Long-term loans and advances are a critical item on the balance sheet that requires meticulous audit procedures to ensure proper disclosure, compliance with legal frameworks, and safeguarding against misrepresentation. These represent financial assets that are typically recoverable after a period exceeding one year and may include loans to related parties, deposits, prepaid expenses, and other advances. Below is a comprehensive guide to conducting the statutory audit of long-term loans and advances for Indian companies.
Legal Framework for Long-Term Loans and Advances
- Companies Act, 2013
- Section 128 – Books of Account: The company must maintain proper records for all long-term loans and advances, including supporting documents such as loan agreements, security details, and repayment schedules.
- Section 129 – Financial Statements: As per Schedule III of the Companies Act, long-term loans and advances must be presented separately in the balance sheet, clearly categorized into loans, advances, and deposits.
- Section 186 – Loans and Investments by Companies: Limits on loans and advances are governed by this section. Companies must adhere to the limits set for inter-corporate loans and advances, and any amounts exceeding the prescribed limits must receive board and shareholder approvals.
- Section 188 – Related Party Transactions: Loans and advances to related parties must comply with the disclosure requirements and obtain necessary approvals to avoid conflicts of interest.
- Accounting Standards (AS)
- AS 29 – Provisions, Contingent Liabilities, and Contingent Assets: If there is a potential loss on advances or loans due to non-recoverability, a provision should be created to reflect the impairment.
- AS 13 – Accounting for Investments: The standard provides guidance on classifying advances as financial assets, especially when linked to investments.
- Indian Accounting Standards (Ind AS)
- Ind AS 109 – Financial Instruments: Loans and advances are treated as financial assets. They should be measured at amortized cost, fair value through other comprehensive income (FVOCI), or fair value through profit or loss (FVTPL). Expected Credit Loss (ECL) is a crucial aspect under Ind AS 109, where the risk of non-recovery must be evaluated and accounted for.
- Ind AS 24 – Related Party Disclosures: Requires detailed disclosures of loans and advances given to related parties, including terms, conditions, and outstanding amounts.
- RBI Guidelines for NBFCs
Non-Banking Financial Companies (NBFCs) and banks must follow specific guidelines issued by the Reserve Bank of India for classifying, provisioning, and disclosing loans and advances. This includes recognition of non-performing assets (NPAs) and ensuring adequate provisioning for doubtful debts.
Key Objectives of the Audit
- Verify the accuracy, completeness, and classification of long-term loans and advances.
- Assess compliance with statutory and regulatory requirements.
- Detect risks, misstatements, or fraud in recording or reporting loans and advances.
- Ensure adequate provisions for non-recoverable loans and advances.
Detailed Audit Procedures
- Verification of Documentation
- Review loan agreements, repayment terms, interest rates, and approval documents.
- Verify board and shareholder resolutions, if required, under Section 186 of the Companies Act.
- Cross-check security documents, such as title deeds, guarantees, or lien agreements.
- Classification and Disclosure
- Confirm that long-term loans and advances are correctly classified in the balance sheet under non-current assets.
- Check disclosures as per Schedule III of the Companies Act, including related party transactions and breakups of advances (e.g., capital advances, security deposits, and other loans).
- Compliance with Legal Limits
- Ensure the company has not exceeded prescribed limits for loans and advances under Section 186 of the Companies Act.
- Check that proper approvals were obtained for advances to related parties.
- Valuation and Impairment Testing
- Evaluate whether Expected Credit Loss (ECL) provisions have been created for loans and advances with recovery risks.
- Ensure any permanent diminution in value is appropriately recognized in the financial statements.
- Reconciliation and Analytical Procedures
- Reconcile the balances of long-term loans and advances with subsidiary records and ledger accounts.
- Perform ratio analysis to identify unusual trends or anomalies, such as disproportionate increases in loans or advances.
- Confirmation of Balances
- Send direct confirmation requests to borrowers or deposit holders to verify outstanding balances.
- Match responses with the company’s records and investigate discrepancies.
