CA Intermediate · Auditing and Ethics · Audit of Banks
CA Devika is auditing Narmada Bank Ltd. Her sample of large advances reveals that a borrower's loan of Rs 40 crore, classified as standard, was renewed (evergreened) just before the year-end by sanctioning a fresh loan to a related group company, whose proceeds were immediately used to repay the original loan's overdue instalment. Management argues the original loan is therefore regular. Which is the most appropriate audit response?
She should examine the substance of the transaction, treating the circular funding as possible evergreening that hides an NPA. She then assesses the effect on classification and provisions and, if management does not correct a material misstatement, modifies her audit opinion accordingly.
- AAccept the classification, since the instalment was received in the borrower's account before year-end
- BTreat the matter only as a related party disclosure issue and not as a classification issue
- CAsk management to reduce the provision on the new loan because it is secured
- DExamine the substance of the transactions, treat the circular funding as indicating potential misclassification, evaluate the effect on NPA and provisioning, and consider the effect on her report if management does not correct itCorrect
Explanation
Funds routed through a related entity to repay the overdue amount indicate evergreening, so the repayment is not genuine. The auditor looks at substance over form, assesses the resulting understatement of NPAs and provisions, and modifies her opinion if uncorrected and material. Accepting the credit or treating it only as a disclosure matter ignores the misstatement risk.
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