Audit of NBFCs Flashcards
CA Sheetal is conducting the statutory audit of Kunthu Ltd., a non-banking financial company. It
has branches in various parts of India. The company with a focus on housing finance, has
outstanding non-convertible debentures worth t 170 crore. The company reportedly missed
interest payments oft 17 crore on its debts because of inadequate liquidity. As a result, Kunthu
Ltd. faced a series of downgrades by rating agencies on its debts over the past two months. Rating
was cut to D from A4 implying that the company was in default or expected to be in default soon.
What aspects CA Sheetal should look into in relation to the activity of mobilization of public deposits
(particularly in relation to downgrading of credit facilities) by Kunthu Ltd?
CA S has to ascertain whether the company has complied with the following aspects in relation to the activity of mobilization of public deposits.:
(i) The ceiling on quantum of public deposits has been linked to its credit rating as given by an
approved credit rating agency. In the event of a upgrading/downgrading of credit rating, the
auditor should bear in mind that the NBFC will have to increase/reduce its public deposits in
accordance with the revised credit rating assigned to it within a specified time frame and should
ensure that the NBF Chas informed about the same to the RBI in writing.
(ii) In the event of downgrading of credit rating below the minimum specified investment grade, a
non-banking financial company, being an investment and credit company or a factor, shall
regularize the excess deposit as provided hereunder:
(a) with immediate effect, stop accepting fresh public deposits and renewing existing deposits;
(b) all existing deposits shall run off to maturity;
(c) report the position within 15 working days, to the concerned Regional Office of the RBI
where the NBFC is registered; and
( d) no matured public deposit shall be renewed without the express and voluntary consent of
the depositor.
OM & Co. is the statutory auditor of OTAPS NBFC Ltd. While planning the audit procedures to be
done during the audit of entity, there was a difference of opinion between Mr. 0 and his partner
Mr. M. Mr. 0 is of the opinion that evaluation of internal control system and verification of
registration with RBI should not be the part of audit procedure, as it is the part of interna I audit
only. Briefly state what broad areas should mandatorily become part of the audit procedure of
OM & Co. for conducting the audit of OTAPS NBFC Ltd.? Also comment whether contention of Mr.
0 is correct?
Following are broad areas that should be mandatorily part of the audit procedure for conducting
the audit of NBFC:
(1) Ascertaining the Business of the Company - The first step in carrying out the audit of a NBFC
is to scan through the Memorandum and Articles of Association of the company, so as to
acquaint oneself with the type of business that the company is engaged into. The task of
ascertaining the principal business activity of any NBFC is of paramount importance since the
very classification of a company as a NBFC and its further classification would all depend
upon its principal business activity. Based on the classification of a company, it wi II be
required to comply with the provisions relating to limits on acceptance of public deposits as
contained in the NBFC Public Deposit Directions.
(2) Evaluation of Internal Control System - An auditor should gain an understanding of the
accounting system and related internal controls adopted by the NBFC to determine the nature,
timing and extent of his audit procedures. An auditor should also ascertain whether the
internal controls put in place by the NBFC are adequate and are being effectively followed. In
particular, an auditor should review the effectiveness of the system of recovery prevalent at
the NBFC. He should ascertain whether the NBFC has an effective system of periodical review
of advances in place which would facilitate effective monitoring and follow up. The absence
of a periodical review system could result in non-detection of sticky advances at their very
inception which may ultimately result in the NBFC having an alarmingly high level of NPAs.
(3) Registration with the RBI - Section 45-IA of the RBI Act, 1934, has made it incumbent on the
part of all NBFCs to comply with registration requirements and have minimum net owned
funds. An auditor should obtain a copy of the certificate of registration granted by the RBI or
in case the certificate of registration has not been granted, a copy of the application form filed
with the RBI for registration. It may particularly be noted that NBFCs incorporated after 9th
January, 1997 are not entitled to commence business without first obtaining a registration
certificate from the RBI. An auditor should, therefore, verify whether the dual conditions
relating to registration with the RBI and maintenance of minimum net owned funds have been
duly complied with by the concerned NBFC. The auditor should ascertain whether investment
in prescribed liquid assets have been made and whether quarterly returns as mentioned
above have been regularly filed with the RBI by the concerned NBFC.
