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

4© 2013 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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

38

Q&A

Thank you

Manoj Kumar VijaiEmail: mkumar@bsraffiliates.com

Mobile - +91 22 6134 9404