Audit of Banks - Test 1: answer key

Question 1 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. M/s K. Mehta & Co., Chartered Accountants, has been appointed as the statutory branch auditor of Suryodaya Commercial Bank Ltd., a scheduled commercial bank, for its Coimbatore branch for FY 2025-26. The engagement partner, CA Mehta, begins by reviewing advances and bills purchased. He finds a cash credit account of Zenith Manufacturing Pvt. Ltd. sanctioned at Rs. 8 crore, with outstanding of Rs. 7.60 crore as on 31 March 2026. The latest stock statement is dated 15 December 2025 and supports drawing power of Rs. 6.90 crore. There have been no credits in the account for the last 100 days, except a small deposit of Rs. 10,000. The branch has classified the account as Standard because outstanding is below the sanctioned limit. In another case, six-month bills purchased on 1 January 2026 earned total discount of Rs. 24 lakh; half of the bill period falls after 31 March 2026. The branch recognised the entire discount as income and netted rediscounting charges of Rs. 5 lakh against discount income. A term loan to Alpha Infotech Ltd. is overdue for 95 days but is covered by a Central Government guarantee which has neither been invoked nor repudiated; the branch classified it as Standard and recognised accrued interest. The firm had also conducted concurrent audit of the same branch from April to December 2025.

In respect of the cash credit account of Zenith Manufacturing Pvt. Ltd., which of the following is the most appropriate audit conclusion?

1. The account is Standard because the outstanding balance is below the sanctioned limit of Rs. 8 crore.
2. The account is only SMA-2 because the overdue period is less than 90 days as on the balance sheet date.
3. The account should be treated as out of order and NPA, and classified as Sub-standard if it has remained NPA for not more than 12 months. (correct answer)
4. The account should be classified as Doubtful D1 solely because the stock statement is older than three months.

Answer: C — The account should be treated as out of order and NPA, and classified as Sub-standard if it has remained NPA for not more than 12 months.

Explanation. As per RBI prudential norms, a cash credit account is out of order if outstanding remains continuously in excess of sanctioned limit or drawing power, or where there are no credits for 90 days, or credits are insufficient to cover interest. The stock statement is over three months old, and outstanding exceeds drawing power; there are also no credits for 100 days. The account is therefore NPA and, being NPA for up to 12 months, Sub-standard.

Where it goes wrong. Students compare outstanding only with sanctioned limit and ignore drawing power and the 90-day no-credit condition.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 2 · 2 marks · Chapter 10: Audit of Banks · hard

How should the auditor deal with the discount on bills purchased and rediscounting charges?

1. Recognise the entire discount of Rs. 24 lakh and net rediscounting charges of Rs. 5 lakh against it.
2. Recognise only discount earned up to 31 March 2026, carry unexpired discount as Other Liabilities, and do not net rediscounting charges against discount income. (correct answer)
3. Recognise only discount earned up to 31 March 2026 and net rediscounting charges against the unexpired discount.
4. Defer the entire discount of Rs. 24 lakh until maturity and disclose rediscounting charges as a contingent liability.

Answer: B — Recognise only discount earned up to 31 March 2026, carry unexpired discount as Other Liabilities, and do not net rediscounting charges against discount income.

Explanation. In bank audit, discount on bills purchased outstanding at year end must be apportioned between periods. The unexpired discount relating to the period after 31 March is recorded as Other Liabilities. Rediscounting charges paid to other institutions should not be netted off from discount earned; they are to be accounted separately. Therefore, only the earned portion is income, and netting is not permitted.

Where it goes wrong. Students often approve netting of rediscounting charges because the bank presents a single net discount figure.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 3 · 2 marks · Chapter 10: Audit of Banks · medium

What is the correct treatment of the Central Government assured term loan of Alpha Infotech Ltd.?

