stock audit in banks

© Rajkumar.S.Adukia 1

STOCK AUDIT IN BANKS


Agenda

1. Meaning of stock

2. Bank lending and stock audit

3. Composition of NPA ON Public sector banks in 2005

4. Stock/receivables audit

5. Need for stock audit

6. Scope of stock audit

7. ICAI Pronouncements

8. Relevant Auditing and assurance standards

9. RBI Notifications


Agenda…

10. Conduct of stock audit

a) Pre-commencement

b) Understanding the entity

c) Audit planning

d) Substantive procedures

e) Reporting

11. Working papers

12. Analytical review

13. Internal control evaluation

14. Verification of securities

15. Deficiencies observed in cash-credit accounts

16. References


What is Stock?

Stock or Inventory means the assets: which are held for sale in the ordinary course of business; in the process of production for such sale; or in the form of material or supplies to be consumed in the

production of goods or services for sale (As per AS 2) These goods are normally stored in the warehouses, which are

generally located near the factory.


Bank lending and stock audit

A major part of working capital requirement of any unit would consist of maintenance of inventory .Finance against such inventories by banks is generally granted in the shape of cash credit facility where drawings will be permitted against stocks of goods. It is a running account facility where deposits and withdrawals are permitted

Stock audit acts as a warning signal to those accounts which are likely to turn into NPA

Stock audit helps in prevention and early detection of frauds


Composition of NPA as on Public sector banks in 2006

Data as on 31.03.06 Rs. in crores

Priority sector 21926

Non-priority sector 18072

Public sector 932

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Total 41378

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Source: off –site returns (domestic & Provisional ) of banks, Dept of banking supervision, RBI


Stock or Receivables Audit

This involves:1. verification and valuation of current assets, current liabilities and

loans and advances2. checking for diversion of funds, 3. verifying application of funds,4. verifying the accuracy of stock and book-debts statements,5. arriving at the revised drawing power and6. Any other matter connected with the credit administration


Need for stock audit

1. A stock audit is necessary to give an assurance regarding the following:

A suitable environment exists for preservation of stock A responsible person is safeguarding the stock Degraded stock have been written off Adequate safeguards exist against fire and natural calamities Physical stocks tally with the stock statements submitted to bank The pledged/hypothecated stock is realizable Stock is owned by the borrower All sanction terms have been adhered to Stocks are not stagnating and becoming obsolete


2. To investigate, wherever the party is not submitting periodic stock statements regularly

3. To investigate, where the accounts have been marked as substandard

4. To find out reasons when there are too many qualifying remarks about stocks and receivables in the Auditor’s report on the Balance Sheet of the borrower

5. To find out suspect dealing in lending procedure6. Where there are too many qualifying remarks about stocks and

receivables in the auditors report on the balance sheet of a borrower

7. reasons such as mismanagement, heavy losses, lockout, strikes etc

8. To make the banks aware of their right of enforcement of the security interest provided in the Securitization and Reconstruction of Financial Assets and enforcement of Security Interest Act, 2002.

9. to fulfill H.O requirement


Scope of stock audit

1. Physical verification of stocks.2. Verification of condition of storage3. Valuation of stocks and pointing out variances4. Valuation of obsolete / non-moving stock.5. Age-wise categorization of stocks.6. Evaluation of the stock management by the Co.7. Reconciliation of stock statements submitted with the accounting

records maintained by borrowers particularly, relating to quantity, rate, value of inventories, age, marketability, etc.

8. Verification and evaluation of sundry creditors indicating separately those relating to stock and their relationship with bank finance


9. commenting upon the sources of the raw materials, i.e., whether any credit is available for the material and which of the items are available against cash payments

10. Age-wise and value-wise qualification of debtors11. Determination of the drawing power.12. Checking on adequacy of the insurance cover.13. Verification of documents/ securities14. Commenting upon the comparative Profitability and Inventory

ratio15. Ensuring that the terms and conditions of limit sanctioned have

been complied16. Verification of transactions with sister concerns, unsecured

Loans to Directors and others

17. Any other matters of interest to the bank.


ICAI Pronouncements

As there is no guidance note or standards prescribed for stock audit, the auditors should conduct the audit based on the generally accepted auditing practices and to the best of his judgment and ability

A reference to the following pronouncements of ICAI could be made

Guidance note on Audit of Inventories, Guidance note on Audit of Debtors AS 2 Valuation of Inventories

AS 9 Revenue Recognition


Relevant Auditing and Assurance standards

These can be referred to in 5 stages1. Pre-commencement AAS-26-Terms of Audit Engagement AAS 32-Engagements to perform Agreed upon procedures regarding financial information 2. Understanding the entity AAS 6-Risk Assessments and Internal control AAS 20-Knowledge of the business AAS 21-Consideration of Laws and Regulations in an audit of financial statement AAS 23-Related parties AAS 24-Audit considerations relating to entities using service organizations


