Long-term borrowings are a crucial component of a company’s balance sheet, representing obligations that are due beyond one year from the balance sheet date. This guide provides detailed directions on how to conduct a statutory audit of long-term borrowings for Indian companies in compliance with Indian laws. We will cover the key audit procedures, queries, and potential areas of confusion regarding this balance sheet item.
Key Regulations and Compliance
1. Companies Act, 2013:
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- Sections 73 to 76 and 180 cover the regulations related to borrowings, including restrictions on acceptance of deposits, conditions for accepting secured and unsecured loans, and the need for board and shareholder approvals.
- Section 180(1)(c) requires special resolution for borrowing money exceeding the aggregate of paid-up capital, free reserves, and securities premium.
2. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:
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- These regulations mandate disclosures related to borrowings for listed companies, ensuring transparency and investor protection.
3. RBI Guidelines:
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- For companies classified as Non-Banking Financial Companies (NBFCs), compliance with RBI guidelines on borrowings is mandatory.
4. Accounting Standards:
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- Ind AS 23 (Borrowing Costs) and Ind AS 109 (Financial Instruments) provide guidance on the recognition, measurement, and disclosure of borrowings.
Detailed Audit Procedures
1. Verification of Borrowing Agreements
Objective: To ensure the borrowings are genuine, authorized, and correctly recorded.
- Review of Loan Agreements: Obtain and review all loan agreements, debenture trust deeds, and other related documents. Ensure the terms and conditions, including the principal amount, interest rate, repayment schedule, security provided, and covenants, are properly documented.
- Authorization and Approval: Verify that the borrowings have been duly authorized by the company’s board of directors and, where required, by the shareholders. Check board minutes and shareholders’ meeting minutes for relevant resolutions.
- Loan Limits: Ensure that the borrowings do not exceed the limits set by the company’s Articles of Association and that any borrowings beyond the specified limits have been approved by shareholders through a special resolution, as per Section 180 of the Companies Act, 2013.
2. Compliance with Regulatory Requirements
Objective: To ensure compliance with statutory and regulatory provisions.
- Companies Act, 2013: Verify compliance with sections 73 to 76 (acceptance of deposits) and Section 180 (restrictions on powers of the Board regarding borrowings). Ensure proper filing of forms and returns with the Registrar of Companies (RoC), such as CHG-1 for the creation of a charge.
- SEBI Regulations: For listed companies, ensure compliance with SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, which mandate disclosures related to borrowings.
- RBI Guidelines: For NBFCs, ensure compliance with relevant RBI guidelines on borrowings.
3. Examination of Borrowing Costs
Objective: To ensure borrowing costs are accurately recognized and classified.
- Capitalization of Borrowing Costs: Verify the appropriateness of capitalizing borrowing costs related to qualifying assets as per Ind AS 23. Ensure that the costs are capitalized only during the period when the activities necessary to prepare the asset for its intended use are in progress.
- Interest Expense: Check the accuracy of interest expense calculations and ensure that they are appropriately recorded in the profit and loss account if not capitalized.
4. Classification and Disclosure
Objective: To ensure correct classification and adequate disclosure in financial statements.
- Non-Current Liabilities: Confirm that long-term borrowings are classified under non-current liabilities in the balance sheet. The portion due within the next 12 months should be classified under current liabilities.
- Disclosures: Verify that the financial statements include all necessary disclosures as per Ind AS 109, such as the nature of borrowings, interest rates, repayment terms, maturity profiles, and security provided.
5. Confirmation of Balances
Objective: To ensure the accuracy of recorded amounts.
- Direct Confirmations: Obtain direct confirmations of loan balances from lenders. Reconcile these confirmations with the company’s records to ensure accuracy.
- Reconciliation: Investigate any discrepancies between the confirmations and the company’s books.
6. Covenant Compliance
Objective: To ensure compliance with loan covenants.