- Related Party Transactions
- Verify that all loans and advances to related parties are disclosed as per Ind AS 24 and Section 188 of the Companies Act.
- Check whether terms of advances to related parties are at arm’s length.
- Physical Verification
- Conduct site visits, if applicable, to verify the existence of any physical securities or guarantees related to loans.
Practical Examples
Example 1: Loan to a Subsidiary
Scenario: A holding company has granted a loan of ₹5 crore to its subsidiary for expansion.
Audit Approach:
- Review the loan agreement for terms and conditions.
- Verify board and shareholder approvals under Section 186.
- Confirm the subsidiary’s financial stability to repay the loan.
Practical Insight: Ensure the loan is disclosed separately under loans to related parties in the financial statements.
Example 2: Security Deposit for Premises
Scenario: A company has paid ₹10 lakh as a security deposit for leasing office premises.
Audit Approach:
- Verify the lease agreement and ensure the deposit amount matches the agreement.
- Confirm classification under non-current assets.
Practical Insight: Check for adjustments or refunds upon lease termination.
Example 3: Advances for Capital Goods
Scenario: ₹2 crore advanced to a supplier for machinery procurement.
Audit Approach:
- Review purchase orders and advance payment invoices.
- Confirm receipt and installation of the machinery.
Practical Insight: Ensure advances for capital goods are classified as capital advances.
Example 4: Loan to an Employee
Scenario: ₹50 lakh granted to a senior executive for housing.
Audit Approach:
- Verify loan terms and check adherence to company policies.
- Confirm repayment schedule and interest rates.
Practical Insight: Ensure adequate provisions for overdue amounts, if any.
Example 5: Default in Repayment
Scenario: A borrower has defaulted on a ₹1 crore loan.
Audit Approach:
- Evaluate the adequacy of ECL provision.
- Verify legal proceedings initiated for recovery.
Practical Insight: Disclose the default and provisioning in the notes to accounts.
Example 6: Non-Performing Advances
Scenario: An advance to a vendor remains outstanding for 3 years.
Audit Approach:
- Classify the advance as non-performing and create necessary provisions.
- Verify management’s efforts for recovery.
Practical Insight: Ensure compliance with RBI provisioning norms for NBFCs.
Example 7: Loans Without Collateral
Scenario: A ₹10 crore unsecured loan granted to a supplier.
Audit Approach:
- Verify the rationale for granting an unsecured loan.
- Assess the borrower’s creditworthiness and repayment capacity.
Practical Insight: Highlight risks to management and ensure proper disclosure.
Example 8: Prepaid Expenses
Scenario: ₹1 lakh paid in advance for a software subscription.
Audit Approach:
- Review the subscription agreement and ensure periodic expense recognition.
- Match payment records with accounting entries.
Practical Insight: Classify prepaid expenses separately under advances.
Example 9: Overstated Loans
Scenario: A company inflates loan figures to improve its financial ratios.
Audit Approach:
- Perform external confirmations and analytical procedures.
- Trace loan entries to bank statements and agreements.
Practical Insight: Report findings in the audit report if manipulation is identified.
Example 10: Misclassification of Deposits
Scenario: Fixed deposits shown under long-term loans.
Audit Approach:
- Verify classification and ensure disclosure under other financial assets.
- Check compliance with Schedule III.
Practical Insight: Rectify misclassification and adjust notes to accounts.
Conclusion
The audit of long-term loans and advances requires a structured approach to evaluate compliance with laws, accuracy in financial reporting, and risk management. By incorporating detailed procedures and real-world examples, auditors can ensure a robust review of this critical balance sheet item, maintaining transparency and accountability for stakeholders.
Author
CA Sourabh Kothari (C.A., B.Com)
He is currently working as Partner – Risk and Transaction advisory with a renowned firm in Jaipur having experience in Internal Audit, IFC Audit, Business consultancy, Due Diligence and Management consultancy.
E-mail: Sourabh.kothari@jainshrimal.in | LinkedIn: Sourabh Kothari
