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NBFC - Statutory Audit aspects under Companies Act, 2013
BCA - Workshop on NBFCSt Regis Hotel Palladium, Mumbai
4 August 2016
Agenda
1 Key aspects of audit of NBFCs
2 Laws / Regulatory Aspects
3 Accounting & Disclosure requirements
4 Auditing Aspects
Convergence to Ind AS - roadmap5
Key aspects of the audit of NBFCs
Determining objective and scope of the audit?
Consideration of Laws / Regulations governing NBFCs
Obtaining Knowledge of the business of NBFC?
Determining timing and extent of Audit Procedures
Obtaining sufficient Audit EvidenceRobust Documentation
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3
Objective and Scope of audit of NBFCs
Audit of Internal Financial Controls over Financial Reporting
Limited Review (in case of listed companies)
Exceptional Report to RBI
Certificates to RBI
Special Report to Board of Directors
Reporting requirements of Auditors of NBFCs
Audit of Financial statements under Section 143 of the Companies Act,
2013)
CARO, 2016
Audit of NBFC
3
Understanding business of NBFC
Significant features of an NBFC
Significant segment of Indian financial system
Complimentary to the banking sector in meeting the financial needs of retail segment
Also caters to unorganized business sector and small local borrowers
Organizational flexibility
Broadened and diversified products
Regulated by Reserve Bank of India (RBI)
Categories of NBFC – as per RBI
Asset finance companies
Investment companies
Loan companies
Infrastructure finance companies
Mutual Benefit Finance Companies
Miscellaneous Non-Banking Companies
Residuary Non-Banking Companies
Business of financing of physical assets
Business of acquisition of securities
Business of providing finance -loans/advances/otherwise
75% of total assets in infrastructure loans (NOF –greater than Rs 300 Cr
Nidhis – accepting small deposits
Taps public savings by operating various deposit schemes
Engaged in Chit fund business
RBI classification of NBFC
NBFC
Non-Public deposit taking
(NBFC - ND)
Significantly Important (NBFC –ND-SI)
Non Significantly important
(NBFC – ND-NSI)
Public deposit taking (NBFC - D)
Borrowing operations Funding operations
Deposits from public
Bank finance (cash credit, termloans, commercial papers, FCNRloans)
Debentures (Secured, privateplacement basis)
Securitisation and assignment(selling of receivables)
Asset based funding
Vehicle finance,
Plant and machinery
Consumer durables
Mortgage loan on property
Cash flow based funding
Bills discounting,
Personal loans,
inter corporate loans
Operating aspects of NBFCs
3
Laws / Regulatory aspects
Significant laws / regulations applicable to NBFC
Laws and regulations
Reserve Bank of India Act
NBFC Master circulars/Notification/Directions
Companies Act
Income Tax Act
Others regulations
ICAI pronouncements
Technical guide on audit of NBFCs
Standards on auditing
Accounting standards
Key Regulatory aspects (1/2)
Mandatory Registration
Capital adequacy norms – atleast 15%
Opening Branches and Offices – Minimum NOF Rs. 50 Cr & rating ‘AA’
Credit rating – Minimum Investment grade for accepting Public deposits
Public deposits
Minimum credit rating except AFC
Demand deposits non permitted
Period of Deposit – 12 -60 months / Rate of interest can’t exceed 12.5%
Brokerage & other expense should be within 2% & 0.5%, respectively
Ceiling on Public deposits based on credit rating / NOF
Maintenance of liquid assets atleast 15% of Public deposit in unencumbered approvedsecurities
Key Regulatory aspects (2/2)
Prohibition on lending against own shares
Restriction on lending and investments (Single / Group borrower limits)
Income recognition and Asset classification
Asset liability management
Creation of Reserve fund – 20% of net profit
Submission of documents / returns / information with RBI
KYC guidelines – Customer identification & ceiling on cash transactions
Activity Limit - single borrower(% of Owned fund)
Limit - group borrower(% of Owned fund)
Max Loan/Investment 15% 25%
Max Loan and Investment 25% 40%
3
Accounting & Disclosure requirements
Accounting aspects - Framework
Accounting framework of NBFCs
Accounting Standards prescribed under Companies Act, 2013 (To the extent not consistentwith RBI directions
NBFC Prudential norms prescribed by RBI
Key Accounting standards relevant to NBFCs
AS 9 - Revenue Recognition – finance charges / EMIs / Interest
AS 19 – Leases
AS 13 – Accounting of Investments
Applicability of RBI guidelines – key accounting matters
Income recognition in respect of Non performing assets
Classification of loan assets – standard/ sub standard/ doubtful and loss assets
General loan loss provisioning
Statutory reserves
Accounting aspects – Non Performing Loans (NPAs)
NPA classification as per RBI requirement
* Lease rentals# Hire purchase
Non performing assets Sub-standard -Assets as NPA for a period not exceeding
Doubtful - Assets have remained Sub- standard for a period exceeding
Loan asset tobecome NPA ifoverdue
LR* and HP# tobecome NPA ifoverdue
