Auditing and Ethics · Special Features of Audit of Different Type of Entities

Audit of Banks: Central and Branch Auditors, LFAR, Advances and NPAs

Updated 5 October 2026 · Fact-checked

Bank audit is the statutory audit of a bank's financial statements. Central auditors audit the head office and consider branch auditors' reports; branch auditors audit selected branches. Advances, NPAs and income are the core areas. The central auditors also issue a Long Form Audit Report (LFAR) to the bank's Board of Directors, with a copy to RBI as per RBI instructions.

Understand Audit of Banks

A bank is not like an ordinary company. It handles public deposits, lends heavily, and is regulated by the Reserve Bank of India (RBI) under the Banking Regulation Act, 1949. Because of this, the audit has extra layers: regulatory approval, many branches, heavy reliance on IT systems, and special reporting.

Most banks have hundreds or thousands of branches, so one firm cannot audit everything. The bank's statutory central auditors (SCAs) are appointed for the whole bank. RBI issues eligibility and approval guidelines for statutory auditors of banks. For private and foreign banks, the appointment needs RBI approval. Public sector banks select their SCAs from the RBI-permitted list or panel of firms, under those RBI guidelines. Separate statutory branch auditors (SBAs) audit selected branches. They are appointed by the bank's management in consultation with the central auditors, within RBI guidelines. RBI approval does not apply in the same way to every auditor. Other branches are covered by the central auditors, or by the bank's own internal audit and inspection work, which the SCAs consider when planning. The central auditor forms the opinion on the bank's financial statements as a whole and relies on branch auditors' reports for the branches they audited, after reading them and acting on the points they raise.

The Long Form Audit Report (LFAR) is a detailed report on how the bank's operations and controls work. It is an RBI-prescribed report, in addition to the audit report on the financial statements. It is issued by the statutory central auditors and addressed to the bank's Board of Directors, with a copy to RBI as per RBI instructions. Branch auditors report on their branches as the reporting requirements prescribe, and the central auditor considers those branch reports and findings in preparing the bank-level LFAR. LFAR covers areas such as advances, investments, deposits, internal controls, income recognition and asset classification. Treat it as a structured questionnaire with answers backed by audit work.

The highest-risk areas are advances and NPAs. A bank earns most of its income from interest on loans. If a loan is wrongly shown as a standard asset, income is overstated and provisions are understated. So you check: sanction and documentation, security and its valuation, drawing power, repayment behaviour, and whether the account is classified correctly under RBI's income recognition, asset classification and provisioning (IRACP) norms.

In short: know who audits what, know that LFAR is a separate detailed report addressed to the Board, and know that advances, NPAs and income are the core audit areas, because they carry the largest risk of material misstatement.

Key rules to remember

NPA basic test: Loan facility: NPA if interest and/or instalment of principal remains overdue for more than 90 days; Under RBI norms, a loan facility becomes non-performing when interest or an instalment of principal stays unpaid and overdue beyond the prescribed period. For loan facilities, more than 90 days overdue is the core test. Cash credit and overdraft accounts have their own test, given next. Check the bank's current RBI circulars for other facilities.
Cash credit / overdraft NPA test: NPA if the account is out of order for more than 90 days; Out of order means outstanding balance continuously exceeds the sanctioned limit or drawing power, or there are no credits or insufficient credits to cover interest charged during the period.
Asset classification: Standard → Sub-standard → Doubtful → Loss; A standard asset is not an NPA, but it still carries a general provision under RBI norms. An asset enters the NPA part of this ladder as sub-standard when it becomes NPA under the 90-day tests above. A sub-standard asset is an NPA for a period not exceeding 12 months. A doubtful asset is one that has remained in the sub-standard category for 12 months, that is, an NPA for more than 12 months. A loss asset is one where loss has been identified by the bank, internal or external auditors or RBI inspection, but the amount has not been written off, wholly or partly. Such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted.
Income on NPAs: Interest on NPAs is not recognised as income on accrual; recognise only when actually received; Interest already accrued and unrealised on an account that turns NPA is reversed or provided for as per norms.
Division of audit responsibility: Central auditor: whole bank opinion and bank-level LFAR. Branch auditor: branch financial information and branch-level reporting; Branch auditors report on their branches. The central auditor considers those reports and findings in forming the overall opinion and in preparing the bank-level LFAR, which is an RBI-prescribed report.

