Audit of Different Types of Entities and Banks — Practice

Question 1

State four matters a company auditor's report must additionally address under section 143 of the Companies Act, 2013, beyond the ordinary SA 700 opinion, and explain why these are imposed by statute rather than left to the Standards on Auditing alone.

Accepted Answer

Under section 143, a company auditor's report must additionally state whether proper books of account as required by law have been kept by the company; whether the balance sheet and profit and loss account dealt with in the report are in agreement with the books of account; whether, in the auditor's opinion, the financial statements comply with the applicable Accounting Standards; and whether any director is disqualified from being appointed as a director under the specified disqualification provisions, together with reporting any qualifications, reservations or adverse remarks relating to the maintenance of accounts, and, for specified companies, a statement on the adequacy and operating effectiveness of internal financial controls with reference to financial statements. These are imposed by statute rather than left to the Standards on Auditing alone because they reflect specific regulatory and public-interest concerns particular to the Indian company law framework, going beyond what a general, internationally harmonised opinion on true and fair presentation would necessarily cover; matters such as director disqualification and statutory books of account compliance are specific to Companies Act obligations that exist independently of, and in addition to, the financial reporting framework itself, and Parliament has chosen to make the statutory auditor the mechanism by which compliance with these specific additional obligations is independently verified and reported to shareholders and regulators, rather than leaving such matters to be addressed only if a generic international auditing standard happened to require them.

Question 2

Explain the general purpose of CARO, the kind of additional matters it requires the auditor to report on, and why certain small or specified companies are exempted from its scope.

Accepted Answer

CARO, the Companies Auditor's Report Order, requires the auditor of companies falling within its scope to include a statement in the auditor's report addressing specified additional matters beyond the ordinary financial statement opinion and beyond even the further matters section 143 itself requires, covering areas such as whether the company has maintained proper records of its fixed assets and whether physical verification of those assets has been conducted, whether inventory has been physically verified by management and whether any material discrepancies were noted and properly dealt with, whether the company has complied with the provisions relating to acceptance of deposits, and a range of further specified matters addressing particular areas of corporate compliance and governance risk. The general purpose is to give regulators, creditors and other stakeholders additional, standardised assurance on a set of specific compliance and operational matters that experience has shown to be recurring areas of concern in company affairs, beyond what a bare true-and-fair opinion on the financial statements alone would reveal. Certain small or specified companies are exempted from CARO's scope, generally including small companies and one-person companies among others specified in the Order, reflecting a proportionality judgement that the additional compliance burden CARO reporting imposes on the auditor, and indirectly on the company being required to support that additional reporting, is not justified for entities of a scale, structure or public interest significance low enough that the incremental assurance value to stakeholders is comparatively limited relative to the cost involved, mirroring the same kind of proportionality reasoning seen elsewhere in the syllabus, such as the small company and MSME relaxations in the accounting standards applicability framework.

Question 3

Explain why the source of an auditor's rights and duties differs fundamentally between a company audit and a sole proprietorship audit, and the practical consequence of this difference for how the auditor's scope of work is actually determined in each case.

Accepted Answer

For a company audit, the auditor's rights and duties derive from a comprehensive statute, the Companies Act, 2013, which prescribes in detail the auditor's right of access to books and vouchers, the right to receive information and explanations from officers, the specific matters the auditor must report on, the qualifications and disqualifications governing who may act as auditor, and the process for appointment and removal; this statutory framework applies regardless of what the engagement letter between the auditor and the company happens to say, and indeed the engagement letter operates within, and cannot override, these statutory minimums. For a sole proprietorship audit, by contrast, there is generally no comprehensive statute governing the conduct of the audit at all, since a sole proprietorship is not a company and no equivalent overarching audit legislation applies to it merely because it chooses to have its accounts audited; the auditor's rights and duties in this situation derive entirely from the terms of the specific engagement agreed between the auditor and the proprietor, set out in the engagement letter, since there is no statutory floor of rights and obligations to fall back on or to supplement what the parties have agreed. The practical consequence is significant: for a company audit, the auditor can rely on statutory rights, such as the right of access to books and records, that exist independently of anything the client might prefer, and the scope of the audit's minimum required content is substantially fixed by law regardless of what is negotiated; for a sole proprietorship audit, the auditor's actual scope of work, access rights, and reporting obligations are exactly, and only, what has been agreed in the engagement letter, meaning the auditor must be far more careful and explicit in negotiating and documenting the terms of engagement, since there is no statutory safety net providing rights or requirements the engagement letter happens to omit.