1. Classify as NPA for both provisioning and income recognition because it is overdue for more than 90 days.
2. Classify as Standard for provisioning and continue recognising interest on accrual because the guarantee exists.
3. Classify as Loss asset because the guarantee has not been invoked.
4. Classify as Standard for provisioning but treat it as NPA for income recognition until the guarantee is invoked or repudiated. (correct answer)

Answer: D — Classify as Standard for provisioning but treat it as NPA for income recognition until the guarantee is invoked or repudiated.

Explanation. Where a Central Government guarantee has not been invoked or repudiated, RBI norms require the advance to be treated as Standard for provisioning purposes, but it is regarded as NPA for income recognition. Hence accrued interest should not be recognised until realised. The branch's recognition of interest is therefore not appropriate.

Where it goes wrong. Students either treat all government-assured advances as fully Standard or as NPA for both provisioning and income.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 4 · 2 marks · Chapter 10: Audit of Banks · hard

What is the correct position regarding acceptance of the statutory branch audit by M/s K. Mehta & Co., given that it conducted concurrent audit of the same branch during part of the same year?

1. The firm should decline the statutory branch audit, since RBI prohibits undertaking statutory audit while it was associated with concurrent audit of the same bank in the same year. (correct answer)
2. The firm may accept because concurrent audit ended before the statutory audit commenced.
3. The firm may accept if the bank obtains a board resolution ratifying the concurrent audit.
4. The firm may accept because concurrent audit is an external audit function and not an internal assignment.

Answer: A — The firm should decline the statutory branch audit, since RBI prohibits undertaking statutory audit while it was associated with concurrent audit of the same bank in the same year.

Explanation. RBI has directed that audit firms should not undertake statutory audit assignment while they are associated with internal assignments in the bank during the same year, including concurrent audit. The prohibition is not removed merely because the concurrent assignment ended before statutory audit commenced. Accepting the statutory branch audit in such circumstances would violate RBI directions and independence requirements.

Where it goes wrong. Students think any gap between concurrent and statutory audit cures the independence issue.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 5 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. M/s V. Raman & LLP has been appointed as statutory central auditor of Nirmal Cooperative Bank Ltd. for FY 2025-26 after the previous auditors, M/s P. Das & Co., resigned mid-year. Before accepting, the firm did not communicate in writing with the previous auditors. One partner of the firm has an outstanding housing loan of Rs. 18 lakh from Nirmal Cooperative Bank Ltd. During the audit, management is reluctant to provide complete records relating to gold loans and treasury operations. The branch returns of 12 out of 350 branches are inadequate, and those branches remain unaudited. The audit report draft does not quantify advances, deposits, interest income and interest expense relating to unaudited branches. The auditor also notices that gold ornaments pledged with two branches appear to be the same, indicating a suspected fraud. Management requests the auditor not to report the matter to RBI as it may damage the bank's reputation and instead settle it internally. The LFAR is finalised on 18 July 2026, and the bank asks the auditor to show the submission date as 25 June 2026 to avoid regulatory adverse comment.

Before accepting the statutory central audit of Nirmal Cooperative Bank Ltd., what should M/s V. Raman & LLP have ensured?

1. Only a board resolution of the bank is required; communication with previous auditors and partner indebtedness are irrelevant for bank audits.
2. The firm should obtain consent of RBI; communication with previous auditors is optional if the previous auditor resigned.
3. The firm should only ensure that no partner is indebted for more than Rs. 5 lakh; communication with previous auditors is a formality.
4. The firm must communicate in writing with the previous auditors and also ensure that no partner is disqualified due to indebtedness exceeding Rs. 5 lakh. (correct answer)

Answer: D — The firm must communicate in writing with the previous auditors and also ensure that no partner is disqualified due to indebtedness exceeding Rs. 5 lakh.

Explanation. Clause 8 of Part I of the First Schedule to the Chartered Accountants Act, 1949 requires written communication with the previous auditor before acceptance. Also, a person is disqualified from being an auditor if indebted to the company for more than Rs. 5 lakh, and bank audit eligibility follows company auditor disqualifications. The partner's housing loan of Rs. 18 lakh therefore disqualifies the firm unless cleared.