AAS 29-Auditing in CIS environment 3. Audit planning AAS 2-Objective and Scope of the audit of financial

statements AAS 8-Audit Planning AAS 12-Responsibility of joint auditors AAS 15-Audit Sampling AAS 16- Going concern AAS17- Quality control for Audit work 4. Substantive procedures AAS 1- Basic Principles Governing an Audit AAS 3- Documentation AAS 4- The Auditor’s responsibility to consider Fraud and Error in an audit of financial statements AAS 5-Audit Evidence AAS 7- Relying upon the work of an Internal Auditor


AAS 9-Using the work of an expert

AAS 10-Using the work of another auditor

AAS 11-Representations by management

AAS 13- Audit materiality

AAS 14-Analytical procedures

AAS-19- Subsequent events

AAS 30-External confirmations

AAS 34- Subsequent events

5. Reporting

AAS 27-Communication of Audit matters


RBI Notifications

A reference to the following circulars could be made: DBOD No. BP. BC. 15 / 21.04.048 / 2006-07dated July 1, 2006-

Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances

RBI/2007/234 UBD.BPD (PCB) MC. No. 13 /13.05.000/2006-07dated January 22 , 2007-Master Circular on Management of Advances


Conduct of stock audit

This can be discussed under

1. Pre-commencement

2. Understanding the entity

3. Audit planning

4. Substantive procedures

5. Reporting


Pre-commencement

1. Obtain the engagement letter from the bank.

2. Obtain, the relevant details of the borrower including:

a) Name of the unit and of the key persons

b) Address of both the registered office and

factory of the unit

c) Nature of business

d) Sanction terms and conditions

e) Bank Account No, banking facilities

enjoyed by the borrower


f) if the advance is a consortium lending, names of lead bank

and other banks and their participation

g)) last three months bank statements

h) last three months stock statements

i) latest inspection report of the account, Annual report or any available audit reports

j) Insurance particulars

3. Get an appointment before visiting the borrower’s office.


Understanding the entity

This involves understanding /knowing :

1. the nature of business

2. the nature of goods, especially with regard to the storage- whether stored at multiple locations, whether they are of deteriorating nature etc

3. the processes involved in manufacture, production and ascertaining whether any part of the work is to be sent out of the entity for further processing

4. The key personnel involved in preparation and submission of stock statements and financial statements to the bank


Audit planning

Planning should be based on:

1. Day and time of visit

2. Method of counting

3. Instructions to be given to employees

4. Provisions to be made for receipts of stock during the count, segregation of stock not owned and physical arrangement of stock

5. Location of stock


Substantive procedures

The procedures involved are:

1. In-house audit

2. Physical verification of stock

3. Valuation of stock

4. Verification of Debtors

5. Calculation of Drawing power

6. Checking adequacy of insurance coverage


In- house audit Ensure compliance to sanction terms Check documentation such as DPN, Agreement of hypothecation,

Letter of Acceptance, Continuity letter, etc Check whether prescribed particulars of charges as detailed in S

125(4) along with the instrument by which the charge is created has been filed with the Registrar for registration within 30 days after the date of its creation

Check operation in account during last 6 months Check whether interest is being served in time and repayments are

regular Check whether stock statements are submitted on time Check whether party operates any other bank account and verify

for diversion of funds Check all statutory dues have been paid Check the sales and purchase invoices Scan through previous audit report, if available Check , if bank’s name board is prominently displayed The name of the official present at the time of audit


Physical Verification of stock Godown inspection with regard to its condition, location, rent

payments, maintenance etc Actual counting of stock – reconciliation with the book figures

if there is a difference, Check on record- keeping and verifiy purchase/ Sales

registers and Goods received note and Goods returned note. Check whether no-lien note has been obtained from

processors Confirmation of stock at public warehouse, in transit or sent on

consignment Check for unpaid stocks Age-wise analysis of stock and movement of stock Check for abnormal increase in stock


Valuation of stock

Ascertain Accounting policy adopted for valuation Cost of inventory should not include: Abnormal waste Storage cost if not part of manufacturing process Administrative overheads not contributing to bringing inventory to

present location Selling and distribution expenses Check for arithmetical accuracy Check that the cost of obsolete and damaged items are written off Check for consistency in basis of valuation Cut-off procedures at year-end are followed