Question 4

Explain the distinctive emphasis of a trust audit compared to an ordinary company audit, and describe one specific procedure the auditor would perform to address it.

Accepted Answer

The distinctive emphasis of a trust audit, compared to an ordinary company audit, is verifying that trust funds have been applied in accordance with the objects of the trust as stated in the trust deed, a concern that has no direct parallel in an ordinary company audit, where the focus is instead on whether the financial statements as a whole present fairly the results of whatever activities the company has chosen, within the bounds of its own objects clause and general commercial freedom, to pursue. A trust, by contrast, exists specifically to hold and apply property or funds for a defined purpose or set of beneficiaries stated in its constituting document, the trust deed, and a trustee's fundamental legal and fiduciary obligation is to apply the trust's resources strictly in accordance with that stated purpose, not according to the trustee's own commercial judgement about what might be a good use of the funds; an application of trust funds outside the objects stated in the deed is a breach of trust regardless of how commercially sound or well-intentioned it might otherwise be. A specific procedure the auditor would perform to address this is examining a sample of the trust's expenditure transactions during the period and tracing each one back to the specific objects and purposes set out in the trust deed, assessing whether the nature of each expenditure genuinely falls within what the deed permits, and specifically investigating any expenditure that appears unrelated to, or difficult to reconcile with, the trust's stated charitable, religious, or other defined objects, since such expenditure would represent exactly the kind of misapplication the trust audit's distinctive emphasis exists to detect.

Question 5

State the NPA threshold, and classify each of the following advances: (a) interest overdue for 75 days; (b) an account that has been classified NPA for 8 months; (c) an account that has remained sub-standard for a full 12 months without improvement; (d) an advance where a specific loss has been identified but the amount has not yet been wholly written off.

Accepted Answer

An advance becomes a non-performing asset where interest and/or an instalment of principal remains overdue for a period of more than 90 days; this single threshold is the hinge of the entire framework, since everything about income recognition and provisioning for that advance follows from whether the 90-day line has been crossed. Item (a), interest overdue for 75 days, has not crossed the threshold and remains a standard asset, since 75 days is less than the more-than-90-day requirement for NPA classification. Item (b), an account classified NPA for 8 months, falls within the sub-standard asset category, since a sub-standard asset is one that has remained an NPA for a period less than or equal to 12 months, and 8 months falls within that window. Item (c), an account that has remained sub-standard for a full 12 months without improvement, moves into the doubtful asset category, since a doubtful asset is one that has remained in the sub-standard category for a period of 12 months; the classification sequence is important here, doubtful is defined by reference to having already spent 12 months as sub-standard, not by an independent, parallel time count from the original NPA date, so a candidate must apply the definitions sequentially rather than treating sub-standard and doubtful as two separate time bands measured from the same starting point. Item (d), an advance where a specific loss has been identified but the amount has not yet been wholly written off, is a loss asset, this category being defined not primarily by a further time threshold but by the fact of an identified, essentially certain loss that has simply not yet been formally written off the books, the asset being considered uncollectible in substance regardless of the precise duration it has carried that status.

Question 6

A bank has accrued interest income of Rs.4,00,000 on an advance for the current year on an ongoing accrual basis, but the account crossed the NPA threshold six months into the year and no interest has actually been received since that point. Explain the audit concern, the required treatment, and the effect of correcting it.

