Advanced Auditing, Assurance and Professional Ethics · Special Features of Audit of Banks & Non-Banking Financial Companies

Advances: Audit, NPA Classification and Provisioning

Updated 5 October 2026 · Fact-checked

Advances are a bank's loans and are its largest and riskiest asset. You audit them by checking sanction, documents, security, and repayment status. Then you apply IRAC norms: classify each account as standard, sub-standard, doubtful or loss, stop income on NPAs, and compute the required provision on the right base.

Understand Advances: Audit, NPA Classification and Provisioning

Advances are the main earning asset of a bank. They are also the area with the highest risk of misstatement. The risk is that loans are shown at full value and interest is booked as income when the borrower is not paying. That is why advances get the most audit time in a branch audit.

The RBI prescribes IRAC norms (Income Recognition, Asset Classification and Provisioning). Income recognition follows one idea: income on a non-performing asset is not recognised until it is actually received. Interest already charged to the account but not collected is reversed.

An advance becomes a Non-Performing Asset (NPA) when interest and/or an instalment of principal remains overdue for more than 90 days. This is the general test for term loans. Other account types have their own tests. NPAs are then placed in three categories: sub-standard, doubtful and loss. Everything else is a standard asset.

Sub-standard means the asset has been an NPA for up to 12 months. Doubtful means it has stayed sub-standard for more than 12 months. Loss means the loss has been identified (by the bank, internal or external auditors, or RBI inspection) but not fully written off. Once an account is classified as an NPA, it is upgraded to standard only when all arrears of interest and principal are paid by the borrower. This is subject to RBI rules on restructuring and resolution, which have their own conditions for upgrade.

Provisioning follows the category. The provision depends on the outstanding amount, the value of security, and, for doubtful assets, how long the asset has been doubtful. That period is counted from the date the asset is classified as doubtful, which is after 12 months as sub-standard. The auditor does not set the norms. The auditor checks that classification is correct, that security values are supportable, and that the provision is computed and booked properly. Note that the percentages below are the RBI's general norms. Verify them against the latest RBI Master Circular and the bank's own policy before answering a numerical question.

Key rules to remember

NPA test (general): Interest or instalment of principal overdue for more than 90 days → NPA; Special tests apply for overdraft/cash credit (out of order), bills purchased/discounted and agricultural advances. Use the test given in the question.
Out of order (CC/OD): Any one of these makes the account out of order, and so an NPA: (a) outstanding balance continuously exceeds the sanctioned limit or drawing power for more than 90 days; (b) no credits continuously for 90 days as on the balance sheet date; (c) credits during the previous 90 days are not enough to cover the interest debited during the same period; Each test is an alternative, so one is enough. Do not look only at the balance. Compare credits in the 90-day period with interest debited in that same period.
Sub-standard asset: NPA for a period of up to 12 months; Provision: 15% of outstanding on the secured portion. On the unsecured exposure, the general rate is 25%, but it is 20% for unsecured exposure in infrastructure loan accounts. If the question gives rates, use those.
Doubtful asset: Sub-standard for more than 12 months; The bands run from the date the asset is classified as doubtful, which is after 12 months as sub-standard. Secured portion: 25% (up to 1 year as doubtful), 40% (1 to 3 years as doubtful), 100% (more than 3 years as doubtful). Unsecured portion: 100%.
Loss asset: Loss identified but not fully written off; Provision: 100% of outstanding, or write off.
Standard asset provision: Provision as a percentage of outstanding standard advances, at the rate prescribed by RBI for the category; Rates differ by sector, such as agriculture, SME, commercial real estate. Use the rate given in the question.
Provision on doubtful asset: Provision = (Unsecured portion × 100%) + (Secured portion × applicable %); Unsecured portion = Outstanding − Realisable value of security.
Income recognition: NPA: interest recognised only when received; uncollected interest already booked is reversed; Reverse the amount credited to profit and loss but not collected.

How to solve Advances: Audit, NPA Classification and Provisioning questions

Use the same sequence for a theory answer or a numerical question on advances. It keeps your answer in provision-facts-conclusion form.

1Identify the type of account: term loan, cash credit/overdraft, bill, or agricultural advance. The NPA test depends on it.
2Apply the NPA test to the facts given. Count the days overdue from the due date to the balance sheet date.
3If it is an NPA, find its category by how long it has been NPA and whether the loss has been identified.
4Stop income recognition. Reverse unrealised interest already credited to profit and loss.
5Find the security value. Split the outstanding into secured and unsecured portions.
6Apply the provision percentage to each portion and add them.
7Compare with the provision the bank has made. State the shortfall or excess and its effect on profit.
8Write the conclusion: the audit procedure to adopt, whether to raise a query with management, and the effect on the report if the shortfall is material.

Quickest way: Four-line IRAC check

When to use it: Use this when time is short, especially in a 30% case-scenario MCQ or a short numerical.

Line 1: Is the account NPA? Check 90 days overdue (or out of order for CC/OD).
Line 2: Which category? Up to 12 months is sub-standard, more than 12 months is doubtful, identified loss is loss.
Line 3: Split outstanding into secured and unsecured. Apply the percentages.
Line 4: Compare with the bank's provision. The difference is the adjustment to profit and to advances (net).

