Verification of Security against Advances :
From the view point of security, advances are to be classified in the balance sheet in the following manner:
(a) Secured by tangible assets.
(b) Covered by bank/government guarantees.
(c) Unsecured.
An advance should be treated as secured to the extent of the value of the security on the reporting date. If only a part of the advance is covered by the value of the security as at the date of the balance sheet, that part only should be classified as secured; the remaining amount should be classified as unsecured.
As mentioned earlier, the Reserve Bank has specified that advances against book debts may be included under the head ‘secured by tangible assets’.
The following points are relevant for classifying the advances based on security.
(a) Government guarantees include guarantees of Central/State Governments and also advances guaranteed by Central/State Government owned corporations and financial institutions like IDBI, IFCI, ICICI, State Financial Corporations, State Industrial Development Corporations, ECGC, DICGC, CGTS, etc.
(b) Advances covered by bank guarantees also include advances guaranteed against any negotiable instrument, the payment of which is guaranteed by a bank.
(c) Advances covered by bank/government guarantees should be included in unsecured advances to the extent the outstanding in these advances exceed the amount of related guarantees.
(d) While classifying the advances as secured, the primary security should be applied first and for the residual balance, if any, the value of collateral security should be taken into account. If the advance is still not fully covered, then, to the extent of bank/government guarantees available, the advance should be classified as ‘covered by bank/government guarantee’. The balance, if any, remaining after the above classification, should be classified as ‘unsecured’.
(e) There may be situations where more than one facility is granted to a single borrower and a facility is secured, apart from primary and collateral securities relating specifically to that facility, by the residual value of primary security relating to any other credit facility (or facilities) granted to the borrower. In such a case, in the event of shortfall in the value of primary security in such a credit facility, the residual value of primary security of the other facility (or facilities, as the case may be) may be applied first to the shortfall and the value of collateral securities should be applied next.
(f) In the case of common collateral security for advances granted to more than one borrower, if there is a shortfall in value of primary security in any one or more of the borrowal accounts, the value of collateral security may be applied proportionately to the shortfall in each borrowal account.
(g) Advances covered by ECGC/DICGC,CGTS guarantees should be treated as covered by guarantees to the extent of guarantee cover available. The amount already received from DICGC/ECGC/CGTS and kept in sundry creditors account pending adjustment should be deducted from advances.
(h) An account which is fully secured but the margin in which is lower than that stipulated by the bank should nevertheless be treated as fully secured for the purposes of balance sheet presentation.
(i) All documentary bills under delivery-against-payment terms (i.e., covered by RR/Airway Bill/Bill of lading) for which the documents are with the bank as on the balance sheet date should be classified as ‘secured’.
(j) Documentary bills under delivery-against-acceptance terms which remain unaccepted as at the close of 31st March (i.e., for which the documents of title are with the bank on this date) should be classified as secured. All accepted bills should be classified as ‘unsecured’ unless collaterally secured.
(k) Cheques purchased including self-cheques (i.e., where the drawer and payee are one and the same) should be treated as unsecured.
(l) Advances against supply bills, unless collaterally secured, should be classified as unsecured even if they have been accepted by the drawees.
(m) ‘Security’ means tangible security properly discharged to the bank and will not include intangible securities like guarantees (including State government guarantees), comfort letters, etc. Moreover, the rights, licenses, authorisations, etc., charged to the banks as collateral in respect of projects (including infrastructure projects) financed by them, should not be reckoned as tangible security. (Ref Master Circular No. RBI/2015- 16/99DBR.BP.BC.No.23/21.04.018/2015-16 dated July 1 2015 on Disclosure in Financial Statements- Notes to Accounts)
In examining whether an advance is secured and, if so, to what extent, the auditor is concerned with determining –
(a) whether the security is legally enforceable, i.e., whether the necessary legal formalities regarding documentation, registration, etc., have been complied with;
(b) whether the security is in the effective control of the bank; and
(c) to what extent the value of the security, assessed realistically, covers the amount outstanding in the advance.
The auditor should examine the following aspects in respect of advances classified as ‘secured’:
(a) Documents executed are complete and in force.
(b) Where documents have not been renewed, the limitation period has not expired.
(c) Evidence is available as to the market value of the security.
(d) Evidence is available that –
(i) hypothecated/pledged goods are the property of the borrowers and are not old/obsolete or otherwise unsaleable;
advances against book debts of borrowers are related to their current debts and not old/doubtful debts; and
Stocks hypothecated/pledged are paid stocks owned by the borrower.
(e) In the case of companies, the charge is appropriately registered with the Registrar of Companies and a certificate of registration of charge or other
evidence of registration is held.
(f) Borrowers are regular in furnishing the requisite information regarding the value of security lodged with the bank.
(g) In respect of the second charge being available in respect of certain assets, the amount of the lender(s) enjoying the first charge on such asset be worked out and only the residuary value, if any, available for second charge holders, be considered.