Accepted Answer

The audit concern is that once this account crossed the NPA threshold, more than 90 days overdue, income recognition must shift from an accrual basis to a cash basis, meaning interest income should be recognised only when actually received, and continuing to accrue interest for the remainder of the year after the NPA threshold was crossed directly overstates both the bank's reported income and the corresponding asset, the accrued interest receivable, which itself represents amounts increasingly unlikely to ever actually be collected given the underlying account's non-performing status. The required treatment is that interest income should have ceased to be recognised on an accrual basis from the point the account was classified NPA, six months into the year on these facts, with only interest actually received thereafter, which the facts state is nil, recognised as income; any interest already recognised on an accrual basis for the period after NPA classification, representing income that should never have been accrued once the account crossed the threshold, must be reversed. Assuming interest accrued evenly through the year, roughly half of the 4,00,000, that is approximately 2,00,000, relates to the period after NPA classification and should be reversed, since it was recognised in a period during which the account was already non-performing and accrual-based recognition was no longer appropriate; correcting this would reduce reported income by approximately 2,00,000 and correspondingly reduce the reported interest receivable asset by the same amount, bringing the bank's financial statements into line with the prudential requirement that a non-performing asset's income be recognised only on actual receipt, reflecting the genuine, substantially reduced likelihood that accrued but unpaid interest on an account that has already stopped performing will ever actually be collected.

Question 7

Explain why provisioning percentages for advances increase as an account progresses from sub-standard through to doubtful and loss classification, connecting this to the general principle of prudence.

Accepted Answer

Provisioning percentages increase as an account progresses through the classification categories because the probability, and the likely severity, of ultimate loss on the advance genuinely increases the longer an account remains non-performing and the further it progresses through the classification stages, and the level of provision required is meant to reflect a realistic assessment of that increasing risk rather than a fixed percentage applied uniformly regardless of how long or how severely an account has failed to perform. An account newly classified as sub-standard, having only recently crossed the 90-day threshold, still carries some meaningful possibility of recovery, whether through the borrower resuming payments, restructuring, or other recovery action, and the provisioning percentage set for this category, while higher than for a standard asset, reflects that residual possibility of recovery rather than an assumption of near-total loss. As an account remains non-performing for longer, moving into the doubtful category, and particularly as it remains doubtful for an extended period, the realistic prospect of full recovery diminishes correspondingly, since the passage of time without resolution is itself evidence that whatever difficulty caused the original default has not been resolved and may be deepening, and the provisioning percentage is correspondingly increased to reflect this greater likelihood of loss. By the loss asset stage, where a loss has effectively been identified and the asset is considered uncollectible, provisioning approaches or reaches the full amount outstanding. This graduated structure is a direct application of the general principle of prudence running throughout financial reporting: a degree of caution is exercised in making the judgements needed under conditions of uncertainty, and as the uncertainty around an advance's collectibility resolves progressively towards a worse outcome the longer non-performance persists, prudence requires the provision recognised to track that deteriorating assessment rather than remaining static at whatever level was originally set when the account first became non-performing.

Question 8

A bank auditor notices that several accounts approaching the 90-day overdue threshold received a small, token payment just before crossing it, resetting the overdue clock, a pattern repeated across multiple accounts and multiple periods for the same set of borrowers. Explain the specific concern this raises, connect it to professional scepticism, and describe the audit response.