Where it goes wrong. Students treat resignation of the previous auditor as dispensing with communication and overlook the Rs. 5 lakh indebtedness limit.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 6 · 2 marks · Chapter 10: Audit of Banks · hard

How should the auditor deal with 12 unaudited branches whose returns are inadequate?

1. Only state the number of unaudited branches; quantification of their advances, deposits and interest is not required.
2. Exclude the unaudited branches from the scope and issue an unmodified report with a note in LFAR only.
3. Disclose the number of unaudited branches and quantify advances, deposits, interest income and interest expense relating to such branches in the audit report. (correct answer)
4. Resign from the audit unless all 350 branches are examined under statutory audit before signing the report.

Answer: C — Disclose the number of unaudited branches and quantify advances, deposits, interest income and interest expense relating to such branches in the audit report.

Explanation. The audit report should not merely state the number of unaudited branches. It should also quantify advances, deposits, interest income and interest expense for such unaudited branches. This disclosure is required by the chapter and provides useful information to users. Resignation is not the automatic response, and LFAR alone is not a substitute for disclosure in the main audit report.

Where it goes wrong. Students remember only the number of unaudited branches and forget quantification of key balances.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 7 · 2 marks · Chapter 10: Audit of Banks · medium

What should the auditor do regarding the suspected fraud in gold loans where management requests internal settlement?

1. Comply with management's request because reporting may harm the bank's reputation and cause public panic.
2. Report the matter to RBI in addition to the Chairman/Managing Director/Chief Executive of the bank, considering SA 240 and RBI directions. (correct answer)
3. Report only in the LFAR and take no other action.
4. Report only to the statutory central auditor and not to RBI.

Answer: B — Report the matter to RBI in addition to the Chairman/Managing Director/Chief Executive of the bank, considering SA 240 and RBI directions.

Explanation. RBI directions require the auditor, on coming across anything susceptible to fraud or fraudulent activity in the course of audit, to report the matter to RBI in addition to the Chairman/Managing Director/Chief Executive of the bank. SA 240 also requires appropriate response to identified fraud risks. Management's reputation concerns do not override regulatory reporting.

Where it goes wrong. Students choose confidentiality or LFAR-only reporting and ignore mandatory reporting to RBI.

Authority. SA 240

Question 8 · 2 marks · Chapter 10: Audit of Banks · hard

What is the correct course of action regarding the LFAR date?

1. The auditor should retain the actual date of 18 July 2026 and should not backdate; LFAR is required to be submitted latest by 30 June every year. (correct answer)
2. The auditor may backdate to 25 June 2026 because the bank is the appointing authority.
3. The auditor may backdate if the delay was due to management's non-cooperation.
4. The LFAR has no prescribed due date and may be submitted at any time before the AGM.

Answer: A — The auditor should retain the actual date of 18 July 2026 and should not backdate; LFAR is required to be submitted latest by 30 June every year.

Explanation. Statutory central auditors are required to submit the LFAR to the bank latest by 30 June every year. Backdating an audit document is improper and undermines documentation integrity under SA 230. Delay due to management non-cooperation should be documented and addressed, not concealed by changing the date.

Where it goes wrong. Students may justify backdating due to client pressure and forget the 30 June LFAR deadline.

Authority. SA 230

Question 9 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. How is the statutory auditor of a nationalised bank appointed?

How is the statutory auditor of a nationalised bank appointed?

1. By the shareholders at the annual general meeting without any regulatory approval.
2. By the Central Government directly without involvement of the bank's Board.
3. By the bank concerned acting through its Board of Directors, with prior approval of RBI. (correct answer)
4. By the Comptroller and Auditor General of India in all cases.

Answer: C — By the bank concerned acting through its Board of Directors, with prior approval of RBI.

Explanation. The chapter states that the auditor of a nationalised bank is appointed by the bank concerned acting through its Board of Directors, with prior approval of RBI. Shareholder approval is relevant for a banking company, not for a nationalised bank in this manner. CAG appointment is not the general rule stated for nationalised banks.

