Loan audit is an important aspect of a business operation that auditors need to seriously look into. This is evidenced by the fact that banks and other lenders will likely force businesses to bankruptcy if the loan covenants are violated. To this end, it is the duty of the auditors to ensure that their clients are not in violation of the loan covenants. Auditors should also look out for misappropriations in other aspects of the accounts as this is a common practice employed by managers to conceal their violation of loan covenants. In this article are tips on how to perform a successful loan audit.
STEPS TO PERFORM LOAN AUDIT
Obtain a working knowledge of the contents of the loan covenants: obtain a copy of the loan covenant, read through it thoroughly so as to get a working knowledge of the content and legal implications of the content. Take particular note of restrictive clauses in the loan covenants. Where the contents of the loan covenant seems to be subtle, consult a legal practitioner (lawyer or attorney) for clarifications as laws and agreements are supposed to be clear and not clever.
Calculate ratios: calculate ratios to be sure that the loan covenant has not been violated. Ratios to be calculated will be dependent on the content of the agreement that is why you need to get a working understanding of the loan covenant.
Check your clients accounting policies: loan audit cannot be successfully performed if the auditor did not review the accounting policies of their clients.
Watch out for complex transactions: clients have a way of working with investment bankers and other loan experts to make transactions look complex so as to have their way around the generally accepted accounting practice (GAAP). Ask questions when in doubt of the right treatment for any particular complex transaction. Your professional body should be the first place that you will have to run to. You can also go to forums to post the question making sure you do not mention names.
Evaluate the treatments of other items in the accounts: take a close look at the treatments of other items in the account. Managers and business executives purposely give wrong treatment to certain items in the accounts just to fool the auditors. Loan audits are a technique used by auditors to discover areas prone to fraud and errors and subsequently lead to whistle blowing.
Make sure loans are used for what they are taken for. A common fraud in the banking sector is the ‘non performing loan fraud’. These are loans given to connected persons. Loan audit some times delves into discovering the true identity of those behind any loan given or taken.
With the way things are going, I see loan fraud as becoming the next gray area for fraudsters and perpetrators of financial crimes.