Audit of Restructure Assets - Nagpur Branch, ICAI

of 5
AUDIT OF RESTRUCTURED ACCOUNTS –
AREAS OF CONCERN
CA Pranav Joshi
Partner,
P. G. Joshi & Co., Chartered Accountants
WHAT IS DEBT RESTRUCTURING?
Definition
Restructuring of Debt is the modification of the terms of a loan (Loan Agreement) to provide relief to the debtor
who could otherwise default on payments. Restructuring may involve:
 Extending the period of repayment;
 Reducing the total amount owed;
 Providing additional finance to the borrower;
 Structuring repayments of existing loans (including carving Working Capital Term Loans (WCTL) out of Cash
Credit facilities);
 Funding of Interest on term loans (including WCTL) for a specified period; and/or
 Exchanging a portion of the debt for equity in the debtor company (Strategic Debt Restructuring Mechanism).
ASSET CLASSIFICATION
Apart from relief in the form of reduced current liability or availing additional finance to help get its operations
back on track, another important reason why Banks & Borrowers were opting for the scheme was to maintain the
Asset Classification of the distressed advances. Entering into a restructuring mechanism enabled the banks to
retain the “Standard” status of an otherwise failing loan account a little longer.
However, the RBI, through its master circular dated 1 July, 2014, has mandated that the accounts classified as
'standard assets' should be immediately reclassified as 'sub-standard assets' upon restructuring. The latest master
circular dated 1 July, 2015 has given relaxation to the said clause subject to certain conditions.
Further, the circular states that the Non Performing Assets, upon restructuring, would continue to be classified as
per the extant asset classification norms with reference to the pre-restructuring repayment schedule only.
Up-gradation of Account: All restructured accounts which have been classified as non-performing assets upon
restructuring, would be eligible for up-gradation to the 'standard' category after observation of 'satisfactory
performance' during the 'specified period'. Specified Period (as per Master Circular Dated 1
st
July, 2015) is defined
as a period of one year from the date when the first payment of interest or installment of principal falls due under
the terms of restructuring package. Previous master circular dated 1
st
July, 2014 shed more light on the said
definition by saying – “Specified Period means a period of one year from the commencement of the first payment of
interest or principal, whichever is later, on the credit facility with longest period of moratorium under the terms of
restructuring package.”

of 5
AUDIT OF RESTRUCTURED ACCOUNTS
Basis of Audit
Most debt restructuring schemes are finalized and approved by the Corporate Debt Restructuring Cell (CDR Cell).
On approval, a detailed sanction of the CDR scheme is made available to the consortium members/Bank according
to which the advance is restructured.
CDR schemes vary from case to case and the CDR document should be carefully examined before deciding upon
the audit strategy. Typical points of concern in a restructuring arrangement are discussed below.
Typical Components of Restructuring Scheme
The sanction terms of the advances which are subjected to restructuring mechanisms (CDR or Non-CDR) are
typically restructured in the following ways:
Restructuring Scheme
Original Loan/
Source Loan
Component Relief Restructured
Loan
Working Capital
(CC)
Sanctioned
Amount
Reduction in Interest Rates CC 1
Working Capital
(CC)
Unpaid Interest Conversion to Working Capital Term Loan (WCTL) with structured
repayments
*WCTL 1
Term Loan Unpaid Interest Unpaid interest & future interest to be funded by the bank through a
"Funded Interest Term Loan" (FITL) for a specified period with
structured repayments
FITL 1
WCTL 1 Future Interest to
be charged
Future interest to be funded by the bank through a "Funded Interest
Term Loan" (FITL) for a specified period with structured repayments
FITL 2
*WCTL may be carved out of irregularities like LC devolved, overdue installments on term loans, Pressing creditors, Statutory
Dues and any other urgent payments.
The above transaction is explained below:
Original Loan/Source Loan Component Loan Name
(Example)
Repayment (Annual)
Working Capital (CC) @ 10%
p.a.
Sanctioned = Rs. 100 Cr
Irregularities (LC devolved
etc.) = Rs. 10 Cr
Sanctioned Amount
Rs. 100 Cr.
CC 1
Sanctioned = Rs. 100
Cr.
Interest as and when debited
(Eg. 7% p.a.)
Rs. 7.00 Cr.
Irregularities
Rs. 10 Cr.
WCTL 1
Sanctioned = Rs. 10
Cr.
NIL -
Term Loan
Standard O/s as per
schedule = Rs. 50 Cr.
Actual O/s = Rs. 65 Cr.
Principal = Rs. 50 Cr.
Unpaid Interest =
Rs. 15 Cr.
FITL 1
Sanctioned = Rs. 20
Cr.
(*10% x Rs. 50 Cr. =
Rs. 5 Cr. + Rs. 15 Cr.
Unpaid interest)
Principal as per Schedule.
Rs. 2.00 Cr.
(*10% x Rs. 20
Cr. = Rs. 0.1 Cr.)
WCTL 1 Future Interest to
be
charged for a
specified period
FITL 2
Sanctioned = Rs. 1 Cr.
Principal as per Schedule.
Rs. 0.10 Cr.
(*10% x Rs. 1 Cr.
= Rs. 0.1 Cr.)
*rate of interest on term loan for 1 year

