classified loan for the troubled one. Evidence supporting treatment as a legitimate restructuring rather than disguised evergreening would include a documented, credible business recovery plan or turnaround assessment supporting the view that the difficulty is genuinely temporary and resolvable, evidence that the restructured terms were set based on a realistic assessment of the borrower's actual expected future cash flows rather than merely whatever terms allow the loan to appear performing on paper, and, importantly, the restructuring's transparent classification and reporting in accordance with applicable regulatory norms specifically governing restructured advances (which typically require their own distinct disclosure and, often, a period of continued monitoring or a specified provisioning treatment even where full NPA classification is not immediately triggered), rather than the restructuring being used specifically as a device to avoid classification and provisioning consequences altogether without any genuine, credible improvement in the borrower's underlying position.

Question 13

Explain why a 'standard asset,' despite carrying no more than normal credit risk, still attracts a general provision under RBI norms, rather than requiring no provision at all.

Accepted Answer

Even a standard asset, current in its payments and showing no signs of default or distress, carries some baseline, inherent level of credit risk simply by virtue of being a loan extended to a borrower whose future ability and willingness to repay can never be predicted with absolute certainty; a general provision on standard assets reflects this baseline, portfolio-level expected loss that exists across any lending book as a statistical matter, even though no specific, individually identifiable loan within the standard category is currently showing any particular sign of distress. This is conceptually analogous to the expected credit loss framework's Stage 1, 12-month expected loss provisioning for financial assets with no significant increase in credit risk, familiar from the Financial Reporting paper's own treatment of Ind AS 109, reflecting the same underlying principle that a portfolio of loans, viewed collectively, will statistically experience some baseline level of default even among loans that are individually, currently performing without any specific indication of trouble, and prudent financial reporting requires recognising this baseline, portfolio-level expected loss rather than assuming a portfolio of currently-performing loans carries genuinely zero risk of any future loss whatsoever.

Question 14

Explain why a comprehensive audit, combining financial, propriety and performance dimensions, is considered a more complete form of public accountability for a PSU than performing each of the three types of audit as entirely separate, unconnected exercises.

Accepted Answer

Performing financial, propriety and performance audit as entirely separate, unconnected exercises risks each examination missing insights that would only become apparent when the three dimensions are considered together and cross-referenced against each other; a comprehensive audit, by integrating all three within a single, coordinated examination, allows an auditor to connect financial findings (how money was actually spent and recorded) with propriety findings (whether that spending reflected due economy and adherence to proper standards) and performance findings (whether the spending actually achieved its intended objectives), building a genuinely integrated picture of the PSU's overall stewardship of public resources that no single dimension alone could provide. For instance, a comprehensive audit might reveal that a scheme's financial records show full budget utilisation (financial audit finding), but that a disproportionate share of that spending went to unusually high consultancy fees inconsistent with due economy (propriety audit finding), which in turn helps explain why the scheme's actual outcomes fell well short of its targets (performance audit finding), a causal chain connecting all three dimensions that only becomes visible when they are examined together as one integrated, comprehensive exercise, rather than as three entirely separate audits conducted independently with no deliberate cross-referencing between their respective findings.

Question 15

State the role the Comptroller and Auditor General of India plays in the audit of public sector undertakings, distinct from an ordinary commercial company's statutory audit.

Accepted Answer

The Comptroller and Auditor General of India (CAG) has a specific constitutional and statutory role in the audit of government companies and public sector undertakings, including appointing (or approving the appointment of) the statutory auditor, issuing directions to the statutory auditor on the manner in which the accounts are to be audited, and conducting a supplementary or test audit of the accounts, with the right to comment upon or supplement the statutory auditor's report; this is distinct from an ordinary commercial company's statutory audit, where the auditor is appointed by and reports solely to the company's own shareholders with no equivalent external constitutional authority reviewing or supplementing the audit, reflecting the additional layer of public accountability and oversight PSU audits are subject to given that public funds and the public interest, rather than only private shareholder interests, are at stake.

Practice — Audit of Banks, NBFCs and Public Sector Undertakings

Sign in to save attempts to your dashboard and track your accuracy over time

Find a verified tutor

Join a live course

Browse coaching centres

About

Categories

Support

Documentation

Get Study Tips & Updates

Download Our App

Download for iOS

Download for Android

Popular Cities