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CA Intermediate · Auditing and Ethics · Audit of Banks

While auditing Sagar Cooperative Commercial Bank, CA Nisha finds that a term loan of Rs 40 lakh to a borrower has had interest overdue for more than 90 days as at the balance sheet date. The bank continues to recognise the interest as income on an accrual basis. What is the correct audit response?

The auditor should require the account to be classified as an NPA, since interest is overdue beyond 90 days. Income is then recognised only on receipt, and uncollected interest booked earlier is reversed. If management refuses, the auditor should modify the opinion. Collateral does not prevent NPA classification.

  1. AAccept the treatment, since the loan is secured by collateral
  2. BAccept it, since interest accrued is earned under the accrual concept irrespective of recovery
  3. CAsk management to treat the account as a non-performing asset and stop recognising interest income on it, reversing interest already booked but not collected, failing which consider a qualified opinionCorrect
  4. DDisclose the interest only in the notes and leave the profit unchanged

Explanation

Under RBI prudential norms, a term loan with interest overdue for more than 90 days is an NPA. Income on an NPA is recognised only when actually received, and uncollected interest already booked must be reversed. If management refuses to correct, the overstatement of income leads the auditor to modify the opinion. Collateral does not change NPA classification.

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