Where it goes wrong. Students apply the Companies Act AGM appointment rule to nationalised banks.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 10 · 2 marks · Chapter 10: Audit of Banks · hard

Scenario. Under the Banking Regulation Act, 1949, the balance sheet and profit and loss account of a banking company are prepared in which forms?

Under the Banking Regulation Act, 1949, the balance sheet and profit and loss account of a banking company are prepared in which forms?

1. Form A for Balance Sheet and Form B for Profit and Loss Account in the Third Schedule. (correct answer)
2. Form B for Balance Sheet and Form A for Profit and Loss Account in the Second Schedule.
3. Form I for Balance Sheet and Form II for Profit and Loss Account in the First Schedule.
4. Schedule III of the Companies Act, 2013 only, without any banking-specific form.

Answer: A — Form A for Balance Sheet and Form B for Profit and Loss Account in the Third Schedule.

Explanation. Section 29 of the Banking Regulation Act, 1949 requires a banking company to prepare its Balance Sheet and Profit and Loss Account in the forms set out in the Third Schedule, or as near thereto as circumstances admit. Form A contains the Balance Sheet and Form B contains the Profit and Loss Account.

Where it goes wrong. Students mix up Form A and Form B or wrongly apply Schedule III of the Companies Act exclusively.

Authority. Section 29

Question 11 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. A Chartered Accountant is appointed as auditor of a bank previously examined under statutory audit by another Chartered Accountant. What is the correct professional requirement before acceptance?

A Chartered Accountant is appointed as auditor of a bank previously examined under statutory audit by another Chartered Accountant. What is the correct professional requirement before acceptance?

1. Communication with the previous auditor is required only if the previous auditor was removed by the bank.
2. Communication with the previous auditor is optional if the appointment is approved by RBI.
3. A public notice in a newspaper is sufficient compliance instead of communication with the previous auditor.
4. Written communication with the previous auditor is mandatory, and acceptance without such communication is professional misconduct. (correct answer)

Answer: D — Written communication with the previous auditor is mandatory, and acceptance without such communication is professional misconduct.

Explanation. Clause 8 of Part I of the First Schedule to the Chartered Accountants Act, 1949 prohibits a Chartered Accountant in practice from accepting a position as auditor previously held by another Chartered Accountant without first communicating with him in writing. RBI approval or newspaper notice does not replace this requirement.

Where it goes wrong. Students believe regulatory approval or previous auditor resignation removes the need for communication.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 12 · 2 marks · Chapter 10: Audit of Banks · hard

Scenario. What does the declaration of indebtedness obtained by a bank before appointing statutory auditors signify?

What does the declaration of indebtedness obtained by a bank before appointing statutory auditors signify?

1. It is a declaration that the auditor will not accept any other audit assignment during the year.
2. It declares whether the auditor owes money to the bank in any case whatsoever, which is relevant for eligibility. (correct answer)
3. It is a declaration of the bank's outstanding advances to borrowers, given to the auditor for sampling.
4. It is a declaration that the auditor has no relatives employed in the bank.

Answer: B — It declares whether the auditor owes money to the bank in any case whatsoever, which is relevant for eligibility.

Explanation. RBI has advised that banks should obtain a declaration of indebtedness before appointing statutory central or branch auditors. Indebtedness refers to owing money to the bank in any case whatsoever. This helps verify eligibility, since indebtedness beyond the prescribed limit can disqualify the auditor.

Where it goes wrong. Students confuse declaration of indebtedness with independence declarations about other assignments or relatives.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 13 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. How should interest accrued on a non-performing asset be treated in a bank's books?

How should interest accrued on a non-performing asset be treated in a bank's books?

1. It should be recognised on accrual basis if the borrower has enough net worth.
2. It should be recognised on accrual basis if the advance is fully secured.
3. It should be recognised on accrual basis but disclosed as a contingent asset.
4. It should not be recognised on accrual basis; it is booked as income only when actually received, and may be recorded in a memorandum account for control. (correct answer)

Answer: D — It should not be recognised on accrual basis; it is booked as income only when actually received, and may be recorded in a memorandum account for control.