of 5
Areas of Concern
While auditing restructured advances, there are two areas which need great attention:
1. RBI guidelines on FITL A/c
2. Provision for Diminution in the Fair Value (DFV) of restructured Advances
FUNDED INTEREST TERM LOAN A/C
What is FITL?
Funding of interest means transfer of interest charged to term loan accounts for a specified period to another loan
account i.e. giving additional term finance to the extent of interest which is then repayable in structured
installments. Such funding is done by crediting the Loan A/c (Term loan or WCTL) and debiting a “Funded Interest
Term Loan A/c (FITL)” post charging of interest in the Term Loan A/c.
It may be seen that the specified period up to which the interest is funded is up to the point the borrower reaches
BEP as per the revised projections.
Asset Classification Norms
The FITL created by conversion of unpaid interest will be classified in the same asset classification category in
which the restructured advance has been classified. Further movement in the asset classification of FITL would also
be determined based on the subsequent asset classification of the restructured advance.
For further details on asset classification and provisioning norms on restructured assets, please refer RBI master
circular
Income Recognition Norms
i. The income, if any, generated may be recognised on accrual basis, if FITL is classified as 'standard', and on
cash basis in the cases where the same has been classified as a non-performing asset.
ii. The unrealised income represented by FITL should have a corresponding credit in an account styled as
"Sundry Liabilities Account (Interest Capitalization)".
Explanation: As it is understood, the FITL is created out of funding of interest charged in the Term Loan
Accounts (including WCTL). When interest charged to the Term Loan Accounts, interest income is accrued
in the P&L A/c. However, as the interest is funded by the bank itself, the interest income should not be
booked. Hence, a provision to the extent of the funded interest is to be made by crediting a "Sundry
Liabilities Account (Interest Capitalization)”.
However, it must be taken care that the any interest charged on the FITL A/c, if unpaid, should not to be
provided for. There will always be a difference in the balance in the FITL A/c and the Sundry Liabilities
Account (Interest Capitalization) to the extent of unpaid interest.
iii. Only on repayment (principal) in case of FITL, the amount received will be recognized in the P&L Account,
while simultaneously reducing the balance in the "Sundry Liabilities Account (Interest Capitalisation)".

