Audit of Lending Industry - Specialized Industries PDF

AUDIT OF LENDING INDUSTRY I. Description This module introduces the non-banking financial institutions called the Lending companies, and its characteristics. Learners will be introduced to the RA 9474 or otherwise known as Lending Company Regulation Act which was signed in...

AUDIT OF LENDING INDUSTRY I. Description This module introduces the non-banking financial institutions called the Lending companies, and its characteristics. Learners will be introduced to the RA 9474 or otherwise known as Lending Company Regulation Act which was signed in May 22, 2007. II. Learning Contents A. Description of the business The Bangko Sentral ng Pilipinas (BSP) is the monitory and regulatory body of all the financial institutions inside the Philippines. Broadly, there are 4 different types of financial institutions in the country: 1. Universal and commercial banks: Resource wise, these represent the largest group of financial institutions. These banks offer a range of financial services. The universal banks differ from commercial banks in ways that they have the authority to engage in underwriting and other functions of investment houses and to invest in equities of non-allied undertakings in addition to the functions of an ordinary bank. 2. Rural and cooperative banks: These banks are well known and popular among rural communities in the Philippines. These banks play an active role in developing the rural economy by providing basic financial services to the rural communities. These services can range from helping farmers through the different stages of production to buying vehicles. The difference between the rural banks and Cooperatives is the way they are owned. Rural banks are owned and managed privately while cooperative banks are organized/owned by cooperatives or federation of cooperatives. 3. Thrift banking system: The system is composed of savings and mortgage banks, private development banks, stock savings and loan associations and microfinance thrift banks. These banks are engaged in accumulating savings of depositors and investing them. They also provide short-term working capital and medium- and long-term financing to businesses engaged in agriculture, services, industry and housing, and diversified financial and allied services, and to their chosen markets and constituencies, especially small- and medium- enterprises and individuals. AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 1 Desiree D. Cemefrania, CPA 4. The market also consists of some non-banks with quasi-banking functions. This group consists of institutions engaged in the borrowing of funds from 20 or more lenders for the borrower's own account through issuance, endorsement or assignment with recourse or acceptance of deposit substitutes for purposes of re-lending or purchasing receivables and other obligations. B. Securities and Exchange Commission Lending Companies - A corporation engaged in granting loans from its own capital funds or from funds sourced from not more than nineteen (19) persons. The term shall be synonymous with lending investors. (Section 3, Republic Act No. 9474 or the Lending Company Regulation Act) It shall only be established as a stock corporation with the words “Lending Company”, “Lending Investor” or any other word descriptive of its primary activity of granting loans to the public, except words commonly used to identify financing companies, included in its corporate and trade name. No lending company shall conduct business unless g ranted an authority to operate by the Securities and Exchange Commission (“SEC”). (Sec. 4, R.A. No. 9474 and Rule 3 of its Implementing Rules and Regulations [“IRR”]) Powers of a Lending Company A lending company may grant loans in such amounts and reasonable interest rates and charges as may be agreed upon between the lending company and the debtor: Provided , That the agreement shall be in compliance with the provisions of R.A. No. 3765 ( Truth in Lending Act ) and R.A. No. 7394 ( Consumer Act of the Philippines ); Provided, further , That the Monetary Board, in consultation with the SEC and the industry, may prescribe such interest rate as may be warranted by p revailing economic and social conditions. (Sec. 7, R.A. No. 9474) AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 2 Desiree D. Cemefrania, CPA Financing Companies - Corporations primarily organized for the purpose of extending credit facilities to consumers and to industrial, commercial, or agricultural enterprises, 1. by direct lending or by discounting or by factoring commercial papers or accounts receivable, or 2. by buying and selling contracts, leases, chattel mortgages, or other evidences of indebtedness, or 3. by financial leasing of movables as well as immovable property. It does not include banks, investment houses, savings and loan associations, insurance companies, cooperatives, and other financial institutions organized or operating under other special laws. (Sec. 3(a), R.A. No. 8556 or the Financing Company Act, as amended) It shall be organized in the form of a stock corporations, subject to the following requirements: a) At least forty percent (40%) of the voting stock of the corporation