Audit of Non-Banking Financial Companies – CA Final Audit Question Bank

Audit of Non-Banking Financial Companies – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Audit of Non-Banking Financial Companies – CA Final Audit Question Bank

Question 1.
Shubham & Associates are going to start the audit of NBFCs. They have not performed much work for the NBFCs in the past years. You are required to explain the requirements related to registration and regulation of NBFCs which an auditor needs to keep in his mind while planning the audit of NBFC which would help this firm.
Answer:
Registration and regulation of NBFC;
Sec. 45-IA of RBI (Amendment) Act, 1997 provides that no NBFC is allowed to commence or carry on the business of a NBFC without
(a) obtaining a certificate of registration issued by the RBI.
(b) having a Net Owned Fund (NOF) ₹ 100 crores.

• The registration is required where the financing activity is a principal business of the company.
• Financial activity will be considered as principal business if the company’s financial assets constitute more than 50% of the total assets and income from financial assets constitute more than 50% of the gross income, A company which fulfils both these criteria is required to get itself registered as NBFC with RBI.
• However, to obviate dual regulation, certain categories of NBFC which are regulated by other regulators are exempted from requirement of registration with the RBI, for example: companies registered with SEBI or IRDA.
• The RBI has issued directions to NBFC on acceptance of public deposits, prudential norms, risk exposure norms & other measures to monitor financial solvency and reporting by NBFC.
• RBI also issued directions to auditors to report to the RBI, BOD and shareholders, any noncompliance with the RBI Act and regulations made by the RBI.

Question 2.
What are the different types of NBFCs registered with RBI?
or
Write short notes on Categories of Non-banking Finance Companies (NBFCs). [Nov.05 (4Marks)]
Answer:
Categories of NBFC:
RBI vide its circular classified the NBFC into following categories:

(a) Investment and Credit Company (ICC): Investment and Credit Company means any company which is a financial institution carrying on as its principal business – asset finance, the providing of finance whether by making loans or advances or otherwise for any activity other than its own and the acquisition of securities; and is not any other category of NBFC as defined by the RBI in any of its Master Directions.

(b) Infrastructure Finance Company: An IFC is defined as non-deposit taking NBFC that fulfils the specified criteria.

(c) Systemically Important Core Investment Company: Companies which carry on the business of acquisition of shares and securities in group companies.

(d) Infrastructure debt Fund-NBFC: IDF-NBFC is a company registered as NBFC to facilitate the flow of long term debt into infrastructure projects. IDF-NBFC raise resources through issue of Rupee or Dollar denominated bonds of minimum 5 year maturity.

(e) NBFC-Micro Finance Institution: A non-deposit NBFC that fulfils prescribed conditions.

(f) Non-Banking Financial Company – Factors (NBFC-Factors): A non-deposit taking NBFC engaged in the principal business of factoring. The financial assets in the factoring business should constitute at least 50% of its total assets and its income derived from factoring business should not be less than 50% of its gross income. ,

(g) Non-Operative Financial Holding Company (NOFHC): A non-deposit taking NBFC, which holds the shares of a banking company and the shares of all other financial services companies in its group, whether regulated by the Bank or by any other financial regulator, to the extent permissible under the applicable regulatory prescriptions.

Question 3.
Write short note on: Infrastructure Finance Companies.
Answer:
Infrastructure Finance Companies (IFC):
An IFC is defined as non-deposit taking NBFC that fulfils the criteria mentioned below:

1. a minimum of 75 percent of its total assets should be deployed in infrastructure loans;
2. Net owned funds of ₹ 300 crores or above;
3. minimum credit rating ‘A or equivalent of CRISIL, FITCH, CARE, ICRA or equivalent rating by any other accrediting rating agencies;
4. Capital to Risk Asset Ratio (CRAR) of 15%.