Verification of debtors An analysis of sundry debtors ledger and sales register Age-wise classification of debtors Bad and doubtful debts should be excluded from drawing power

calculations The age of book-debts should not be more than stipulated sanction

terms All realizations from debtors should be routed through the borrowal

account Sale to sister concerns/ related parties to be scrutinized A check on few invoices/Gate passes to ensure actual movement

of goods Confirmation of balances from certain parties Check for debit balances in debtors account


Drawing power calculation Ensure margin requirements as per sanction terms are

considered Check for arithmetical accuracy Check that old and obsolete stocks are excluded Check that debtors greater than 90 days are excluded Check that the statement is submitted as per bank’s format only Drawing power is required to be arrived at based on the stock

statement which is current. The outstanding in the account based on drawing power

calculated from stock statements older than three months, would be deemed as irregular

The account will become NPA if such irregular drawings are permitted in the account for a continuous period of 90 days even though the unit may be working or the borrower's financial position is satisfactory.


Insurance coverage

Check whether the stock hypothecated is adequately insured Check whether the policy is in force Check whether stocks with third parties are also covered Check whether bank clause is included in the policy Check whether the stock is covered against all major perils Check whether the collateral security is also insured adequately


Reporting

1. The report has to be submitted to the authority appointing the auditor .

2. It should be in the prescribed format and should be exhaustive and inclusive of all facts and summaries

3. It should include the date, time, location of visit and the name of the officials conducting the audit and the official of the entity present at the entity at the time of conducting the audit

4. Copies of confirmations, management representations, etc should be submitted along with the report


Working papers Sanction letter Stock and book-debts statements for last 3 months Bank statements for last 3 months A certified copy of the constitution of entity- partnership deed,

Memorandum and Articles of Association, etc. Financial statements for the last 3 years Copy of insurance policy in force Comprehensive management representation letter Organization chart of the entity Flow chart for the actual manufacturing process A copy of agreement ownership/rent agreement of office/ godown In case of a company, the following copies (i) a copy of form No.18

along with filing fees receipt for registered office address (ii) A copy of form no 32 along with filing fees receipt for directors. (iii) A copy of form No. 8 & 13 along with filing fees receipt & charge registration certificate (iv) A copy of Form No.8 & 17 along with filing fees receipt & certificate for registration of charge and balance sheet.


Analytical reviewcertain analytical procedures have to be carried out to review the

financial soundness of the business of the borrower including: Check records of opening stock, purchases, production, sales and

closing stock Compare closing stock with those of previous year quantity Compare composition of closing stock with the previous year Compare the current year Gross Profit with that of last year Compare actual stock with budgeted figures Compare inventory ratios with those of the industry and firms


Internal control evaluation

1. On Stock Whether persons involved in stock taking differ from those

responsible for store-keeping Whether store procedures provide for the use of pre-numbered

forms Whether a system of cross-checking exists for checking data

generated by different departments Whether controls exists for receipts and issues of stores

2. On Debtors Whether basis for fixing credit limits are clearly laid down Whether debts and realizations are recorded promptly and

receipts are linked with outstanding


Verification of securities

SCOPE OF AUDIT:1. To verify physically the certificates of the securities held by the

Branch.2. To see that the registers for the securities held physically are

maintained properly.3. To verify that securities held by the branch are tallying with

Security Holding Register.4. To obtain the statement showing the securities sent for demat and

cross tally with the records maintained in the register.5. To check Vault and other registers with the Stock Holding Register

to see the reconciliation between physically verified scrips and total investments made by the Bank. This scrutiny will reveal major queries relating to demat, redemption, withdrawals, re-deposits, call/put options


Deficiencies generally observed in cash-credits

1. Stock / Book Debts / QIS statements not furnished in time.2. Stock Statement received from Borrower filed in a routine way

without scrutiny. Non moving stock not identified.3. Age wise analysis of Debtors not done. Debtors more than 90

days considered for D.P.4. D.P. not correctly calculated. 5. Inadequate insurance, insurance not available, Policy without

Bank Clause/coverage of all risk.6. Operations in the accounts not scrutinized with reference to

projections, QIS statements, audited accounts etc.7. In case of consortium advances account is not monitored in

close coordination with the member bank


8. Physical verification of assets and stock not done as per stipulation. Defects pointed out by the Inspectors are neglected..

9. Valuation of stock not verified. 10. Confirmation for stock with third party not obtained or physical

verification of Stock not done.11. Material received from third parties for job work not excluded

while calculating D.P.12. Diversion of funds and inter account transfers are not properly

monitored.13. Accounts not reviewed/renewed at regular interval.14. Monitoring of account where sub-limit is transferred to

branches.15. Borrower having operations with other bank.16. To cover the valuation of security, revaluation of assets done

which may not be genuine.


References

www.rbi.org.in


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stock audit in banks

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