Accepted Answer

This pattern raises a specific and serious concern known as evergreening, where a bank, or in some cases a borrower colluding with bank staff, arranges token or minimal payments timed specifically to occur just before an account would otherwise cross the 90-day overdue threshold, artificially resetting the ageing calculation and thereby keeping an account classified as standard, or preventing it from progressing further through the NPA sub-classifications, when in economic substance the underlying borrower is genuinely unable to service the debt and the advance is, in reality, non-performing or deteriorating. This connects directly to the professional scepticism principle established at the very start of this subject, which requires the auditor to maintain a questioning mind and to be alert specifically to conditions that may indicate possible misstatement due to fraud, and a repeated pattern of narrowly timed, minimal payments across multiple accounts and multiple periods for the same set of borrowers is exactly the kind of unusual, recurring pattern that should trigger heightened scepticism rather than being accepted at face value simply because each individual payment, viewed in isolation, appears to be a legitimate instalment received within the technical timeframe. The auditor's response should go well beyond simply confirming that each individual payment was technically received before the 90-day mark; the auditor should investigate the substance of these accounts more deeply, examining the borrowers' broader financial position and repayment capacity, considering whether the pattern of only ever paying the minimum amount needed to avoid crossing the threshold, repeated systematically, is itself evidence that the underlying obligation is not genuinely being serviced in the ordinary course, and considering whether this reveals a systemic weakness or deliberate manipulation in the bank's own classification and monitoring processes that would call into question the reliability of the bank's self-reported NPA classification more broadly, potentially requiring the auditor to independently reclassify these specific accounts based on their true underlying substance rather than accepting the bank's own classification, and to consider the implications of this finding for the reliability of the bank's classification system as a whole across its wider loan book.

Question 9

State two matters an auditor of a co-operative society is typically required to additionally report on beyond an ordinary true and fair opinion, and explain the reasoning behind requiring them.

Accepted Answer

An auditor of a co-operative society is typically required to additionally report on matters including whether the society's transactions, as examined by the auditor, appear to be within the scope of the powers granted to it under its bye-laws, and whether the society has maintained the statutory reserves required under the applicable Co-operative Societies Act at the prescribed level. The reasoning behind requiring the bye-laws compliance check is that a co-operative society, similar in spirit to a trust though structured differently, is formed for a specific, member-oriented purpose set out in its bye-laws, and its management is expected to operate within those defined powers on behalf of, and for the benefit of, its member base, so independent verification that transactions have not strayed outside the scope those bye-laws actually permit protects members who may have limited ability to scrutinise day-to-day operations themselves. The reasoning behind the statutory reserve check is that co-operative legislation typically mandates a portion of surplus be set aside into reserves specifically to protect the society's long-term financial stability and its members' collective interest, rather than being fully distributed, and independent verification that this statutory requirement has genuinely been met protects against a society management team that might otherwise prioritise short-term member payouts over the reserve accumulation the law requires for the society's own longer-term soundness.

Question 10

Explain why local body audits place particular emphasis on compliance with budgetary and statutory spending provisions, contrasting this with the emphasis in an ordinary commercial company audit.

Accepted Answer

Local body audits place particular emphasis on compliance with budgetary and statutory spending provisions because local bodies, such as municipal corporations and similar local government entities, administer public funds raised through taxation, levies and government grants, and are typically subject to detailed statutory requirements governing how those funds may be budgeted, allocated across specified categories of expenditure, and spent, reflecting the public accountability owed to the citizens whose money is being administered and to the higher levels of government that have granted or overseen the funds. An ordinary commercial company audit, by contrast, is primarily concerned with whether the financial statements fairly present the company's financial position and performance to its shareholders and other private stakeholders, and while a company must of course comply with applicable law, there is generally no equivalent detailed statutory budget the company's own management is required to spend strictly within, since a company's management retains broad commercial discretion over how to allocate its resources in pursuit of the business's objects. A local body's spending, by contrast, is often constrained to specific budgeted heads determined through a public or governmental budgeting process, and spending outside those approved heads, or exceeding budgeted limits without proper authorisation, can itself constitute a compliance failure regardless of whether the underlying expenditure was otherwise reasonable or beneficial; the local body auditor accordingly devotes significant attention to verifying that actual expenditure has remained within, and been properly authorised against, the approved budget and the applicable statutory spending framework, a dimension of audit work that has no direct parallel in an ordinary commercial audit focused primarily on fair presentation to private stakeholders.

Question 11

Define a standard asset under the IRAC framework, and explain why the definition is expressed in terms of 'not carrying more than normal risk' rather than by reference to a specific overdue period, unlike the NPA sub-categories.