Question 4.
You are the auditor of IJK Ltd., a NBFC registered with RBI. How would you proceed to ensure the compliance of Prudential Norms directions by it. [Nov. 08 (4 Marks)]
Or
As an auditor of a non-banking financial company registered with RBI, what are the prudential norms of RBI, whose compliance is to be verified. [Nov. 12 (6 Marks)]
Or
You are the auditor of MP Ltd., a NBFC registered with RBi as an Investment Company. How would you proceed to ensure the “Compliance of Prudential Norms Directions” by MP Ltd.? [Nov. 18-Old Syllabus [4 Marks)]
Answer:
Compliance of Prudential Norms by NBFC

1. Prudential Norms: The auditor has to verify the compliance of prudential norms relating to
   1. income recognition;
   2. Income from investments;
   3. Asset classification;
   4. Provision for bad & doubtful debts;
   5. Capital adequacy norm;
   6. Prohibition of granting loans against its own shares;
   7. Prohibition on loans & investments for failure to repay public deposits &
   8. Norms for concentration of credit etc.
2. Policy for demand Loans: The auditor shall ensure that Board of the NBFC shall frame a policy for granting demand/call loans and implement the same.
3. Classification of Advances: The auditor should verify the classification of advances and loans as standard/substandard/doubtful/loss and that proper provision has been made in accordance with the directions.
4. Income from NPA: Auditor should ensure that unrealised income from non-performing assets has not been taken to profit and Loss Account.
5. Recovery in NPA Accounts: The auditor should check all NPAs of the previous years to verify whether during the current year any payments have been received or still they continue to be NPA during the current year also.

Additional Verification point in case of investment company:
In case of Investment Company, NBFC Prudential Norms stipulates the following:

• NBFCs should not lend more than 15% of its owned funds to any single borrower and not more than 25% to any single group of borrower.
• The ceiling on investments in shares by a NBFC in a single entity and the aggregate of investments in a single group of entities has been fixed at 15% and 25% respectively.
• Moreover, a composite limit of credit to and investments in a single entity/group of entities has been fixed at 25% and 40% respectively of the owned fund of the concerned NBFC.

Auditor is required to verify that the credit facilities extended and investments made by the concerned NBFC are in accordance with the prescribed ceiling.

Question 5.
You are the auditor of ABC Ltd., a NBFC registered with RBI. How would you proceed to ensure the compliance of Public Deposit Directions by it.
Answer:
Compliance of Public Deposit Direction by NBFC:

1. Credit Rating: Obtain a copy of the credit rating assigned to NBFC and check whether the public deposits accepted/held by it are in accordance with the level of credit rating assigned to it.
2. Interest and Brokerage payments: Test checks the interest and brokerage calculations to ascertain that the NBFC has not paid in excess.
3. Written Application: Examine whether the NBFC has accepted or renewed any public deposit only after a written application form the depositor in the specified form.
4. Deposit Register: Verify the deposit register maintained by a NBFC and test check the particulars that have been entered therein in respect of each depositor with supporting receipts issued to the depositors.
5. Repayment of deposits: Check whether the NBFC is regularly paying its deposits on due dates.
6. Custody of investments: Check whether the investments made in approved liquid assets have been lodged in safe custody with a designated bank. Obtain a certificate from the bank to that effect.
7. Submission of Accounts: Ascertain whether audited statement of accounts together with a copy of the auditor’s report and director’s report thereon have been submitted within prescribed time limit from the date of holding the AGM.
8. Filing of Annual return: Check whether the NBFC has filed its annual return in specified time.
9. Board Resolution in case of non-acceptance of public deposits: In case, NBFC is not accepting/ holding public deposits, check whether a board resolution has been passed by the NBFC to the effect that it has neither accepted any public deposits nor would it accept any public deposits during the year.

Question 6.
Write short note on: Classification of Frauds by NBFC. [May 14 (4 Marks), RTP-May 19, Nov. 20]
Or
Under what heads can the frauds committed by Non-Banking Financial Companies (NBFCs) be classified? [Nov. 17 (5 Marks)]
Answer:
Classification of Frauds by NBFC:
In order to have uniformity in reporting, frauds have been classified as under based mainly on the provisions of the Indian Penal Code:-

(a) Misappropriation and criminal breach of trust.

(b) Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts and conversion of property.

(c) Unauthorised credit facilities extended for reward or for illegal gratification.

