Audit of Banks: formula sheet

Key formulas

Core idea: why bank audit differs

Public deposits + regulation + scale + IT + advances risk = special audit approach

Use this as the skeleton for any 'how is bank audit different' answer.

Banking Regulation Act, 1949

Governs banking companies: licensing, permitted business, capital, restrictions on loans, prescribed form of accounts, audit

Applies to banking companies; other banks are governed by their own statutes in addition to RBI norms.

RBI Act, 1934

Establishes RBI as regulator; RBI issues directions on reserves, asset classification, provisioning, reporting

RBI directions are a major source of audit criteria for advances and disclosures.

Form of financial statements

Balance sheet and profit and loss account in the form prescribed under the Banking Regulation Act (Third Schedule)

Not Schedule III of the Companies Act, 2013.

Bank audit structure

Central statutory auditors + branch auditors (statutory branch auditors, concurrent, internal and others)

The central auditor relies on branch reports but remains responsible for the opinion.

Control reliance logic

Stronger tested controls → lower control risk → less substantive testing; weaker controls → more substantive testing

This is the core reasoning for any answer on testing controls. Reliance needs testing of operating effectiveness, not just understanding.

Two types of IT controls

IT controls = General controls (environment) + Application controls (within the software)

Name both types in answers. General controls support the proper working of application controls.

Maker-checker

Maker enters the transaction; a different person (checker) verifies and authorises it

A key segregation of duties control in CBS. Never let one person do both for the same transaction.

IT general control areas

Access security + Program change + Data backup/recovery + IT operations

Use these four as a checklist when asked about the IT environment of a bank branch.

Inter-branch rule

Total of all inter-branch debit balances = Total of all inter-branch credit balances (net nil at bank level)

Any difference left at year-end is an unreconciled item. Check ageing and treatment of old entries.

Investment categories (RBI)

HTM = amortised cost; AFS = fair value, net change recognised in AFS reserve (OCI); HFT = fair value, changes to profit and loss

This follows the RBI (Classification, Valuation and Operation of Investment Portfolio of Commercial Banks) Directions, 2023, effective from 1 April 2024. HTM is carried at amortised cost: acquisition cost adjusted for amortisation of any premium or discount over the remaining life of the security, on the method the Directions prescribe. AFS and HFT are both fair valued. For AFS the net change goes to the AFS reserve (OCI), and the Directions prescribe how net unrealised losses in that reserve are dealt with, so check the Directions for the treatment. HFT changes go to profit and loss. The Directions also set conditions for HTM, including limits on its size, sales and transfers. Check the current limits in the latest Directions rather than relying on memory, and test compliance with them. State the category before discussing valuation.

Reconciliation check

Balance per bank's books ± reconciling items = Balance per RBI or other bank's statement

Use it for balances with RBI and other banks. List outstanding items and check their subsequent clearance.

Deposit interest check

Interest = recomputed using the scheme terms and RBI directions: cumulative deposits compounded at the scheme's frequency (commonly quarterly); non-cumulative deposits = Principal × Rate × Period for each payout interval; savings deposits on a daily product basis

Used to recompute interest on a sample of deposits. Apply the rate per annum from the bank's schedule on the bank's day-count basis, and check the period against the deposit dates, the type of deposit and the payout frequency in the scheme.

Governing format

Balance sheet = Form A; Profit and loss account = Form B (Third Schedule, Banking Regulation Act, 1949)

Remember A for the balance sheet, B for the profit and loss account.

Balance sheet identity

Total capital and liabilities = Total assets

Use it to check any balance sheet question that gives all items but one. Contingent liabilities and bills for collection are memorandum items outside these totals.

Net profit

Profit for the year = Total income − Total expenditure

Income is interest earned plus other income. Expenditure is interest expended, operating expenses, and provisions and contingencies.

Net interest income

Net interest income = Interest earned − Interest expended

A useful working number when a question asks you to analyse the spread.

Audit report vs LFAR

Audit report = opinion on true and fair view; LFAR = detailed answers on specific matters

Both are required for a bank. One does not replace the other.

Quick revision

• A bank is regulated by the RBI, so the audit must consider banking law as well as general audit law.
• Know the main types of bank audit and the purpose of each. Statutory central audit and statutory branch audit are statutory audits. Concurrent audit is an ongoing internal control audit prescribed by the RBI and done by firms the bank appoints. Internal audit and stock audit are other audits the bank arranges.
• Be clear on who appoints the auditor and what happens when the work is split between central and branch auditors.
• Internal controls in a bank depend heavily on technology, so IT general controls and application controls matter.
• Advances are the highest-risk area because of valuation, security and recognition of income.
• When an account becomes a non-performing asset (NPA), interest accrued and credited to income but not collected is reversed (derecognised) or provided for, and no further interest is recognised except on actual receipt, as per RBI IRAC norms.
• Learn the categories of asset classification and the reason for each.
• Provisioning depends on the asset category, so link classification to provision in every answer.
• For deposits, focus on completeness, authorisation and confirmation of balances.
• For investments, check classification, valuation, and existence of the holding.
• Know the structure of the bank's balance sheet and profit and loss account at heading level.
• In reporting, remember that the auditor gives an opinion on the financial statements and also reports on matters required by law. Know that the long form audit report (LFAR) is a separate, more detailed report in addition to the audit report.

Common mistakes

• Saying a bank's financial statements follow Schedule III of the Companies Act, 2013. Fix: Remember that banking companies use the form prescribed under the Banking Regulation Act, 1949, not Schedule III.
• Treating bank audit as the same as a company audit with a bigger scale. Fix: Add the special features: public deposits, RBI regulation, branch structure, IT systems, and advances classification.
• Treating understanding of controls as the same as testing them. Fix: Understanding means knowing design and implementation. Testing means checking operating effectiveness over the period. Write both separately.
• Confusing IT general controls with application controls. Fix: General controls cover the environment: access, change, backup, operations. Application controls work inside a specific program: validations, limits, auto-computation.
• Treating all investments at cost or all at market value. Fix: Always name the category first: HTM, AFS or HFT. Then state the valuation basis for that category.
• Writing only physical verification for investments. Fix: Securities are often in demat form or with a custodian. Include confirmation from the depository or custodian and reconciliation to the bank's records.
• Using the company Schedule III format for a bank balance sheet. Fix: Remember that banking companies follow the Third Schedule of the Banking Regulation Act, 1949, Forms A and B.
• Mixing up Form A and Form B. Fix: Link A with the balance sheet and B with the profit and loss account by their alphabetical order.

Exam tips

• Start theory answers with the law, then the feature, then the audit impact. Examiners look for this chain.
• For 'how does it differ' questions, give at least four distinct features, each with an effect.
• Do not cite section numbers unless you are sure. Plain-words rules are safe.
• MCQs often test which Act prescribes the format of bank accounts and who regulates banks. Learn these two facts cold.
• Revise this topic with the appointment and reporting topics, as they are frequently combined in case-style questions.
• Whenever a question mentions CBS, answer in two blocks: general controls and application controls. This covers the full marks structure.
• In MCQs, any option that suggests relying on controls with no testing, or skipping substantive work entirely, is nearly always wrong.
• Use the four-part skeleton Context, Controls, Procedure, Conclusion in written answers so each part earns step marks.