shall be owned by citizens of the Philippines; b) A minimum paid-up capital as required by SEC issuances regarding financing companies; and c) The corporate name of financing companies shall contain the term “financing company”, “finance company”, “finance and investment company” or any other title or word(s) descriptive of its operations and activities as a financing company. Rights and Powers  Engage in quasi-banking and money market operations with the prior approval of the Bangko Sentral ng Pilipinas (“BSP”);  Engage in trust operations subject to the provisions of the General Banking Act upon prior approval by the BSP;  Issue bonds and other capital instruments subject to pertinent laws, rules and regulations; AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 3 Desiree D. Cemefrania, CPA   Rediscount their paper with government financial institutions subject to relevant laws, rules and regulations;  Participate in special loan or credit programs sponsored by or made available through government financial institutions; and  Provide foreign currency loans and leases to enterprises that earn foreign currency by exports or other means subject to existing laws, rules and regulations promulgated by the BSP. Such rights and powers may be included in the financing company’s Articles of Incorporation after submission of the appropriate license/authority issued by the government agency involved. C. Implementing Rules and Regulations of Lending Company Regulation Act of 2007 (Ra 9474) I. Title - Implementing Rules and Regulations of Republic Act No. 9474, otherwise known as the “Lending Company Regulation Act of 2007” II. Definition of Terms a. Act b. Affiliate c. Subsidiary d. Branch Office e. BSP f. Certificate of Authority g. Charges on loan h. Debtor i. Monetary assets j. Lending Company k. Networth l. Quasibank m. SEC/ Commission Refer to RA 9474, define the terms a-m. AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 4 Desiree D. Cemefrania, CPA III. Requirements for Organization a. Form - A lending company shall be established as a stock corporation. Existing Lending Companies organized as single proprietorships or partnerships shall, within a period of one (1) year from the effectivity of the Act, organize themselves as a stock corporation with the minimum capitalization prescribed under the Act and secure a Certificate of Authority to operate a lending company. The words “Lending Company” or “Lending Investor” or any other word descriptive of its primary activity of 5 granting loans to the public except words commonly used to identify financing companies shall always be included in the corporate and trade name. b. Requirements for Securing an Authority – A lending company shall file with SEC four (4) copies of a duly accomplished application form to operate as a lending company, signed under oath by the President, together with the following documents in the prescribed form: i. Information Sheet; ii. NBI clearance of each director/officer; iii. Foreign directors/officers, in addition to the NBI Clearance, shall submit a clearance from the Bureau of Immigration (BI), a photocopy of his passport showing a valid visa or stay in the Philippines, ACR i-card, and a work permit issued by the Department of Labor and Employment iv. President’s Sworn Statement and Undertaking that the corporation will not accept or solicit investments, other 6 than loans, from more than 19 persons without SEC approval, and upon presentation of valid claims, it shall immediately indemnify or return the investments of persons from said unauthorized public solicitation of funds; Moreover, the sworn statement shall likewise contain an undertaking that the country or state of the foreign applicant allows Filipino citizens and corporations to do lending business therein. v. For an existing lending investor applying for a Certificate of Authority, it shall submit an external auditor’s sworn statement and undertaking that based on his/her examination of the corporate books of accounts and other related records of the corporation, it has not accepted or solicited investments, other than loans, from more than 19 persons without prior AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 5 Desiree D. Cemefrania, CPA  compliance with Sections 8 and 12 of the Securities Regulation Code and its Amended Implementing Rules and Regulations. vi. Business plan including method of marketing its product and sources of the funds and maturities of credit; and vii. Statement of its compliance with Rule 17.1(2)(A)(i) and (ii) of the Amended Implementing Rules and Regulations of the Securities Regulation Code. c. Branches, Extension or Satellites Offices or Units. d. Licensing Fees Initial Fees: shall be paid to SEC at the time of filing of application Head Office A fee of 1/10 of 1% of the paid-up capital of the lending company shall be paid for the issuance of a Certificate of Authority to Operate as a Lending Company. Branch, extension A fee of 1/10 of 1% of the assigned capital of the office, unit or satellite branch, extension office, unit or satellite office shall office likewise be paid for the issuance of an original Certificate of Authority Annual Fee An annual fee shall be paid not