(d) Negligence and cash shortages. Reporting as fraud is required only if the intention to cheat/ defraud is suspected/proved. However, if fraudulent intention is not suspected/proved, at the time of detection, cases of negligence and cash shortage will be treated as fraud and reported, if:

• Cash shortages are more than ₹ 10,000/- and
• Cash shortages are more than ₹ 5000/- and detected by management/auditor/inspecting officer and not reported on the occurrence by the persons handling cash.

(e) Cheating and forgery.

(f) Irregularities in foreign exchange transactions. Reporting as fraud is required only if the intention to cheat/defraud is suspected/proved.

(g) Any other type of fraud not coming under the specific heads as above.

“ICAI Examiner Comments”
Though examinees pointed out the various classification of frauds by NBFC but few examinees failed to explain the manner of reporting in cases where fraudulent intention is suspected and proved. Some examinees wrongly mentioned general types of frauds committed by corporates. ,

Question 7.
Ram and Associates, a firm of Chartered Accountants, are the auditors of NBFC (Investment and Credit Company). Some of the team members of the audit team who audited this NBFC have left the firm and the new team members are in discussion with the previous team members who are still continuing with the firm regarding the verification procedures to be performed.

In this context, please explain what verification procedures should be performed in relation to audit of NBFC – Investment and Credit Company (NBFC-ICC). [MTP – Oct. 19, RTP-Nov. 19]
Answer:
Audit of NBFC – Investment and Credit Companies:

(A) Points related in Investments:

(i) Physical Verification: Auditor should physically verify the securities held by a NBFC. Where any security is lodged with an institution or a bank, a certificate from the bank/institution to that effect must be verified.

(ii) Income recognition: Verify that dividend income wherever declared by a company, has been duly received and accounted for. NBFC Prudential Norms directions require dividend income on shares of companies and units of mutual funds to be recognised on cash basis.

(iii) Authorisation: Verify the Board Minutes for purchase and sale of investments.

(iv) Classification: Ascertain from the Board resolution or obtain a management certificate to the effect that the investments so acquired are current investments or Long Term Investments.

(v) Valuation: Check whether the investments have been valued in accordance with the NBFC Prudential Norms Directions and adequate provision for fall in the market value of securities, wherever applicable, have been made there against, as required by the Directions.

(vi) Compliance of AS 13: An auditor will have to ascertain whether the requirements of AS 13 “Accounting for Investments” or other accounting standard, as applicable, (to the extent they are not inconsistent with the Directions) have been duly complied with by the NBFC.

(vii) External Confirmations: In respect of shares/securities held through a depository, obtain a confirmation from the depository regarding the shares/securities held by it on behalf of the NBFC. Obtain a confirmation from the approved intermediary regarding securities deposited with/borrowed from it as at the year end.

(B) Point related to Credit:

(i) Sanctioning: Auditor should examine whether each loan or advance has been properly sanctioned. He should verify the conditions attached to the sanction of each loan or advance
i. e. limit on borrowings, nature of security, interest, terms of repayment, etc.

(ii) Security: Auditor should verify the security obtained and the agreements entered into, if any, with the concerned parties in respect of the advances given. He must ascertain the nature and value of security and the net worth of the borrower/guarantor to determine the extent to which an advance could be considered realisable.

(iii) Loan against own shares: Verify whether the NBFC has not advanced any loans against the security of its own shares.

(iv) Compliance of prudential norms: Check whether the NBFC has not lent/invested in excess of the specified limits to any single borrower or group of borrowers as per NBFC Prudential Norms Directions.

(v) Appraisal and follow up System: Auditor should verify whether the NBFC has an adequate system of proper appraisal and follow up of loans and advances. In addition, he may analyse the trend of its recovery performance to ascertain that the NBFC does not have an unduly high level of NPAs.

(vi) Classification: Check the classification of loans and advances (including bills purchased and discounted) made by a NBFC into Standard Assets, Sub-Standard Assets, Doubtful Assets and Loss Assets and the adequacy of provision for bad and doubtful debts as required by NBFC Prudential Norms Directions.

