CA Inter P5 · Chapter 10
Audit of Banks MCQs with Answers
11 multiple-choice questions on Audit of Banks for CA Inter P5 Auditing and Ethics. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
The statutory auditor of a banking company is appointed in accordance with:
- A) Section 30 of the Banking Regulation Act, 1949, with the previous approval of the Reserve Bank of India
- B) Article 148 of the Constitution of India
- C) The Chartered Accountants Act, 1949, by the Institute's Council
- D) Section 139 of the Companies Act, 2013, by the board of directors alone
Show answer & explanation
Answer: A) Section 30 of the Banking Regulation Act, 1949, with the previous approval of the Reserve Bank of India
Section 30 of the Banking Regulation Act, 1949 requires the balance sheet and profit and loss account of a banking company to be audited by a person duly qualified to be an auditor of companies, and the appointment is made with the previous approval of the RBI. The RBI may also direct special audits.
Question 2
Under the RBI prudential norms, a term loan becomes a non-performing asset when:
- A) Interest and/or an instalment of principal remains overdue for a period of more than 90 days
- B) The loan is not renewed on the review date
- C) Interest remains unpaid for 30 days
- D) The borrower's credit rating is downgraded
Show answer & explanation
Answer: A) Interest and/or an instalment of principal remains overdue for a period of more than 90 days
Under RBI's income recognition and asset classification norms, a term loan is a non-performing asset where interest and/or an instalment of principal remains overdue for more than 90 days. Rating downgrades or review delays may be warning signals but do not by themselves define an NPA.
Question 3
A borrowal account of a bank became a non-performing asset on 30 June 2024 and has remained NPA continuously since then, with no upgradation. The security is fully realisable at its book value and no loss has been identified by the bank, the auditor or RBI inspectors. Under the RBI prudential norms on asset classification, what is its classification as at 31 March 2026?
- A) Standard asset
- B) Loss asset
- C) Sub-standard asset
- D) Doubtful asset (doubtful for up to one year, D1)
Show answer & explanation
Answer: D) Doubtful asset (doubtful for up to one year, D1)
Under RBI norms, an asset is sub-standard if it has remained NPA for a period less than or equal to 12 months; here, from 30 June 2024 to 30 June 2025. An asset that has remained in the sub-standard category for 12 months becomes doubtful, so the account became doubtful on 30 June 2025. From 30 June 2025 to 31 March 2026 it has been doubtful for 9 months, which is within one year, so it is D1. It is not a loss asset because no loss has been identified and the security is realisable, and it cannot be standard while it remains NPA.
Question 4
Under RBI norms, a cash credit or overdraft account is treated as 'out of order' when:
- A) The outstanding balance remains continuously in excess of the sanctioned limit or drawing power for 90 days, or there are no credits continuously for 90 days or credits are insufficient to cover interest debited during the period
- B) The account shows any debit balance at the year-end
- C) The borrower submits stock statements late on one occasion
- D) The account has fewer than ten transactions in a quarter
Show answer & explanation
Answer: A) The outstanding balance remains continuously in excess of the sanctioned limit or drawing power for 90 days, or there are no credits continuously for 90 days or credits are insufficient to cover interest debited during the period
RBI norms treat a CC/OD account as out of order if the outstanding balance remains continuously in excess of the sanctioned limit or drawing power for 90 days, or where the balance is less than the limit/DP but there are no credits continuously for 90 days as on the balance sheet date or credits are not enough to cover interest debited. An out-of-order account becomes an NPA.
Question 5
The Long Form Audit Report (LFAR) in a bank audit is:
- A) The auditor's report under SA 700 printed in a longer format
- B) A report required only for co-operative banks under State Acts
- C) A report prepared by the bank's management for its shareholders
- D) A report prescribed by the RBI covering matters such as advances, internal controls and compliance, submitted by the auditor in addition to the main audit report
Show answer & explanation
Answer: D) A report prescribed by the RBI covering matters such as advances, internal controls and compliance, submitted by the auditor in addition to the main audit report
The LFAR format is prescribed by the RBI and requires auditors to report on specified aspects of the bank's functioning, including advances, cash, investments, compliance with prudential norms and internal controls. It is submitted in addition to the statutory audit report and is not part of the published report.
Question 6
A borrower's cash credit account has a sanctioned limit of Rs. 50 lakh. The latest stock statement shows stock of Rs. 80 lakh and unpaid creditors for goods of Rs. 20 lakh. The margin stipulated is 25%. What is the drawing power?
