Interest Income
As a measure of control and also to ensure that the legal remedies against defaulting borrowers are not adversely affected, banks commonly follow the procedure of recording interest on non-performing advances in a separate account styled as ‘Interest Suspense’ or other similar account. Amounts lying in Interest Suspense Account do not represent income of the bank and have also to be deducted from the relevant advances. The auditor should also check whether, in terms of the income recognition guidelines issued by the RBI, the bank has either reversed or made provision in respect of interest accrued and credited to income account, in respect of an advance (including bills purchased and discounted) that becomes NPA as at the close of any year. Income in case of NPA account should be recognised only on realisation on cash basis as per RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/ 2015-16 dated 01/07/2015. These norms are also applicable to Government Guaranteed Advances.
In case of accounts under Corporate Debt Restructuring (CDR) scheme, the auditor should see whether the income on projects under implementation which have been classified as standard has been accounted for on accrual basis pursuant to the RBI’s income recognition norms. Banks are not permitted to recognize income on accrual basis from projects under implementation which have been classified as ‘sub–standard’ asset. Bank may recognize income in such accounts only on realisation on cash basis. Income in respect of Funded Interest and where loans are converted into equity, debentures or any other instrument is to be recognized on the same basis as in the case of restructuring and re-schedulement of loans.
The said norms also require that the banks should not recognise income from those projects under implementation which have been classified as sub-standard and it should be recognised only on cash basis. The auditor should also, accordingly, see whether any interest on such projects which has been recognised as income in the past is either reversed or a provision for an equivalent amount is made in the accounts.
The auditor may assess the overall reasonableness of the figure of interest earned by working out the ratio of interest earned on different types of assets to the average quantum of the respective assets during the year. The auditor should obtain an in-depth understanding as to how the bank’s management monitor their business, analyse its credit portfolio and the interest income thereon.
For example, the auditor may obtain from the bank an analysis of sector-wise and segment-wise deployment of credit, including the lending rates of advances in various sectors and figures of advances outstanding at the end of each month/quarter. From such information, the auditor may work out a weighted average lending rate. This analysis can be done for corporate and retail loan portfolio separately. In case of retail loans, the portfolio can be further bifurcated into home loans, auto loans, personal loans, jewel loans, etc. Further, the auditor should understand the process of computation of the average balance and re-compute the average balance on sample basis.
The auditor should set the expectation for the movement in yield based on the discussion and inquiries made with the management; rate movement observed in the industry, etc., and should obtain explanations for major variances in the yield on month on month basis or quarterly basis.
To ascertain completeness of interest income in the analysis, the auditor should obtain general ledger break-up for the interest income earned during the respective months/quarter and examine whether the aggregation of the same agrees with the interest income considered for the yield analysis. The auditor should analyse monthly/quarterly yields and document the reasons for the variances as per the expectation set. The auditor may also compare the average yield on advances with the corresponding figures for the previous years and analyse any material differences. The auditor may also compare the reported market yield in percentage terms with market rates, RBI rates, advertised rates and rates across various products of the bank. Interest Income includes interest accrued but not due on investments.
The auditor should, on a test check basis, verify the rates of interest as per terms of sanction in the CBS as well as the calculation of interest through product rate sheets generated by CBS to satisfy himself that –
(a) Interest has been charged on all the performing accounts upto the date of the balance sheet;
(b) Interest rates charged are in accordance with the bank’s internal regulations, directives of the RBI and agreements with the respective borrowers. The scrutiny of interest rates charged is particularly important in the case of advances made on floating interest rate basis;
(c) Discount on bills outstanding on the date of the balance sheet has been properly apportioned between the current year and the following year;
(d) Interest on inter–branch balances has been provided at the rates prescribed by the head office; and
(e) Any interest subsidy received (or receivable) from RBI in respect of advances made at concessional rates of interest is correctly computed.
The auditor should also understand the process of accrual of interest income on credit card portfolio. Credit card account will be treated as an NPA if the minimum amount due as stated in statement is not fully paid within 90 days from the date of last statement The auditor should understand the assumption taken for accrual of interest income such as revolving portfolio, standard assets etc. and independently assess the reasonableness of these assumptions.
The auditor should also satisfy himself that interest on non– performing assets has not been recognised unless realised.
As per AS 9, “Revenue Recognition”, dividends should be recognised when the right to receive payment is established, i.e. dividend has been declared by the corporate body at its Annual General Meeting and the owner’s right to receive payment is established. The auditor should test certain samples of the dividend income booked during the period by obtaining the counterfoils of dividend warrants and the amount credited in the bank account.
In the case of bill discounting, interest income is received in advance hence, the auditor should examine whether the interest income for the period has been accounted for properly and the balance is treated as other liabilities. In CBS, the interest on bill discounted is system driven and the auditor should verify the in-built logic of the system. For the sample cases, the auditor should verify the interest income on bill discounted by obtaining the underlying documents like purchase order, letter of credit, etc.
The auditor should also understand the process of increase or decrease in base rate and process of updating in the system. The auditor should also ascertain compliance with RBI guideline in respect of increase in tenor of retail loan due to increase in base rate. The auditor should also verify on sample basis to whether the increase/decrease in base rate are effected in the system on the effective date.
Interest income includes interest accrued but not due on assets. However, as banks normally debit the borrower’s account with interest due on the month end, at balance sheet date there would not usually be any amount of interest accrued but not due on advances on balance sheet date. Auditor should verify the same.The auditor should examine the completeness of accrual of the interest by obtaining a detailed break-up of the loan portfolio (scheme wise or segment wise) and the interest accrual on the same. The aggregation of loan portfolio should be agreed to the general ledger.
The auditor should examine whether interest has been accrued on the entire investment and money market lending portfolio by obtaining the detailed break-up of the investment and money market lending portfolio along with the interest accrued thereon and agree the same with the general ledger. The auditor should re-compute the interest accrual on sample basis considering parameters like frequency of payment of interest amount, rate of interest, period elapsed till the date of balance sheet, etc., from the term sheet, deal ticket, agreements, etc.
The auditor should obtain the list of the dividend income booked during the period and agree the total with the general ledger. Income on NPI should be realised on cash basis only. Income on Investments has been explained in detail in Chapter 10 of the Part III of the Guidance Note.
In determining the extent of sample checking, the auditor should take into account, inter alia, the results of the analytical procedures and the reports, if any,
on income and expenditure/ revenue audit as well as other internal and RBI inspection reports. The auditor’s assessment of the effectiveness of concurrent audit would also affect the extent of his detailed checking of interest earned. In determining the extent of sample checking, the auditor may place greater emphasis on examining interest on large advances.