Accepted Answer

A standard asset is an advance that does not disclose any problem and does not carry more than normal risk attached to the business, essentially the default, healthy classification an advance holds so long as it has not crossed into non-performing status. The definition is expressed in terms of not carrying more than normal risk, rather than by reference to a specific overdue period, because standard is defined as the residual category, everything that has not yet triggered the specific, precisely defined 90-day overdue threshold that marks the boundary into non-performing status; there is no meaningful further internal sub-classification needed within standard the way there is within the NPA category, because the whole analytical purpose of the classification framework is to differentiate degrees of deteriorating performance once an advance has actually crossed into difficulty, and an advance that has not crossed that threshold is, by definition, still performing in the ordinary expected way and does not require the same graduated risk analysis. The NPA sub-categories, by contrast, are expressed by reference to specific overdue periods and durations precisely because once an advance has crossed into non-performing status, the further, more granular question of exactly how long it has remained in difficulty becomes directly relevant to assessing the increasing probability and severity of eventual loss, which is what drives the graduated provisioning framework discussed elsewhere in this chapter; that granularity is simply not needed, and would not be meaningful, for an advance that remains within the ordinary, performing standard category.

Question 12

Explain why contingent liabilities such as letters of credit and guarantees issued are typically far larger, relative to a bank's balance sheet, than the equivalent for an ordinary trading company, and state one specific audit concern this raises.

Accepted Answer

Contingent liabilities such as letters of credit and guarantees issued are typically far larger relative to a bank's balance sheet than the equivalent for an ordinary trading company because issuing these instruments is itself a core part of a bank's ordinary business activity, generating fee income, rather than being an incidental, occasional arrangement as it typically is for a trading or manufacturing company that might issue an occasional guarantee in connection with a specific commercial transaction. A bank routinely issues letters of credit to facilitate its customers' trade transactions and guarantees to support its customers' contractual obligations to third parties as a standard, high-volume line of banking business, and because these instruments represent the bank's own conditional promise to pay if the underlying customer defaults or a specified condition is triggered, the cumulative scale of such commitments across a bank's entire customer base can, and typically does, represent a substantial multiple of the bank's own balance sheet size, in a way that would be highly unusual for an ordinary trading company whose contingent obligations are typically modest and incidental to its main commercial activities. One specific audit concern this raises is that a bank's true overall risk exposure cannot be assessed from its balance sheet alone, since a very significant proportion of the bank's actual credit risk exposure to its customers sits off the balance sheet in these contingent instruments, and the auditor must therefore devote specific, dedicated procedures to verifying the completeness and accuracy of the bank's contingent liability disclosures, and to assessing whether any of these contingent exposures have crystallised, or are likely to crystallise, into an actual liability requiring recognition, since a bank whose off-balance-sheet contingent exposure is poorly controlled or inadequately disclosed could face a sudden, large increase in actual liabilities that its balance sheet alone gave no warning of.

Question 13

Explain the branch audit structure commonly used for larger banks, and why this structure creates a specific responsibility for the central statutory auditor beyond simply relying on each branch auditor's individual conclusions.

Accepted Answer

Many banks are audited through a combination structure, with a central statutory audit covering the bank's head office and overall financial statements, and separate branch-level audits, particularly for larger or higher-risk branches, conducted either by the same audit firm or, commonly, by separate firms specifically engaged for individual branch audits, with the results of these various branch audits then consolidated into the bank's overall financial statements and audit opinion. This structure exists because a large bank may operate through hundreds or thousands of branches spread across a wide geographic area, making it impractical for a single central audit team to directly perform detailed fieldwork at every branch, so branch-level auditors, often local firms with knowledge of the specific area and closer proximity to conduct the necessary fieldwork, perform the detailed testing at their assigned branches and report their findings upward. This creates a specific responsibility for the central statutory auditor that goes beyond simply collecting and mechanically aggregating each branch auditor's individual conclusions: the central auditor must evaluate the adequacy of the branch audit work performed, considering whether the branch auditors' procedures and conclusions provide a sufficient basis to support the central auditor's own overall opinion on the bank's financial statements as a whole, must consider whether any significant matters or qualifications raised by individual branch auditors need to be reflected in the central audit opinion or investigated further, and must exercise the central auditor's own professional judgement about the sufficiency of the overall audit evidence obtained across the whole combination of central and branch-level work, rather than treating the branch auditors' individual reports as automatically conclusive without any further evaluation of their adequacy in the context of the bank as a whole.