How to solve Audit of Banks questions

Use this method for any bank audit question, whether it asks about appointment, LFAR, branch audit or an advances or NPA situation.

1Identify what is asked: who audits (central or branch), what is reported (audit report or LFAR), or which area (advances, NPA, income, deposits, investments).
2State the regulatory frame in one line: RBI norms, Banking Regulation Act, 1949 and the IRACP norms.
3State the rule or procedure in plain words, with its condition, for example a loan facility with interest or instalment overdue for more than 90 days, or a cash credit account out of order for more than 90 days.
4Apply it to the facts given. Pull out dates, amounts, security and account behaviour.
5Do the working if numbers are given, such as classification, income reversal or provision, and show each step.
6Conclude clearly: classification, reporting consequence, or required auditor action.
7Add the auditor's response if relevant: seek evidence, discuss with management, reflect in LFAR or modify the opinion if material.

Quickest way: Rule, facts, consequence in six lines

When to use it: Use for MCQs and for short 4-5 mark written answers when time is tight.

MCQs: spot the keyword. 'Overdue more than 90 days' points to NPA. 'Consolidates branch reports' points to central auditor. 'Detailed report on operations and controls' points to LFAR.
Eliminate options that mix roles, such as a branch auditor giving the opinion on the whole bank.
For classification MCQs, count days from the due date, not from the sanction date.
Written answer format: Provision (rule) – Facts – Conclusion. Put each on its own line so the examiner can award step marks.
For advances procedures, list in order: sanction and documents, security and valuation, drawing power, repayment record, classification, provisioning.
End with the audit impact: income overstated, provision short, report modified or LFAR comment.

Common mistakes in Audit of Banks

Saying the branch auditor gives the opinion on the bank's financial statements.
Students mix up who signs the report with who contributes to it.
Fix: Write that the central auditor forms and signs the overall opinion, using branch auditors' reports for branches they audited.
Treating LFAR as the same as the audit report.
Both have 'report' in the name and both are issued by the auditor.
Fix: Remember LFAR is a separate, detailed report on operations and controls, issued in addition to the audit report on the financial statements and addressed to the Board.
Counting 90 days from the date of sanction or disbursement.
Students rush and use the wrong starting date.
Fix: Count from the date the interest or instalment became due and remained unpaid.
Continuing to recognise interest income on an NPA account.
Students apply normal accrual accounting from Accounting Standards.
Fix: For NPAs, income is recognised only when received, as per RBI norms. Reverse unrealised accrued interest as required.
Checking only the loan balance and ignoring security and drawing power.
Advances are seen as a simple receivable.
Fix: Always verify documents, security existence and value, drawing power, and whether the account is regular. These decide classification and provision.
Ignoring the RBI role in appointment of bank auditors, or assuming it applies the same way to every auditor.
Students apply the general company-audit appointment process, or over-simplify the bank rule.
Fix: Write that RBI guidelines govern auditor eligibility. Statutory central auditors are appointed with RBI approval (private and foreign banks), while public sector banks select them from the RBI-permitted list or panel under those guidelines. Branch auditors are appointed by the bank's management in consultation with the central auditors, within RBI guidelines.

Worked examples

Example 1

A bank branch has a term loan of ₹40,00,000 where the quarterly instalment due on 30 June 2026 has not been paid. On 31 March 2027 the account is still unpaid. As the branch auditor, how do you treat the account and the interest income recognised after the due date?

Show the solution

Rule: a loan facility becomes an NPA when interest and/or instalment of principal remains overdue for more than 90 days.
Facts: the instalment fell due on 30 June 2026. Days after the due date: July 31 + August 31 + September 28 = 90, so the 90th day is 28 September 2026. The default continues till 31 March 2027, well beyond 90 days.
Conclusion on status: on 29 September 2026 the instalment becomes overdue for more than 90 days, so the account is an NPA from the day-end of 29 September 2026, when the bank's system-driven classification process runs. The exact date of recognition in the books depends on that day-end process, but the account is clearly an NPA on 31 March 2027.
Time in NPA: from about 29 September 2026 to 31 March 2027 is about six months, which is under 12 months, so it is a sub-standard asset. It would become a doubtful asset only after remaining sub-standard for 12 months, that is, after about 29 September 2027 if the default continues.
Income: interest accrued and not collected on this account after it turned NPA cannot stay as income. It should be reversed or not recognised, and recognised only when actually received.
Auditor action: check the bank's classification in its system, compare it with this analysis, and if the branch still shows it as standard, report the misclassification in your branch report to the central auditor and reflect the effect on income and provision, so that it can be considered in the bank-level LFAR.