31 March 2017 4 months 6 months 14 months >14 months
31 March 2018 3 months 3 months 12 months >12 months
Accounting aspects – Minimum Provisioning requirements
Minimum provisioning as per RBI requirement
Standard assets – 0.35% as at 31 March 2017 and 0.40% as at 31 March 2018
Prov
ision
ing
requ
irem
ents
Doubtful
Secured:Upto 1 year- 20%1 to 3 years – 30%
>3 years- 50%Unsecured:
100% of outstanding
Substandard – 10% of outstanding
Loss assets – 100% of outstanding
Disclosures in financial statements
NBFC related specific disclosures:
Loans and advances related- Concentration of Advances and NPAs
- Movement in NPA
- NPA purchased/sold
- Restructured accounts disclosure
- Exposures to real estate and capital market
- Securitization and assignment
- Financial asset sold to SC/RC for asset reconstruction
- Financing of parent company products
Investments – Gross/provision/Net balances & movement in provision
Borrowings - Concentration of Deposits
Derivatives and risk exposures (Quantitative & Qualitative)
NBFC related specific disclosures:
Others
Capital adequacy (CRAR)
SBL / GBL compliances
Additional disclosures as per para 13 of NBFC (Non deposit accepting or holding)companies prudential norms (Reserve Bank) Directions, 2007
Maturity pattern of assets and liabilities
Ratings assigned by credit rating agencies
Registration obtained from other financial sector regulators
Penalties imposed by RBI and other regulators
Customer complaints
Disclosures in financial statements
3
Auditing Aspects of NBFCs
Understanding the entity / Governance structure of the entity
Compliance with laws and regulations
Assessment of Entity level Controls / Process level controls and Risk assessment
Assessment of IT control environment
Non Performing advances (NPA assessment, classification and reporting / Restructuring / evergreening of loans)
Financing / Borrowings / Investments
Disclosure requirements (SEBI / Companies Act / RBI)
Assessment of Fraud risk and its impact on audit approach
Audit Approach
Auditors responsibility
Regulatory and compliance matters Validity of registration with RBI
Maintaining minimum NOF/ minimum capital adequacy
Compliance with Prudential norms on income recognition, asset classification and provisioning
Compliance with RBI guidelines on
• deposit acceptance
• KYC / ALM norms
• Asset liability management (formation of committee, Study the findings of the committee)
• Fair practices code (application for loans and their processing, Loan appraisal, disbursementterms and condition, repossession of assets etc)
Exposure Limits of credit or investment
Frauds – Compliance with RBI requirement /
Special reporting to BOD / CARO reporting
Review of the RBI Inspection report
Auditor responsibility – (1 / 5)
Financing operations Compliance with credit policy for sanction of loans
Detailed verification of complete documentation based on nature of transaction and legal status of borrower
Security creation of security and payment of appropriate stamp duty
Adherence to fair practice code
Verification of systems and procedures for recording / registering charges
Correctness of computation of interest / finance charges
Appropriateness of systems / applications controls employed
Internal controls over cash receipts
Verification of the system of inspecting the physical assets
Method of recording repossessed assets and their disposal
Auditor responsibility – (2 / 5)
Non performing assets Examination of classification of NPA
NPA upgradation – check compliance with conditions to be satisfied
Adequacy of provisions against sub-standard, doubtful and loss assets
Verify the provision is separately disclosed in the Balance Sheet
Alertness of ever greening of loans
Restructuring of loans
Income tax considerations (NPA provision is not allowed while computation of total income)
Auditor responsibility – (3 / 5)
Borrowings - Deposits Compliance with RBI Directions in respect of acceptance and repayment of public deposits
Internal controls over recording public deposits and repayments
Accuracy of interest provision as per the rates agreed
Compliance with with-holding tax laws
Borrowings – Banks and Institutional borrowings
Verification of relevant documents for classification as secured / unsecured
Accuracy of interest provision as per the rates agreed
Review of Internal controls over borrowings
Review of disclosure of borrowings as per Companies Act and other accounting pronouncements
Registration of charges with ROC
CARO implication: End use of borrowings Funds raised for short term purpose have not been utilised for long term investment
Auditor responsibility – (4 / 5)
Investments Verification of classification and related requirements – disclosure, valuation, provision for
diminution
Ensure compliance with RBI Directions:
Investment policy should be framed by the Board
Investment policy should spell the criteria
Verification of sale / purchase / inter class transfer of investments
Appropriate disclosure for investments pledged
Ensure that the investments are held in the name of the Company