Explanation. Income from NPAs is not recognised on accrual basis due to uncertainty of realisation; it is booked as income only when actually received. Banks may record accrued interest in a memorandum account for control, but such interest is not included in gross advances. Security or borrower net worth does not justify accrual once the account is NPA.

Where it goes wrong. Students think adequate security or borrower net worth permits accrual on an NPA.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 14 · 2 marks · Chapter 10: Audit of Banks · hard

Scenario. A loan is granted for short-duration crops. When will it be classified as NPA?

A loan is granted for short-duration crops. When will it be classified as NPA?

1. If the instalment of principal or interest remains overdue for two crop seasons. (correct answer)
2. If the instalment remains overdue for one crop season.
3. If the instalment remains overdue for 30 days.
4. If the instalment remains overdue for 90 days irrespective of crop duration.

Answer: A — If the instalment of principal or interest remains overdue for two crop seasons.

Explanation. For agricultural advances for short-duration crops, the loan is treated as NPA if instalment of principal or interest remains overdue for two crop seasons. For long-duration crops, one crop season is the criterion. The ordinary 90-day rule is not applied in the same manner to short-duration crop loans.

Where it goes wrong. Students apply one crop season to all agricultural advances or apply the ordinary 90-day rule.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 15 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. An advance is assured by a State Government and instalment remains overdue for more than 90 days. How should it be treated under RBI norms?

An advance is assured by a State Government and instalment remains overdue for more than 90 days. How should it be treated under RBI norms?

1. It should always be treated as Standard for provisioning and income recognition until the guarantee is invoked.
2. It should be treated as Standard for provisioning but NPA for income recognition only.
3. It should be treated as NPA for both provisioning and income recognition. (correct answer)
4. It should be treated as a Loss asset immediately.

Answer: C — It should be treated as NPA for both provisioning and income recognition.

Explanation. The special treatment of treating a assured advance as Standard for provisioning but NPA for income recognition applies to Central Government guarantees not invoked or repudiated. For State Government assured advances, if overdue for more than 90 days, the advance is considered NPA for both provisioning and income recognition.

Where it goes wrong. Students apply the Central Government guarantee treatment to State Government guarantees.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 16 · 2 marks · Chapter 10: Audit of Banks · hard

Scenario. In a consortium lending arrangement, the borrower remits funds to the lead bank, but a member bank has not received its share of repayment. How should the member bank classify its share?

In a consortium lending arrangement, the borrower remits funds to the lead bank, but a member bank has not received its share of repayment. How should the member bank classify its share?

1. As Standard because the borrower has remitted funds to the lead bank.
2. As NPA based on the record of recovery in the member bank's books, until its share is received or express consent is obtained from the lead bank. (correct answer)
3. As Standard if the overall consortium account is serviced, irrespective of receipt by the member bank.
4. As a Loss asset immediately because the lead bank has retained the funds.

Answer: B — As NPA based on the record of recovery in the member bank's books, until its share is received or express consent is obtained from the lead bank.

Explanation. Consortium advances are classified based on the record of recovery of the respective member bank. If the borrower remits to the lead bank but the member bank does not receive its share, the account is treated as not serviced in the member bank's books and hence NPA. The member bank should arrange transfer of its share or obtain express consent from the lead bank.

Where it goes wrong. Students classify based on borrower-level remittance to the lead bank rather than recovery in the member bank's books.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 17 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. For a cash credit account with funded exposure exceeding Rs. 5 crore, what is the correct requirement regarding stock audit?

For a cash credit account with funded exposure exceeding Rs. 5 crore, what is the correct requirement regarding stock audit?