Question 14

A partnership firm engages an auditor purely voluntarily, with no statutory requirement triggering the audit. Explain what governs the scope and conduct of this audit, and separately explain how the Standards on Auditing still apply despite the absence of any statute requiring the audit at all.

Accepted Answer

The scope and conduct of this voluntary partnership audit are governed entirely by the terms agreed between the auditor and the partnership in the engagement letter, since no statute comparable to the Companies Act applies to a partnership audit, and there is, in this specific scenario, not even a tax-law-triggered audit requirement compelling the engagement, the audit being undertaken purely at the partners' own voluntary choice; the engagement letter is accordingly the sole source defining what the auditor is engaged to examine, what access to records and information the auditor will have, what form of report will be issued, and any other terms governing the relationship, and the partners and the auditor are free to negotiate these terms as they see fit, subject only to whatever the auditor's own professional obligations require them to insist upon as a condition of accepting the engagement at all. Despite the complete absence of any statute requiring this audit, the Standards on Auditing nonetheless continue to apply in full to how the auditor actually conducts the engagement, because the Standards on Auditing are not conditional on statutory compulsion; they are the professional body's own mandatory standards governing how any audit, once an auditor has agreed to perform one and describes the resulting work as an audit, must be conducted, applicable to a chartered accountant conducting any audit engagement regardless of whether that audit was statutorily mandated or purely voluntary. This means that although the partnership had complete freedom over whether to have an audit at all, and the engagement letter defines the specific scope of what is being audited, once the engagement is accepted as an audit, the auditor is bound by the full weight of SA 200's overall objectives, the risk assessment and evidence-gathering standards, and the reporting requirements this whole subject has developed, exactly as rigorously as in a statutorily mandated company audit; voluntariness affects whether an audit happens and what its engagement-letter-defined scope covers, not the professional rigour with which it must, once undertaken, actually be performed.

Question 15

A candidate preparing for both this chapter and the audit of items chapter treats bank advances testing as simply an extension of ordinary receivables testing for a company, with no meaningfully different emphasis. Correct this view, identifying the specific structural reason bank advances require a distinctive framework of their own.

Accepted Answer

This view understates a genuine and important structural difference. Ordinary trade receivables for a company represent amounts owed for goods or services already delivered in the ordinary course of trading, generally with a comparatively short expected collection period, and the audit concern, as developed in the audit of items chapter, centres primarily on existence, through confirmation, and on valuation, principally through assessing the adequacy of a doubtful debt provision based on ageing and collection experience, using a relatively simple, largely undifferentiated approach to that provision. Bank advances are structurally different in a way that genuinely requires a dedicated, more granular framework: they are the bank's core product rather than an incidental consequence of trading, they are typically far larger individually and collectively relative to the entity's overall balance sheet than trade receivables are for an ordinary company, they carry contractually defined repayment schedules against which precise, day-counted overdue periods can and must be tracked, and the entire regulatory and provisioning framework governing them, the IRAC norms with their specific 90-day threshold and further, precisely defined sub-classification into sub-standard, doubtful and loss categories each carrying its own prescribed minimum provisioning percentage, is a detailed, externally mandated regulatory structure with no real equivalent governing how an ordinary company must provide for its trade receivables, which instead relies on the company's own internally developed policy and judgement. Because the classification is externally mandated and precisely defined by reference to specific overdue day-counts, rather than being a matter of internally developed judgement as an ordinary doubtful debt provision is, the bank auditor's task shifts specifically towards independently testing the accuracy of that precise, rules-based classification against the regulatory framework itself, which is a genuinely different audit exercise from assessing the reasonableness of a judgement-based provision, and is exactly why bank advances audit merits its own dedicated treatment rather than being folded into ordinary receivables testing.

Practice — Audit of Different Types of Entities and Banks

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