Auditor responsibility – (5 / 5)
Other matters• Review of Minutes of Board / audit committee
Understanding of systems audit and internal audit
Compliance with direct and indirect tax laws
3
Typical accounting / disclosure matters
Typical accounting / disclosure matters
Collateral valuation
Impairment of loans
Processing fees
ELN valuation
NPA provision disclosure
Cash flow disclosure
CAPAD computation
Special Report to the Board of Directors
Specific matters to be reported to the Board of Directors under RBI Directions:
Continuance of NBFI business and COR compliance
Eligibility to hold COR
Correctness of classification of Asset Finance Company
Correctness of classification of Micro Finance Institution
Additional clauses for Non-Deposit taking NBFC
Ensure passing of Board resolution for non-acceptance of public deposit
Verify if any public deposits accepted during the year
Status of Compliance with prudential norms
Verification of computation of CRAR and filing of NBS 7 return within the due date
Special Report to the Board of Directors
Additional clauses for Deposit taking NBFC
Public deposit related Public deposits and other borrowings are within admissible limits Regularisation of excess of public limits Minimum investment grade rating obtained Aggregate amount of deposit within the limits specified by Rating agency Any default in paying to depositors after interest/principle is due NOF between 25 lakh and 2 crores having deposit in excess of permissible limits
Frozen the level of deposits Brought down level of deposits to level of revised ceiling in terms of notification
Other RBI compliances Correctness of CAPAD ratio Compliance with RBI prudential norms Ensure compliance with liquid assets requirement Return of deposit (NBS 1) and half yearly return filed within due dates Compliance with prudential norms on opening of new branches / closure of existing
branches
3
Convergence to Ind AS – Roadmap
IFRS convergence: A quick recap
Previous plan –1 April 2011
Finance minister’s speech in July 2014
January 2015 – press release on revised roadmap issued by
the MCA; phase wise implementation proposed
While voluntary early adoption is possible for other companies,
it is not permitted for banks, NBFCs and insurance
companies
Banks, NBFCs and Insurance companies will apply Ind AS
from 2018-19 with comparatives for 2017-18
February 2015 – roadmap for transition to Ind AS
notified and 39 converged (final) standards issued
Why is it important to start now?
Business Impact
Early update of market
communication
Impact on processes and systems
Complexity and group wide adoption
Interdependencies to the Finance / IT-
initiative
First time adoption
The adoption of Ind AS will change how business is managed and the sooner the Company can evaluate the economic effects on the business, the sooner it can take appropriate decisions. Business impact is relevant for your business, in order to understand the changes in the financial statements.
The adoption of Ind AS, especially Ind AS 109 will change what entities communicate with their stakeholders (i.e. impact on P&L volatility and other KPIs).
Interdependencies and interactions with other Finance/IT initiatives will have to be carefully evaluated and planned in advance.
Some complex accounting issues may require an appropriate time to take decisions and find solutions. The impact on business processes and IT systems will have to be carefully evaluated and planned in advance
All group entities will adopt Ind AS for internal and/ or external reporting and therefore need sufficient time to implement which requires an early start to help ensure clear and timely guidelines, including the IT architecture and the main organizational decisions.
Starting early will help the Company to evaluate the different options available to it with respect to adoption of Ind AS
Practical challenges
All stakeholders to be conversant with Ind AS – end objective to prepare and use/ interpret Ind AS financial statements for regular reporting
Application of management judgment in accounting policies, evaluation of options under Ind AS will put additional burden on entities
Extensive use of fair value measurements in areas such as financial instruments and business combinations
Ind AS compliant data requirements from subsidiary, joint ventures and associates for consolidation purposes
Changes in recognition and measurement criteria & extensive disclosure requirements need redesigning of accounting systems to provide timely information
Ind AS itself is evolving, leading to constant updates and changes in existing standards
Skill-sets Judgment Fair Value Group Transition Data Capture IFRS Updates
Training personnel Setting up frameworks and accessing data
Using the work of experts specializing in fair valuation
Using a recognised structured approach for transition
Modifying the reporting systems
Regular IFRS updates / Ind AS
Companies are responding in the following ways
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Q&A