Question 8.
Write short note on: Matters to be included in Auditor’s Report in case of NBFC not accepting deposits. (May 16 (4 Marks)
Or
What are the specific Matters to be included in Auditor’s Report in an audit of NBFC not accepting public deposits. [May 17 (4 Marks)]
Answer:
Matters to be included in Auditor’s Report in case of NBFC:

In addition to the Report made by the auditor u/s 143 of the Companies Act, 2013, the auditor shall also make a separate report to the Board of Directors of the Company on the matters as specified in paragraph 3 of the NBFCs Auditor’s Report (Reserve Bank) Directions, 2016:

Matters to be reported in case of all NBFC – Para 3

1. Whether the company has obtained a Certificate of Registration (CoR) from the Bank. (Conducting Non-Banking Financial Activity without a valid CoR is an offence under the RBI Act, 1934)
2. In case of a company holding CoR issued by the Bank, whether that company is entitled to continue to hold such CoR in terms of its Principal Business Criteria (Financial asset/income pattern) as on March 31 of the applicable year.
3. Whether the NBFC is meeting the required net owned fund requirement as laid down in Directions issued by RBI.

Matters to be reported in case of NBFC not accepting public deposits – Para 3

(i) Whether the Board of Directors has passed a resolution for non-acceptance of any public deposits;

(ii) Whether the company has accepted any public deposits during the relevant period/year.

(iii) Whether the company has complied with the prudential norms relating to income recognition, accounting standards, asset classification and provisioning for bad and doubtful debts as applicable to it;

(iv) In respect of Systemically Important Non-deposit taking NBFCs:

(a) Whether the capital adequacy ratio as disclosed in the return submitted to the Bank, has been correctly arrived at and whether such ratio is in compliance with the minimum CRAR prescribed by the Bank;
(b) Whether the company has furnished to the Bank the annual statement of capital funds, risk assets/exposures and risk asset ratio within the stipulated period.

(v) Whether the NBFC has been correctly classified as NBFC Micro Finance Institutions (MFI).

“ICAI Examiner Comments”
Majority of candidates failed to discuss the disclosure of Capital adequacy ratio/risk asset ratio in respect of Systemically Important Non-deposit taking NBFCs.

Question 9.
What are the obligations of auditor to submit Exception Report to RBI in case of non-banking financial companies? [Nov. 16 (4 Marks)]
Or
Sudhir and Associates, a firm of Chartered Accountants, was appointed as auditor of an NBFC. The audit work has been completed. The audit team which was involved in the fieldwork came across various observations during the course of a uait of this NBFC and have also an limited understanding about the exceptions which are required to be reported in the audit report. They would like to understand in detail regarding the obligations on the part of an auditor in respect of exceptions in his report so that they can conclude their work. Please explain. [MTP-May 20]
Answer:
Obligation of Auditor to submit exception report to RBI:
Para 5 of NBFC Auditor’s Report (Reserve Bank) Directions, 2008 provides that Where, in the case of a NBFC, the statement regarding any of the items referred to in para 3, is unfavourable or qualified, or in the opinion of the auditor the company has not complied with:

(a) the provisions of Chapter IIIB of Reserve Bank of India Act, 1934; or
(b) the NBFC Acceptance of Public Deposits (Reserve Bank) Directions, 2016; or
(c) NBFC-Non-SystemicallylmportantNon-DeposittakingCompany(Reserve Bank) Directions,2016 and NBFC-Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016
it shall be the obligation of the auditor to make a report containing the details of such unfavourable or qualified statements and/or about the non-compliance, as the case may be, in respect of the company to the concerned Regional Office ofthe Department of Non-Banking Supervision of the Bank under whose jurisdiction the registered office of the company is located.

Note: Duty of the Auditor to submit exception report’shall be to report only the contraventions of the provisions of RBI Act, 1934, and Directions, Guidelines, instructions and such report shall not contain any statement with respect to compliance of any of those provisions.