of 5
Explanation: By repaying the principal amount of FITL A/c, the borrower is essentially paying the interest
charged on the Term Loan Accounts which were funded by the FITL A/c. Hence, the provision made is to
be reduced to that extent.
Transfer of Interest for closing month
It has been noticed at many instances that interest on the term loan accounts is charged after EOD on the
reporting date. In such case, the transfer of interest charged to the FITL A/c may not be done as the books get
closed. Auditors may advice the bank to transfer the interest for the closing month (on an estimated basis) by
passing a journal entry and debit the FITL A/c by crediting the concerned term loan accounts before EOD on
reporting date. This way when the interest is charged at EOD, the amount credited in the term loan account will
get nullified with a minor difference.
If the interest charged for the closing month is not transferred to the FITL A/c, provision for interest income will be
less to that extent and will result in inflated income from interest in the books of accounts.
PROVISION FOR DIMINUTION IN THE FAIR VALUE (DFV) OF RESTRUCTURED ADVANCES
Diminution in Fair Value is the sacrifice made by the bank in order to restructure advances. Restructuring of
advances may adversely impact the future interest income the Bank would have earned from those advances. Such
reduction in Bank’s income has to be provided for by the Bank. The reduction in interest income or the sacrifice
(amount of provision) is calculated as the difference between the fair value of the loan before and after
restructuring. Calculation of DFV would be required only to the loans part of the original sanction. Loans
sanctioned as part of restructuring (Eg. FITL) will not require calculation of DFV.
Fair value of loan is the present value of the scheduled future cash flows in the form of repayment of principal and
interest income.
Calculation of DFV
DFV = (FV of loan before Restructuring) – (FV of loan after Restructuring), to be provided for only if positive.
Fair Value of loan Before Restructuring
Original
Loan
Type
Loan
Tenure
O/s Amount (Principal) Interest
Rate
*Discount Rate
Term Loan As per
Sanction
Standard Amt O/s on reporting date as per original
repayment schedule.
While preparing the repayment schedule, the
difference between the Amt O/s on reporting date
as per revised repayment schedule and the Amount
O/s on reporting date as per original repayment
schedule is to be considered as payable as on the
reporting date. The discounting factor for the same
is to be taken as 1.
Interest
Rate as per
original
sanction
Interest Rate as per original
sanction. In cases where the
existing credit facilities to a
borrower carry different rates
of interest, the weighted
average interest rate.
Working
Capital
Deemed
to be 1
year
Amount Sanctioned or O/s, whichever is higher Interest
Rate as per
original
sanction

of 5
Fair Value of loan After Restructuring
Restructured
Loan
Type
Loan
Tenure
O/s Amount (Principal) Interest
Rate
*Discount Rate
Term Loan
(Including
WCTL)
As per
Sanction
Amount O/s on reporting date as per revised
repayment schedule
Interest
Rate as per
revised
sanction
*(As per RBI circular dated 02 July, 2015)
Audit Remarks:
1. Standard Balance Vs Actual Balance: Calculation of DFV is not dependant on the actual outstanding balance
in the loan account as on the reporting date. The standard balance which should have been outstanding as
per the repayment schedule is to be considered.
2. Structured change in interest rate as per sanction: Interest rate should be changed as per the
original/revised schedule while calculating future interest amounts.
3. Floating Interest Rates: Incase interest per the original sanction was charged at a floating rate (Say Base Rate
+ 4%), the interest rate as per original sanction should be calculated on the Base Rate as on the reporting
date and not on the BR as on the date of original sanction/restructuring.
The diminution in the fair value may be re-computed on each balance sheet date till satisfactory completion of all
repayment obligations and full repayment of the outstanding in the account, so as to capture the changes in the
fair value on account of changes in BR and the credit category of the borrower. Consequently, banks may provide
for the shortfall in provision or reverse the amount of excess provision held in the distinct account.
The total provisions required against an account (normal provisions plus provisions in lieu of diminution in the fair
value of the advance) are capped at 100% of the outstanding debt amount.
SUMMING UP
The CDR document can be considered as the bible while auditing restructured advances. The approved scheme
may include peculiar conditions which have not been covered in this discussion. It has been an experience that
mistakes are invariably found in the calculation of DFV and accounting of FITL transactions including provision to
be made. The auditor will have to carefully examine the transactions surrounding such advances.

Audit of Restructure Assets - Nagpur Branch, ICAI

More Related Content

What's hot (20)

Similar to Audit of Restructure Assets - Nagpur Branch, ICAI (20)

More from Pranav Joshi (8)

Audit of Restructure Assets - Nagpur Branch, ICAI