Answer: The instalment is overdue for more than 90 days from 29 September 2026, so the account is classified NPA at the day-end of that date under the bank's system-driven process. It is sub-standard at 31 March 2027, and doubtful only after 12 months as sub-standard. Interest after it turned NPA is not recognised as income until received. A wrongly standard classification is a reportable misclassification.

Example 2

Distinguish between the roles of statutory central auditors and statutory branch auditors in a bank audit, and explain the purpose of the LFAR.

Show the solution

Provision: a bank is audited by central auditors appointed for the whole bank and by branch auditors for selected branches. RBI guidelines govern the appointment of central auditors: with RBI approval for private and foreign banks, and from the RBI-permitted list or panel under those guidelines for public sector banks. Branch auditors are appointed by the bank's management in consultation with the central auditors, within RBI guidelines.
Central auditors: audit the head office and consolidated accounts, consider branch auditors' reports, and form and sign the opinion on the bank's financial statements.
Branch auditors: audit the financial information of their branch, including advances, NPAs, income and controls, and report on the branch to the central auditor.
Interaction: the central auditor may give instructions to branch auditors, reads their reports, and acts on matters they raise.
LFAR: an RBI-prescribed, detailed report on how the bank's operations and internal controls work, in areas such as advances, deposits, investments and income. It is given in addition to the audit report on the financial statements, and is addressed to the bank's Board of Directors, with a copy to RBI as per RBI instructions.
Purpose of LFAR: it gives the Board and RBI a structured view of control weaknesses and compliance, based on audit work done at branches and head office.
Conclusion: the central auditor carries overall responsibility for the opinion and prepares the bank-level LFAR, considering the branch auditors' reports and findings, while branch auditors provide branch-level findings.

Answer: Central auditors give the overall opinion and issue the bank-level LFAR, considering branch auditors' reports. Branch auditors, appointed by the bank's management in consultation with the central auditors within RBI guidelines, report on their branches. LFAR is a separate, RBI-prescribed, detailed report on operations and controls, issued by the central auditors to the Board in addition to the audit report.

Exam tips

Write in the provision-facts-conclusion format. Examiners give step marks for stating the RBI rule before applying it.
In MCQs, link keywords to roles. 'Consolidates', 'overall opinion' means central auditor. 'Branch level', 'reports to central auditor' means branch auditor.
For advances questions, always mention security, drawing power and account behaviour, not just the overdue period.
When a numerical question gives dates, write the due date and the date on which 90 days end. For a due date of 30 June 2026, the 90th day is 28 September 2026, so the account is overdue for more than 90 days from 29 September 2026 and is classified NPA at the day-end of that date under the bank's system-driven process. Show the day count and avoid claiming more precision than the question gives. This protects step marks.
Mention the audit consequence at the end: misstated income, short provision, LFAR comment or modified opinion if material.

Practice questions from Special Features of Audit of Different Type of Entities

Audit of Banks in other exams

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

Audit of Banks: frequently asked questions

What is the difference between a central auditor and a branch auditor in a bank?

The central auditor is appointed for the whole bank, audits the head office, and gives the opinion on the bank's financial statements. A branch auditor audits a specific branch and reports on it, and the central auditor considers that report in forming the overall opinion.

What is LFAR in bank audit?

The Long Form Audit Report is an RBI-prescribed, detailed report on the bank's operations and internal controls, covering areas like advances, deposits, investments and income. It is issued in addition to the audit report on the financial statements. The central auditor prepares the bank-level LFAR, considering branch auditors' reports and findings, and addresses it to the bank's Board of Directors, with a copy to RBI as per RBI instructions.

How do you audit advances in a bank branch?

Check sanction and documentation, existence and value of security, drawing power, and repayment record. Then test whether the account is classified correctly under RBI norms and whether provisions and interest income are right. Report weaknesses in the LFAR input.

Why is interest on NPAs not recognised as income?

Because the borrower is not paying, the bank cannot be reasonably sure of collecting it. RBI norms therefore require recognition only when interest is actually received. Unrealised accrued interest is reversed as required.