1. Stock audit is optional and may be avoided if the borrower submits monthly stock statements.
2. Stock audit is required only if the bank is the lead bank of the consortium.
3. Stock audit is required only for accounts classified as NPA.
4. Stock audit should be carried out by the bank, and where the bank is not the lead bank, the stock audit report should be obtained from the lead bank and reviewed. (correct answer)

Answer: D — Stock audit should be carried out by the bank, and where the bank is not the lead bank, the stock audit report should be obtained from the lead bank and reviewed.

Explanation. The chapter states that stock audit should be carried out by the bank for all accounts having funded exposure of more than Rs. 5 crore. Where the bank is not the leader of the consortium, the branch should obtain the stock audit report from the lead bank. The auditor should review the report, especially comments on security valuation and drawing power.

Where it goes wrong. Students think stock audit applies only to NPA accounts or only to the lead bank.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 18 · 2 marks · Chapter 10: Audit of Banks · hard

Scenario. A doubtful D2 account has outstanding of Rs. 200 lakh and realisable security of Rs. 120 lakh. What is the minimum provision required under RBI norms?

A doubtful D2 account has outstanding of Rs. 200 lakh and realisable security of Rs. 120 lakh. What is the minimum provision required under RBI norms?

1. Rs. 128 lakh (correct answer)
2. Rs. 80 lakh
3. Rs. 120 lakh
4. Rs. 200 lakh

Answer: A — Rs. 128 lakh

Explanation. For a doubtful asset under D2 category, provision is 40% of the secured portion plus all of the unsecured portion. Secured portion is Rs. 120 lakh, so 40% is Rs. 48 lakh. Unsecured portion is Rs. 80 lakh, so full is Rs. 80 lakh. Total provision is Rs. 128 lakh.

Where it goes wrong. Students apply 40% to the entire outstanding or forget full provision on the unsecured portion.

Authority. Banking Regulation Act 1949; RBI IRAC Norms

Question 19 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. Is Companies (Auditor's Report) Order, 2020 applicable to a banking company as defined in the Banking Regulation Act, 1949?

Is Companies (Auditor's Report) Order, 2020 applicable to a banking company as defined in the Banking Regulation Act, 1949?

1. Yes, it applies fully to all banking companies in addition to the bank audit report.
2. Yes, but only to private sector banks and not to public sector banks.
3. No, CARO 2020 is not applicable to a banking company. (correct answer)
4. Yes, but only for reporting on cash losses and internal audit.

Answer: C — No, CARO 2020 is not applicable to a banking company.

Explanation. The chapter specifically states that the reporting requirements relating to CARO 2020 are not applicable to a banking company as defined in clause (c) of Section 5 of the Banking Regulation Act, 1949. Bank audits are governed by banking-specific reporting requirements, LFAR and RBI directions.

Where it goes wrong. Students apply CARO 2020 to banks because it applies to companies generally.

Authority. CARO 2020; Section 5

Question 20 · 2 marks · Chapter 10: Audit of Banks · hard

Scenario. In the auditor's report of a nationalised bank to the Central Government, which of the following is required to be stated?

In the auditor's report of a nationalised bank to the Central Government, which of the following is required to be stated?

1. Only whether the financial statements are true and fair, with no other matters.
2. Whether the financial statements show a true and fair view, whether transactions noticed were within the powers of the bank, and whether returns from offices and branches were adequate for audit. (correct answer)
3. Only the number of unaudited branches and the CARO 2020 checklist.
4. Only the adequacy of internal financial controls over financial reporting and tax provisions.

Answer: B — Whether the financial statements show a true and fair view, whether transactions noticed were within the powers of the bank, and whether returns from offices and branches were adequate for audit.

Explanation. For a nationalised bank, the auditor reports to the Central Government on whether the financial statements present a true and fair view, whether transactions coming to notice were within the bank's powers, whether returns from offices and branches were adequate for audit, and any other matter requiring the Central Government's attention. CARO is not applicable to banking companies.

Where it goes wrong. Students reduce the nationalised bank audit report to only a true and fair opinion and omit statutory bank-specific assertions.

Authority. CARO