Contingent Liabilities
In respect of contingent liabilities, the auditor is primarily concerned with seeking reasonable assurance that all contingent liabilities are identified and properly valued. To this end, the auditor should, generally follow the audit procedures given below:
(a) The auditor should verify whether there exists a system whereby the non fund based facilities to parties are extended only to their regular constituents, etc.
(b) Ascertain whether there are adequate internal controls to ensure that transactions giving rise to contingent liabilities are executed only by persons authorised to do so and in accordance with the laid down procedures.
(c) The auditor should also examine whether in case of LCs for import of goods, as required by the above mentioned Master Circular on guarantees and co-acceptances, the payment to the overseas suppliers is made on the basis of shipping documents and after ensuring that the said documents are in strict conformity with the terms of LCs.
(d) Ascertain whether the accounting system of the bank provides for maintenance of adequate records in respect of such obligations and whether the internal controls ensure that contingent liabilities are properly identified and recorded.
(e) Performs substantive audit tests to establish the completeness of the recorded obligations. Such tests include confirmation procedures as well as examination of relevant records in appropriate cases.
(f) Review the reasonableness of the year-end amount of contingent liabilities in the light of previous experience and knowledge of the current year’s activities.
(g) Review whether comfort letters issued by the bank has been considered for disclosure of contingent liabilities.
(h) Obtain representation from the management that:
(i) all contingent liabilities have been disclosed;
(ii) the disclosed contingent liabilities do not include any contingencies which are likely to result in a loss/ expense and which, therefore, require creation of a provision in the financial statements;
(iii) the estimated amounts of financial effect of the contingent liabilities are based on the best estimates in terms of Accounting Standard 29, including any possibility of any reimbursement;
(iv) in case of guarantees issued on behalf of the bank’s directors, the bank has taken appropriate steps to ensure that adequate and effective arrangements have been made so that the commitments would be met out of the party’s own resources and that the bank will not be called upon to grant any loan or advances to meet the liability consequent upon the invocation of the said guarantee(s) and that no violation of section 20 of the Banking Regulation Act, 1949 has arisen on account of such guarantee; and
(v) Such contingent liabilities which have not been disclosed on account of the fact that the possibility of their outcome is remote include the management’s justification for reaching such a decision in respect of those contingent liabilities.
(i) The auditor should also examine whether the bank has given any guarantees in respect of any trade credit (buyer’s credit or seller’s credit)*
The period of guarantees is co-terminus with the period of credit reckoned from the date of shipment.
(j) Verify whether the bank has extended any non-fund facility or additional/ad hoc credit facilities to persons other than its regular customers. In such cases, auditor should examine the existence of concurrence of existing bankers of such borrowers and enquire regarding financial position of those customers.
The specific procedures to be employed by the auditor to verify various items of contingent liabilities are discussed in the following paragraphs. It may be noted that many of the items discussed in the following paragraphs, may be designated in foreign currencies.