later than forty five (45) days before the anniversary date of the CA. Head Office 1/8 of 1% of the required paid-up capital Branch, extension 1/8 of 1% of the required paid-up capital office, unit or satellite office e. Commencement of Operations A corporation/company that has been duly registered and granted a Certificate of Authority to Operate as a Lending Company shall commence operations within one hundred twenty (120) days from date of grant of such authority. Failure to commence operations within said period shall be a ground for the suspension of its CA. f. Lending Companies shall use at least 51% of their funds for direct lending purposes. AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 6 Desiree D. Cemefrania, CPA  g. The total investment of a lending company in real estate and in shares of stock in a real estate development corporation and other real estate based projects shall not at any time exceed twenty-five (25%) percent of its networth. IV. Capital A Lending Company shall have a minimum paid-up capital of One Million Pesos (PhP1,000,000.00), unless the SEC prescribes a higher minimum capitalization, if warranted by the circumstances. Branch, extension, satellite office or unit Metro Manila and other first class cities Php 300,000 Second class and other cities; Php 150,000 Municipalities Php 75,000 V. Citizenship Requirements A majority of the voting stock of the lending company shall be owned by citizens of the Philippines. The percentage of foreign-owned voting stocks in any lending company shall be determined by the citizenship of the individual stockholders. In the case of corporations owning shares in a lending company, the citizenship of the individual owners of voting stock in such corporations shall be the basis in the computation of the percentage. If the percentage of foreign owned voting stock in any Lending Company existing prior to the effectivity of the Act is in excess 12 of forty-nine (49%), it shall not be increased but may be reduced and once reduced, shall not be increased thereafter beyond 49% of the voting stock. No foreign national may be allowed to own stock unless the country of which he is a national accords reciprocal rights to Filipinos. VI. Amount and Charges on Loans A lending company may grant loans in such amounts and interest rates and charges as may be agreed upon between the lending company and the debtor: In accordance with the Truth in Lending Act and prior to the consummation of the transaction, a lending company shall furnish each debtor a disclosure statement, setting forth, to the extent applicable, the following information: AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 7 Desiree D. Cemefrania, CPA   The principal amount of loan;  Rate of interest of the loan;  Service or processing fee, if any;  Amortization schedule;  Any penalty charge for late amortization payment; 13  Collection fee, if any;  Notarial fee;  All other fees in connection with the loan transaction;  Description of the collection and lien enforcement procedures; and  Method of calculating the total amount of obligation in case of default. From the internet obtain a sample of a loan agreement from a lending company. Identify if all of the above requirements are present in the agreement. Don’t forget to cover of hide the name of the borrower. VII. Maintenance of Books of Accounts and Records Every lending company shall maintain books of accounts and records as may be required by the SEC and prescribed by the Bureau of Internal Revenue and other government agencies. In case a lending company engages in other businesses, it shall maintain separate books of accounts for these businesses. The Manual of Accounts prescribed by the BSP for lending investors shall continue to be adopted by lending companies for uniform recording and reporting of their operations, until a new Manual of Accounts shall have been prescribed by the SEC. VIII. Authority of the SEC Lending Companies shall be under the supervision and regulation of the SEC. Reports prescribed by the SEC: Report General Information Sheet (GIS) Within thirty (30) days from annual meeting, as stated in its SEC approved bylaws Audited Financial Statements prepared Within One Hundred Twenty (120) days from by an external auditor accredited by the end of fiscal year, as stated in its SEC AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 8 Desiree D. Cemefrania, CPA SEC approved bylaws Special Forms for Financial Statements Within thirty (30) days from the last day of in Electronic Format submission of the 15 annual Audited Financial Statements Interim semi-annual financial Every July 15 and January 15 statements (using Special Form) including the following:  Balance Sheet  Income and Expense statement;  Cash flow  Statement of Changes in Equity  Schedule of Liabilities  List of Directors and Officers  Aging of Receivables The SEC may examine the Books of Accounts and other records of the lending company. Administrative Sanctions - The SEC shall, at its discretion, impose upon any lending company a basic fine of P10,000.00 16 and P100.00 for each day of continuing violation but such daily fine shall not exceed P50,000.00 for the following: i. Violation of the Act