- A) Rs. 60 lakh
- B) Rs. 45 lakh
- C) Rs. 50 lakh
- D) Rs. 40 lakh
Show answer & explanation
Answer: B) Rs. 45 lakh
Paid stock = Rs. 80 lakh - Rs. 20 lakh = Rs. 60 lakh. Drawing power = 60 x (1 - 25%) = Rs. 45 lakh. Since this is below the sanctioned limit of Rs. 50 lakh, the borrower can draw only up to Rs. 45 lakh. Rs. 60 lakh ignores the margin, and Rs. 40 lakh wrongly applies the margin to gross stock before deducting creditors (80 x 75% - 20).
Question 7
During the audit of a bank branch, the auditor finds that interest on a loan account classified as NPA has been debited to the account and credited to interest income on an accrual basis. The auditor should:
- A) Accept the treatment because accrual accounting must always be followed
- B) Require the unrealised interest to be reversed from income, since income on NPAs is recognised only when actually realised
- C) Ignore it if the amount is below the branch's materiality
- D) Require the interest to be shown as an extraordinary item
Show answer & explanation
Answer: B) Require the unrealised interest to be reversed from income, since income on NPAs is recognised only when actually realised
Under RBI income recognition norms, interest on NPAs is not recognised on accrual basis but only when actually received. Interest already taken to income on an account that becomes NPA should be reversed if uncollected. The auditor checks that unrealised interest is not included in income.
Question 8
To verify balances held by a bank with other banks, the bank auditor should primarily:
- A) Obtain balance confirmations from the other banks and examine reconciliation statements, investigating old unreconciled entries
- B) Rely on the branch manager's certificate of balances
- C) Count the cash in the bank's vaults
- D) Review the bank's advertisements for interest rates
Show answer & explanation
Answer: A) Obtain balance confirmations from the other banks and examine reconciliation statements, investigating old unreconciled entries
Balances with RBI and other banks are verified by obtaining confirmations, comparing them with the books and examining reconciliations. Long-outstanding or unusual reconciling items may indicate errors or frauds and should be investigated. A manager's certificate is internal evidence and less reliable.
Question 9
The forms of balance sheet and profit and loss account of a banking company are prescribed in:
- A) The Third Schedule to the Banking Regulation Act, 1949
- B) Schedule III to the Companies Act, 2013
- C) The CARO
- D) The First Schedule to the Chartered Accountants Act, 1949
Show answer & explanation
Answer: A) The Third Schedule to the Banking Regulation Act, 1949
Section 29 of the Banking Regulation Act, 1949 requires banking companies to prepare their balance sheet and profit and loss account in the forms set out in the Third Schedule to that Act. Schedule III to the Companies Act applies to other companies, and its requirements do not override the special form prescribed for banks.
Question 10
Just before the year-end, a bank sanctioned a fresh loan to a borrower whose existing account was overdue for more than 90 days, and used the proceeds solely to clear the overdue interest and instalments. The auditor should:
- A) Classify the account as standard because overdues have been cleared
- B) Accept the classification but mention it in an Other Matter paragraph
- C) Treat the arrangement as evergreening, disregard the apparent recovery, and classify the account as NPA
- D) Treat the fresh loan as an investment
Show answer & explanation
Answer: C) Treat the arrangement as evergreening, disregard the apparent recovery, and classify the account as NPA
Funding overdue interest or instalments through fresh or additional loans, without genuine recovery from the borrower's own resources, is evergreening. It conceals the NPA status and inflates income. The auditor should treat the account as NPA, reverse any income recognised from such adjustments and report the matter appropriately.
Question 11
The central statutory auditor of a bank receives reports from the auditors of many branches. When using the work of branch auditors, the central auditor should:
- A) Consider the guidance in SA 600, evaluate the branch auditors' reports, and determine how their findings affect the bank's financial statements as a whole
- B) Accept the branch reports without considering their findings
- C) Exclude unaudited branches from the bank's financial statements
- D) Re-audit every branch personally before signing
Show answer & explanation
Answer: A) Consider the guidance in SA 600, evaluate the branch auditors' reports, and determine how their findings affect the bank's financial statements as a whole
In bank audits, branch audits are performed by branch auditors and the central auditor uses their work. Following SA 600 on using the work of another auditor, the central auditor considers the competence of branch auditors, reviews their reports and LFARs, and evaluates the impact of their observations on the bank's overall financial statements and the audit opinion.