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

Audit of Non-Banking Financial Companies (NBFCs) for CA Inter

Updated 5 October 2026 · Fact-checked

An NBFC is a company registered with the RBI that lends, invests or finances but does not hold a banking licence. Its auditor checks the financial statements against the Companies Act and RBI directions, tests income recognition, asset classification and provisioning, and reports on compliance, including matters the RBI requires.

Understand Audit of Non-Banking Financial Companies (NBFCs)

A Non-Banking Financial Company (NBFC) is a company that does financial business such as loans, hire purchase, leasing or investing in securities. It cannot accept demand deposits like a bank and is not part of the payment and settlement system as a bank is. It needs registration with the Reserve Bank of India (RBI), which regulates it.

Because NBFCs are companies, the Companies Act, 2013 applies. Division III of Schedule III applies to NBFCs required to follow Ind AS. Division II applies to other Ind AS companies that are not NBFCs. NBFCs that follow Accounting Standards use Division I, like other non-Ind AS companies. On top of this, the RBI issues directions on capital, asset classification, provisioning, governance and reporting. The auditor must check compliance with both layers.

The core audit risk is the loan book. The RBI requires NBFCs to classify assets by how long dues stay overdue and to provide for losses. Income on a non-performing asset cannot be freely recognised. So the auditor spends most effort on whether assets are classified correctly, whether income is recognised only when it should be, and whether provisions are adequate.

NBFCs that apply Ind AS (based on net worth thresholds set by the regulations) compute loan loss allowances using the expected credit loss model, and the RBI also requires comparing that with the regulatory prudential provision. Smaller NBFCs follow the Accounting Standards. Check which framework your question gives you.

The auditor also has reporting duties. Along with the audit report under SA 700 and Section 143, the auditor gives the reports and certificates the RBI directions require, for example on registration status, the capital adequacy ratio and compliance with the directions. Where the auditor finds a serious breach, such as a material non-compliance, the direction expects it to be reported to the RBI. Learn these as a checklist: framework, asset quality, income, provisioning, capital, reporting.

Key rules to remember

Standard asset (broad rule): Asset not overdue beyond the NPA threshold = Standard asset; A standard asset carries a general provision. For an NBFC that follows Accounting Standards, the rate depends on the category of NBFC, and some categories have rates other than 0.40%. NBFCs that follow Ind AS do not use a fixed rate. They compute expected credit loss (ECL). Use the rate given in the question.
Non-performing asset (NPA): Asset with principal or interest overdue for more than 90 days = NPA; Under the current RBI directions, overdue of more than 90 days makes an asset an NPA; use the days stated in the question.
Classification of NPAs: Sub-standard → Doubtful → Loss; Sub-standard: NPA for up to 12 months. Doubtful: sub-standard for more than 12 months. Loss: an asset identified as a loss by the NBFC, its internal or external auditor or the RBI, to the extent not written off.
Income recognition: Income on NPA = recognised only when actually received; Interest and other income on an NPA is not taken to profit on accrual. Interest accrued earlier but not collected is reversed or provided for.
Provision for loss assets: Provision for loss assets = 100% of outstanding; Apply this where the asset is a loss asset, to the extent not written off.
Provision for doubtful assets: Provision = 100% of unsecured portion + a percentage of secured portion by age; The secured-portion percentage depends on how long the asset has been doubtful. Use the rates in the question.
Provision for sub-standard assets: Provision = 10% × total outstanding (RBI prescribed rate for sub-standard assets of NBFCs); RBI prescribes 10% of the total outstanding for sub-standard assets of NBFCs. The rate given in the question prevails. NBFCs that follow Ind AS apply ECL instead. Any shortfall of ECL below the regulatory provision is transferred to an impairment reserve.
Net NPA: Net NPA = Gross NPA − provisions held for NPAs; This is a simplified measure. Use it with the definition given in the question.

How to solve Audit of Non-Banking Financial Companies (NBFCs) questions

Use this order for any NBFC audit question, whether it asks for audit procedures, classification and provisioning, or reporting.

1Identify the entity and framework: is it an NBFC registered with the RBI, and does it follow Ind AS or the Accounting Standards? State this first. Division III of Schedule III applies to NBFCs required to follow Ind AS; Division II applies to other Ind AS companies that are not NBFCs; NBFCs following Accounting Standards use Division I.
2List the two sources of requirements: the Companies Act, 2013 with Schedule III, and the RBI directions. Say the auditor checks both.
3For loans, find the days overdue and classify each asset as standard, sub-standard, doubtful or loss. Show the date test clearly.
4Apply income recognition: stop accruing income on NPAs and recognise it only on receipt. Reverse accrued but unrecovered income as needed.
5Compute the provision using the rates given in the question and the security available. Show the working line by line.
6State the auditor's procedures: verify ageing, test security valuation, check board-approved policies, and review the capital adequacy position.
7Conclude with reporting duties: the audit report under SA 700 and Section 143, plus the reports and certificates the RBI directions require, and reporting serious non-compliance to the RBI.
8Close with a one-line conclusion that answers the exact question asked.

Quickest way: Classify, compute, then report

When to use it: Use this when time is short, in both MCQs and written answers on NBFCs.