and its Implementing Rules and Regulations; ii. Violation of the terms and conditions of the Certificate of Authority; iii. Violation of any lawful order, decision, or ruling of the Commission; iv. Unjustified refusal to have its bank of accounts audited; and v. Continuous failure to comply with SEC requirements. The penalty of suspension shall be imposed in case of three (3) violations and revocation in case of four (4) violations. IX. Delineation of Authority between SEC and the BSP Lending companies shall be under the supervision and regulation of the SEC, Provided, those lending companies which are subsidiaries and affiliates of banks and quasi-banks shall be subject to BSP supervision and examination in accordance with Republic Act No.7653. AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 9 Desiree D. Cemefrania, CPA  X. Acts Punishable and Persons Liable A fine of not less than Ten Thousand Pesos (PhP10,000.00) and not more than Fifty Thousand Pesos (PhP50,000.00) or imprisonment of not less than six months but not more than ten (10) years or both, at the discretion of the court, shall be imposed upon: (a) Any person who shall engage in the business of a lending company without a validly subsisting authority to operate from the SEC; (b) The president, treasurer and other officers of a corporation, including the managing officer thereof, who shall knowingly and willingly i. Engage in the business of a lending company without a validly subsisting authority from the SEC; ii. Hold themselves out to be a lending company, either through advertisement on whatever form, whether in its stationery, commercial paper, or other document, or through other representations; iii. Make use of a trade or firm name containing the words lending company or “lending investor” or any other 18 designation that would give the public the impression that it is engaged in the business of a lending company as defined in the Act without the appropriate SEC authority; and (c) Violators or violations of the provisions of the Act; (d) Any officer, employee or agent of a lending company who shall: i. Knowingly and willingly make any statement in any application, report, or document required to be filled under the Act, which statement is false or misleading with respect to any material fact; ii. Overvalue or aid in overvaluing any security for the purpose of influencing in any way the action of the company in any loan; (e) Any officer, employee or examiner of the SEC directly charged with the implementation of the Act or of other government agencies who shall commit, connive, aid, or assist in the commission of acts enumerated under Subsection 1 and 2 of this Rule. XI. Applicability of Other Laws AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 10 Desiree D. Cemefrania, CPA  The provisions of Republic Act No. 3765, otherwise known as the “Truth in Lending Act of the Philippines,” Republic Act No. 7394 or the “Consumer Act of the Philippines” and other existing laws, insofar as they are not in conflict with any provisions of this Act, shall have a suppletory applicability to Lending Companies. XII. Effectivity of Implementing Rules and Regulations These Implementing Rules and Regulations shall take effect fifteen (15) days from publication in two (2) newspapers of general circulation. Adopted by the Commission En Banc on August 23, 2007. Mandaluyong City, Philippines. D. Audit Objectives The objective of an audit of an institution's financial statements is to express an opinion on whether its financial statements present fairly, in all material respects, its financial position, the results of its operations, and its cash flows in conformity with generally accepted accounting principles (GAAP). To accomplish that objective, the independent accountant assesses the risk that the financial statements contain material misstatements and plans and performs audit procedures to provide reasonable assurance that the financial statements are free of material misstatements. E. Audit Planning Knowledge of the Client's Business In addition to knowledge of the industry, the independent accountant should have knowledge of matters that are unique to the entity whose financial statements are being audited. With regard to financial institutions, such matters include  risk management strategies,  organizational structure,  product lines and services,  capital structure, locations,  and other operating characteristics. AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 11 Desiree D. Cemefrania, CPA The independent accountant's knowledge of the institution's business should be sufficient to provide an understanding of events, transactions, and practices that may have a significant effect on the institution's financial statements. Knowledge of the institution's business is generally obtained through experience with the client, discussions with predecessor independent accountants (if appropriate), discussion with institution personnel, and review of pertinent documents. Such knowledge may also be obtained or supplemented by reading documents such as:  The charter and bylaws of the institution.  Minutes of meetings of the board of directors, audit committee, credit committee or loan officers or both, and other appropriate committees.  