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Unit 12: Special Features of Audit

12.3.2 Audit Procedure Notes

The following are the necessary steps involved:
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 proposes to engage itself
in. Normally, the Memorandum of Association of any company would be very wide in
scope thereby permitting it to undertake a host of business activities, but companies
generally lend to specialise in and focus on a few select activities.

Notes An auditor should therefore make a careful study of the business policy of the
company so as to ascertain its principal business activities.
For this purpose, an auditor may also scan through the minutes of the Board/Committee
Meetings and hold discussions with the top level management to ascertain the corporate
business plan/strategy which would give him a clear picture as to the principal objects of
the company. An auditor should then independently corroborate his findings with the
actual business done by the company, as reflected by the company’s financial results.

The task of ascertaining the principal business activity of any NBFC is of paramount
importance (more so with the recent amendments made to the RBI Act) since the very
classification of a company as a NBFC and its further classification into a loan company or
an investment company or an equipment leasing/hire purchase finance company would
all depend upon its principal business activity. Based on the classification of a company
into a loan Company/Investment company etc., it will be accordingly 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: The responsibility of maintaining an adequate
accounting system incorporating various internal controls to the extent appropriate to the
size and nature of its business vests with the management. A sound internal control
system would enable an organisation to plug loopholes in its workings, particularly in
the detection of frauds and would also aid in timely decision making.

Notes 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 its very inception which would ultimately result in the NBFC having an alarmingly
high level of NPAs.
3. Registration with the RBI: Section 45-IA inserted by the RBI Act, w.e.f. 9th January, 1997,
has made it incumbent on the part of all NBFCs to comply with registration requirements

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