(4) The auditors must ascertain whether the company properly classified as per the requirements
of various regulations. In case, the NBFC has not been classified by the RBI, the classification
of a company will have to be determined after a careful consideration of various factors such
as particulars of earlier registration granted, if any, particulars furnished in the application
form for registration, company’s Memorandum of Association and its financial results.
(5) NBFC Prudential Norms Directions - Check compliance with prudential norms encompassing
income recognition, income from investments, accounting standards, accounting for
investments, asset classification, provisioning for bad and doubtful debts, capital adequacy
norms, prohibition on granting of loans by a NBFC against its own shares, prohibition on loans
and investments for failure to repay public deposits and norms for concentration of
credit/investments.
In the given situation, OM & Co., is the statutory auditor of OTAPS NBFC Ltd. While planning the
audit procedures to be done during the audit of entity, there was difference of opinion between 0
and his partner M regarding evaluation of internal control and verification of registration with RBI.
As discussed above NBFCs are not entitled to commence business without first obtaining a
registration certificate from the RBI. An auditor should, therefore, verify whether the dual conditions
relating to registration with the RBI and maintenance of minimum net owned funds have been duly
complied with by the concerned NBFC. Further, auditor should gain an understanding of the
accounting system and related internal controls adopted by the NBFC to determine the nature,
timing and extent of his audit procedures. An auditor should also ascertain whether the internal
controls put in place by the NBFC are adequate and are being effectively followed. Accordingly,
contention of Mr. 0 regarding evaluation of internal control system and verification of registration
with RBI should not be part of the audit procedure as it is part of internal audits only, is not correct.
NOF
Net Owned Funds
S Ltd. is a company registered under the Companies Act, 2013. The company is engaged in the business of loans and advances, acquisition of shares / stocks / bonds / debentures/securities issued by Government or local authorities. For the YE 31 March, 2022 following are some extracts from the FS:
(i) Paid-up share capital - Rs. 40.53 Cr.
(ii) Non-Current Assets - Loans & Advances - Rs. 75.50 Cr.
(iii) Current Assets - Loans and advances - Rs. 294.33 Cr.
(iv) Total assets of the company - Rs. 618.55 Cr.
(v) Intangible assets - Rs. 6.35 Cr.
(vi) Profit for the Year - Rs. 8.15 Cr.
(vii) Income from interest and dividends - Rs. 62.31 Cr.
(viii) Gross income - Rs. 111.23 Cr.
Directors intend to apply for registration as NBFC under Section 45-IA of the RBI (Amendment) Act, 1997. Advise.
In order to identify a particular company as NBFC, it will consider both assets and income pattern as evidenced from the last audited BS of the company to decide its principal business. The company will be treated as NBFC when a company’s
(i) Financial assets constitute more than 50% of the total assets (netted off by intangible assets) and
(ii) Income from financial assets constitute more than 50% of the gross income.
A company which fulfils both these criteria shall qualify as an NBFC and would require to be registered as NBFC by RBI.
In the given case, applying the Criteria (i) Financial assets constitute more than 50% of the total assets (netted off by intangible assets),
A. Financial Assets of Sudarshan Ltd. are =
Non-Current Assets - Loans & Advances - Rs. 75.50 Cr.
Add: Current Assets - Loans and advances - Rs. 294.33 Cr.
Total Financial Assets - Rs. 369.83 Cr.
B. Total Assets (netted off by intangible assets) of Sudarshan Ltd. are=
Total assets of the company - Rs. 618.55 Cr.
Less: Intangible assets - Rs. 6.35 Cr.
Total Assets (netted off by intangible assets) - Rs. 612.20 Cr.
In view of above, Financial assets of Sudarshan Ltd. constitute more than 50% of the total assets (netted off by intangible assets).
Applying the Criteria (ii) Income from financial assets constitute more than 50% of the gross income.
Income from financial assets = Rs. 62.31 Cr
Gross Income = Rs. 111.23 Cr
From the above, it is clear that Sudarshan Ltd.’s financial assets constitute more than 50% of the total assets (netted off by intangible assets) and income from financial assets constitutes more than 50% of the gross income. Hence, Sudarshan Ltd. fulfills both these criteria to qualify as an NBFC.
Thus Sudarshan Ltd. can apply for registration under Section 45-IA of RBI (Amendment) Act, 1997 in prescribed form along with the necessary documents.