Common mistakes in Advances: Audit, NPA Classification and Provisioning

Applying the provision percentage to the whole outstanding instead of the secured and unsecured portions separately.
Students remember a single percentage for each category.
Fix: Always first compute realisable security value. Provide 100% on the unsecured part of a doubtful asset, then the secured percentage on the rest.
Counting the 90 days from the date of sanction or the date the loan was disbursed.
The overdue period is confused with the age of the loan.
Fix: Count from the date the interest or instalment became due and remained unpaid.
Continuing to recognise interest on an NPA because the account is still being debited.
Systems debit interest automatically, so students treat the debit as income.
Fix: Income on an NPA is recognised only on receipt. Reverse the interest debited but not collected.
Upgrading an NPA after a small part payment.
Students think any recovery makes the account regular.
Fix: An NPA is upgraded to standard only when all arrears of interest and principal are paid by the borrower, subject to RBI rules on restructuring and resolution.
Accepting the security value in the bank's records without checking it.
The valuation looks official, so it is not challenged.
Fix: Check the date and source of valuation, ownership, charge creation, insurance and whether the valuation is stale. Reduce the security value if it is not supportable.
Writing only the rule in the answer and not the audit action.
Students treat this as a banking topic, not an audit topic.
Fix: End with what the auditor does: obtain evidence, discuss with management, and consider the effect on the audit report.

Worked examples

Example 1

You are auditing a branch of a bank. A term loan account has an outstanding balance of ₹80,00,000. Instalments have been overdue since 15 April 2025 and remain unpaid. The balance sheet date is 31 March 2026. No upgrade has occurred. The branch shows the account as a standard asset and has made no NPA provision. The security (a mortgaged property) has a supportable realisable value of ₹50,00,000. Compute the provision required, using the rates given in this question: 15% for the secured portion and 25% for the unsecured portion of a sub-standard asset.

Show the solution

Test: instalments have been overdue since 15 April 2025. The account is an NPA when it is overdue for more than 90 days. Day 90 is 14 July 2025, so the account becomes an NPA on the 91st day, about 15 July 2025, and it was not upgraded.
Category: from about 15 July 2025 to 31 March 2026 is less than 12 months, so it is a sub-standard asset, not standard.
Split outstanding: secured portion = ₹50,00,000. Unsecured portion = ₹80,00,000 − ₹50,00,000 = ₹30,00,000.
Provision on secured portion = 15% × ₹50,00,000 = ₹7,50,000 (rate as given in the question).
Provision on unsecured portion = 25% × ₹30,00,000 = ₹7,50,000 (rate as given in the question).
Total provision required = ₹7,50,000 + ₹7,50,000 = ₹15,00,000.
The branch has provided nil, so the shortfall is ₹15,00,000. Interest charged but not collected on this account must also be reversed.

Answer: The account is a sub-standard NPA. Required provision is ₹15,00,000 against nil made, so profit is overstated by ₹15,00,000 plus unrealised interest. Raise this with management and ask for an adjustment. If it is not made and it is material, consider a modified opinion.

Example 2

A branch has a cash credit account with sanctioned limit ₹40,00,000. The outstanding balance has continuously remained at ₹46,00,000 for more than 90 days up to the balance sheet date, and credits in the last quarter were less than the interest debited. The branch treats it as standard. What is the audit conclusion, and what procedures should you perform?

Show the solution

Identify the type: this is a cash credit account, so the 'out of order' test applies.
Test: the 'out of order' tests are alternatives, so one is enough. The balance has exceeded the sanctioned limit continuously for more than 90 days, which is sufficient on its own. Credits in the period also did not cover interest debited, which is a second test that is met. Here both are met, so the account is out of order.
Conclusion on status: the account is an NPA and cannot be shown as standard.
Category: it is newly an NPA, so it is sub-standard unless facts show an identified loss.
Income: reverse interest debited but not collected, and stop recognising further interest until received.
Procedures: obtain the account statement and sanction letter, check drawing power calculations and stock statements, review renewal and ad hoc limits, and check the latest security valuation.
Ask management to reclassify and compute the provision. Evaluate the misstatement against materiality.

Answer: The account is out of order, because the balance has stayed above the sanctioned limit for more than 90 days (and credits also fell short of interest debited). It must be classified as a sub-standard NPA. Income on it should be reversed, and provision should be made on the secured and unsecured portions. If the branch does not correct this and the effect is material, the auditor should consider reporting a modified opinion.

Exam tips

In theory answers, start with the rule, then the facts, then the conclusion and audit action. Examiners reward that order.
In MCQs, read the account type first. The same overdue days can mean different things for a term loan and a cash credit account.
In numerical questions, show the split between secured and unsecured portions in a clear table-like list, since marks follow the working.
Mention evidence in verification answers: sanction letter, loan agreement, charge documents, security valuation, stock statements, drawing power, confirmation from borrowers and recovery position.
Always state that you used the RBI norms applicable to the question. If a percentage is given in the question, use it even if it differs from your memory.

Practice questions from Special Features of Audit of Banks & Non-Banking Financial Companies

Advances: Audit, NPA Classification and Provisioning in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Advances: Audit, NPA Classification and Provisioning: frequently asked questions

What is the difference between sub-standard, doubtful and loss assets?

A sub-standard asset has been an NPA for up to 12 months. A doubtful asset has remained sub-standard for more than 12 months. A loss asset is one where the loss has been identified but the amount is not fully written off.

When does an advance become an NPA?

For a term loan, it becomes an NPA when interest and/or an instalment of principal stays overdue for more than 90 days. For a cash credit or overdraft, it becomes an NPA when the account is 'out of order' under the RBI tests: the limit or drawing power is exceeded continuously for more than 90 days, there are no credits for 90 days, or credits in the previous 90 days are not enough to cover the interest debited.

How do I verify advances during a bank branch audit?

Review sanction and documentation, test the security and its valuation, check drawing power and stock statements, and examine repayment history. Then test the NPA classification and the provision calculation on a sample, giving more weight to large and stressed accounts.

Is the provision percentage fixed for every question?

No. The percentages above are the general RBI norms. Sector-specific rates and updates exist, so use the rate given in the question or the latest RBI circular.