- Review Loan Covenants: Examine the loan covenants to ensure that the company complies with the terms stipulated by lenders. This includes financial covenants (e.g., debt-to-equity ratio) and non-financial covenants (e.g., restrictions on additional borrowings).
- Impact of Breaches: Assess the impact of any covenant breaches on the classification and disclosure of borrowings. Ensure appropriate disclosure of any breaches in the financial statements.
7. Reconciliation of Interest Payable
Objective: To verify the accuracy of interest payable.
- Interest Accrual: Reconcile the interest payable as per the company’s books with the interest accrued as per loan agreements and lender confirmations.
- Timely Payment: Verify that interest payments are made timely and check for any penalties or additional charges due to delayed payments.
8. Verification of Security and Guarantees
Objective: To verify the existence and valuation of security provided.
- Security Provided: Review the security provided against borrowings, such as fixed assets, inventories, or receivables. Ensure that these assets are correctly recorded and valued in the financial statements.
- Existence and Valuation: Physically verify the existence of the security provided. For intangible security (e.g., receivables), check supporting documents like invoices and agreements.
- Guarantees: Verify any guarantees provided by or to the company in relation to the borrowings. Ensure proper disclosure of these guarantees in the financial statements.
9. Review of Board and Shareholder Approvals
Objective: To ensure that borrowings are properly authorized.
- Board Resolutions: Check the board resolutions authorizing the borrowings. Ensure that the borrowings are within the limits set by the board and shareholders.
- Shareholder Resolutions: For borrowings exceeding the limits set by the company’s Articles of Association, ensure that shareholder approval has been obtained through a special resolution.
10. Compliance with Debt Covenants
Objective: To ensure the company adheres to debt covenants.
- Financial Ratios: Verify that the company maintains the financial ratios (e.g., current ratio, debt service coverage ratio) required by the loan covenants.
- Non-Financial Covenants: Check compliance with non-financial covenants, such as restrictions on additional borrowings, asset sales, or changes in management.
- Covenant Breaches: Investigate any covenant breaches and assess their implications on the classification and disclosure of borrowings in the financial statements.
Common Queries and Areas of Confusion
1. Classification between Current and Non-Current:
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- Ensure correct classification of the portion of long-term borrowings due within the next 12 months as current liabilities.
- Verify the consistency in classification as per the terms of the borrowing agreements.
2. Interest Rate Variability:
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- Address the treatment of floating versus fixed interest rates.
- Ensure the correct accounting treatment for changes in interest rates over the loan period.
3. Foreign Currency Borrowings:
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- Verify the treatment of exchange rate fluctuations on foreign currency borrowings.
- Ensure compliance with Ind AS 21 (The Effects of Changes in Foreign Exchange Rates) for translation and reporting.
4. Borrowing Costs Capitalization:
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- Determine the appropriateness of capitalizing borrowing costs related to specific projects or assets.
- Verify the cessation of capitalization once the asset is ready for its intended use.
5. Loan Restructuring:
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- Review the accounting treatment for any restructured loans, including modifications in terms, interest rates, and repayment schedules.
- Ensure the correct disclosure of any loan restructuring in the financial statements.
6. Debt Covenants:
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- Verify the company’s compliance with financial and non-financial covenants associated with borrowings.
- Investigate the impact of any breaches of covenants on the classification and disclosure of borrowings.
7. Inter-Company Borrowings:
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- Review the terms and conditions of borrowings between related parties.
- Ensure compliance with transfer pricing regulations and disclosure requirements under the Companies Act.
8. Contingent Liabilities:
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- Identify any contingent liabilities arising from guarantees or letters of credit associated with borrowings.
- Ensure appropriate disclosure in the notes to the financial statements.
Conclusion
Auditing long-term borrowings involves a thorough understanding of regulatory requirements, detailed examination of loan agreements, and verification of compliance with covenants and disclosure norms. By following the outlined procedures, auditors can ensure that long-term borrowings are accurately recorded, classified, and disclosed in the financial statements, providing stakeholders with a clear and accurate picture of the company’s financial obligations.
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