For MCQs, look for the trigger words: 90 days, NPA, income on receipt, loss asset 100%. These identify the correct option fast.
Eliminate options that say income on NPAs is recognised on accrual, or that use a threshold different from the one in the question.
For a numerical, write the table: asset, outstanding, category, provision rate, provision. Total at the end.
For theory, use the format: provision, facts, conclusion. Start with the RBI requirement, apply it to the facts, then state the auditor's action.
Write two or three bullet points on reporting at the end of every NBFC answer. These pick up easy step marks.

Common mistakes in Audit of Non-Banking Financial Companies (NBFCs)

Treating an NBFC like a bank and using bank NPA rules without checking the framework.
Both use the 90-day idea and the same words, so the two topics blur together.
Fix: Open the answer by naming the entity as an NBFC and the RBI directions applicable to NBFCs. Keep bank audit notes separate.
Recognising interest on an NPA on accrual basis.
Students apply the normal accrual concept without remembering the prudential exception.
Fix: Write: income on NPA is recognised only when received. Reverse accrued unrecovered income.
Applying the provision percentage to the wrong base.
Doubtful assets have a secured and an unsecured portion, and students apply one rate to the whole.
Fix: Split the outstanding into secured and unsecured parts first, then apply each rate.
Forgetting the auditor's reporting to the RBI and mentioning only the audit report.
Students focus on SA 700 and ignore sector-specific reporting.
Fix: Add a short paragraph on the RBI-required reports, certificates and reporting of material non-compliance.
Calling a loan overdue beyond 90 days a sub-standard asset for 'more than 12 months'.
Mixing up the age at which an asset becomes an NPA with the age at which it becomes doubtful.
Fix: Remember: overdue beyond 90 days makes it an NPA (sub-standard); more than 12 months as sub-standard makes it doubtful.

Worked examples

Example 1

An NBFC that follows Accounting Standards (not Ind AS) has the following loans at year end. Use the provision rates given here, including 0.40% for standard assets: standard assets ₹50,00,000 at 0.40%; sub-standard assets ₹8,00,000 at 10%; loss assets ₹1,50,000 at 100%. Compute the total provision required.

Show the solution

The question states the NBFC follows Accounting Standards, so a fixed standard asset rate applies. The 0.40% is the rate given in the question.
Standard assets: ₹50,00,000 × 0.40% = ₹20,000.
Sub-standard assets: ₹8,00,000 × 10% = ₹80,000.
Loss assets: ₹1,50,000 × 100% = ₹1,50,000.
Total = ₹20,000 + ₹80,000 + ₹1,50,000 = ₹2,50,000.
The auditor would check the ageing behind each category and compare the provision with the amount in the books.

Answer: Total provision required is ₹2,50,000, on the rates stated in the question for an NBFC following Accounting Standards.

Example 2

During the audit of an NBFC you find a loan where interest has been overdue for 120 days, yet the NBFC has continued to credit accrued interest of ₹40,000 to profit. What should you conclude and report?

Show the solution

Rule: under the RBI directions an asset is treated as an NPA when dues are overdue for more than 90 days.
Facts: interest has been overdue for 120 days, which is more than 90 days, so the loan is an NPA, and the NBFC is still accruing income on it.
Income on an NPA is recognised only on receipt, so the ₹40,000 accrued but not received should not remain in profit.
Since the loan has been an NPA for well under 12 months, it is sub-standard. Ask management to reverse the unrealised income and classify the loan as sub-standard, with provision at the prescribed rate.
If management refuses, assess the effect on income, profit and assets. If the misstatement is material but not pervasive, consider a qualified opinion under SA 705. If it is both material and pervasive, consider an adverse opinion.
Also review other loans for similar errors and consider the effect on the reports required by the RBI directions.

Answer: The loan is an NPA, classified as sub-standard. The ₹40,000 accrued interest must be reversed and provision made. If it is not corrected, the auditor considers a qualified opinion if the misstatement is material but not pervasive, and an adverse opinion if it is both material and pervasive, under SA 705.

Exam tips

Always start with the classification date test (90 days). Most NBFC questions turn on this one step.
In numericals, give a table with secured and unsecured split. Marks are awarded for each line.
Keep two reporting layers in mind: the Companies Act report and the RBI-directed reports. Mention both.
Use the rates given in the question even if they differ from those you remember.
In theory answers use provision, facts, conclusion, and end with the auditor's action.

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

Audit of Non-Banking Financial Companies (NBFCs) 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 Non-Banking Financial Companies (NBFCs): frequently asked questions

What is the main difference between a bank audit and an NBFC audit?

Both focus on advances, NPAs and income recognition. A bank is governed by the Banking Regulation Act and RBI rules for banks, while an NBFC is a company governed by the Companies Act and RBI directions for NBFCs. The reporting forms and some rates differ.

When does an NBFC loan become an NPA?

Under the current RBI directions, when principal or interest remains overdue for more than 90 days. After that it is classified as sub-standard, and later doubtful or loss depending on age and recoverability.

What are the auditor's duties in an NBFC audit?

The auditor audits the financial statements under the Companies Act and SAs, and checks compliance with RBI directions on asset classification, provisioning, income recognition and capital. The auditor also gives the reports and certificates the RBI requires.

Is income on NPAs ever recognised on accrual?

No. Under the prudential norms, income on an NPA is recognised only when it is actually received. Income accrued earlier but not collected is reversed or provided for.