Question 10.
The RBI restrict companies from carrying on the business of a non-banking financial institution without obtaining the certificate of registration, therefore, obtaining registration under section 45-1A of the Reserve Bank of India Act, 1934 is necessary. Additionally, new clause has been inserted under CARO, 2020 for commenting whether the registration has been obtained, if required.
You are required to state the audit procedure and reporting to be followed under above mentioned circumstances.
Or
In the case of companies carrying on the business of a non-banking financial institution the auditor needs to report under CARO, 2020 whether the registration has been obtained under section 45-IA of the Reserve Bank of India Act, 1934, if required.
You are required to state in brief the audit procedure to be followed while reporting under above ‘ mentioned circumstances.
Or
Abhimanyu Finance Ltd. is a Non Banking Finance Company and was in the business of accepting public deposits and giving loans. The company was having net owned funds of ₹ 1,50,00,000 (one crore fifty lakhs) and was not having registration certificate from RBI and applied for it on 30th March 2021. The company appointed Mr. Kabra as its statutory auditors for the year 2020-21.

Advise the auditor with reference to auditor procedures to be taken and reporting requirements on the same in view of CARO 2020? [MTP-March 19]
Answer:
Audit Procedure for reporting under CARO, 2016 w.r.t. registration u/s 45-IA of RBI Act, 1934:
Clause (xvi) of Paragraph 3 of CARO, 2020 requires the company auditor to report:”Whether the company is required to be registered under Section 45-IA of the RBI Act, 1934 and if so, whether the registration has been obtained”.

Sec. 45-IA of RBI (Amendment) Act, 1997 provides that no NBFC is allowed to commence or carry on the business of a NBFC without obtaining a certificate of registration from RBI. The registration is required where the financing activity is a principal business of the company.

Audit Procedure and Reporting

1. Examine the transactions of the company with relation to the activities covered under the RBI Act and directions to determine whether the company is engaged in financial activity.
2. Auditor should examine the financial statements to ascertain whether company’s financial assets constitute more than 50 per cent of the total assets and income from financial assets constitute more than 50 per cent of the gross income.
3. Ascertain whether the net owned funds of the company exceeds such amount so as to require the company to get itself registered as NBFC with RBI.
4. Ascertain whether the company has obtained the registration as NBFC, if not, the reasons should be sought from the management and documented.
5. Auditor’s Report under CARO, 2020 shall incorporate the following:
   • Whether the registration is required under section 45-IA of the RBI Act, 1934.
   • If so, whether it has obtained the registration.
   • If the registration not obtained, reasons thereof.

Question 11.
Mr. G has been appointed as an auditor of LMP Ltd., a NBFC company registered with RBI. Mr. G is concerned about whether the format of financial statements prepared by LMP Ltd. is as per notification issued by the Ministry of Corporate Affairs (MCA) dated October 11, 2018. The notification prescribed the format in Division III under Schedule 111 of the Companies Act, 2013 applicable to NBFCs complying with lnd-AS. Mr. G wants to know the differences in the presentation requirements between Division 11 and Division III of Schedule III of the Companies Act, 2013. Help Mr. G. [Nov. 19 – New Syllabus (5 Marks)]
Or
Write a short note on: Differences between Division 11 (Ind- AS- Other than NBFCs) and Division III (Ind- AS- NBFCs) of Schedule III. [RTP-May 20]
Answer:
Differences between Division II and Division III:
The presentation requirements under Division III for NBFCs are similar to Division II (Non NBFC) to a large extent except for the following:

(a) NBFCs have been allowed to present the items of the balance sheet in order of their liquidity which is not allowed to companies required to follow Division II. Additionally, NBFCs are required to classify items of the balance sheet into financial and non-financial whereas other companies are required to classify the items into current and non-current.

(b) An NBFC is required to separately disclose by way of a note any item of other income’ or ‘other expenditure’ which exceeds 1% of the total income. Division II, on the other hand, requires disclosure for any item of income or expenditure which exceeds 1% of the revenue from operations or ₹ 10 lakhs, whichever is higher.

(c) NBFCs are required to separately disclose under ‘receivables’, the debts due from any Limited Liability Partnership (LLP) in which its director is a partner or member.

(d) NBFCs are also required to disclose items comprising ‘revenue from operations’ and ‘other comprehensive income’ on the face of the Statement of profit and loss instead of showing those only as part of the notes.