Prior-year and interim financial statements and other relevant reports, such as recently issued registration statements.  Risk management strategies and reports, such as interest rate, asset quality, and liquidity reports.  Organizational charts.  Operating policies, including strategies for lending and investing.  Regulatory examination reports  Periodic regulatory financial reports:  Sales brochures and other marketing materials.  Capital or business plans.  Internal reports and financial information utilized by management to make segment– related decisions Related Parties Obtaining knowledge of a client's business should also include performing the procedures to determine the existence of related party relationships and transactions with such parties. IAS24 - Related Party Disclosures ensures that an entity’s financial statement contain sufficient disclosures, that the entity’s financial position or profit/loss may have been affected by; Existence of related parties; Transactions and outstanding balance with related parties. Disclosure of related party transactions and approvals for such transactions is one such area which is intended to prevent directors, Key managerial persons from taking undue advantage of their position for their personal benefit and ensure transparency in dealings of the company. AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 12 Desiree D. Cemefrania, CPA What’s the risk? Related-party transactions sometimes involve contracts for goods or services that are priced at less (or more) favorable terms than those in similar arm’s length transactions between unrelated third parties. Industry Risk Factors Independent accountants with clients in the industry should be aware of the general business and economic risk factors that affect the industry. There is no list of risk factors that can cover all the complex characteristics that affect transactions in the industry. Competition for business, innovations in financial instruments, and the role of regulatory policy were already introduced, as well as emerging regulatory and accounting guidance. Other primary risk factors involve the sensitivity of institutions' earnings to changes in interest rates, liquidity, and asset quality. Independent accountants should consider all such risk factors when planning the audit of an institution's financial statements. a. Interest-Rate Risk b. Liquidity Risk c. Asset-Quality Risk d. Fiduciary Risk e. Processing Risk Define the different types of risks stated above. PSA 320 – Materiality Misstatements, including omissions are material if they individually or aggregately, could be reasonably be expected to influence the economic decisions of the users. F. Internal Control The assets of financial institutions generally are more negotiable and more liquid than those of most other enterprises. As a result, they may be subject to greater risk of loss than are the assets of most other enterprises. In addition, the operations of financial institutions are characterized by a high volume of transactions; as a result, the effectiveness of internal control is a significant audit consideration. AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 13 Desiree D. Cemefrania, CPA After obtaining this understanding, the independent accountant assesses control risk for the assertions embodied in the account balance, transaction class, and disclosure components of the financial statements. The independent accountant may assess control risk at the maximum level (the greatest probability that a material misstatement that could occur in an assertion will not be prevented or detected on a timely basis by the institution's internal control) because the independent accountant believes controls are unlikely to pertain to an assertion, are unlikely to be effective, or because evaluating their effectiveness would be inefficient. Alternatively, the independent accountant may obtain evidential matter about the effectiveness of both the design and operation of a control that supports a lower assessed level of control risk. In such cases, the independent accountant considers whether evidential matter sufficient to support a further reduction is likely to be available and whether performing additional tests of controls to obtain such evidential matter would be efficient. Such evidential matter may be obtained from tests of controls The independent accountant uses the knowledge provided by the understanding of internal control and the assessed level of control risk in determining the nature, timing, and extent of substantive tests for financial statement assertions. 5-Interrelated Components of Internal Control 1. Control environment sets the tone of an institution, influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure. 2. Risk assessment is the institution's identification and analysis of relevant risks to achievement of its objectives, forming a basis for determining how the risks should be managed. 3. Control activities are the policies and procedures that help ensure management directives are carried out. 4. Information and communication are the identification, capture, and exchange of information in a form and time frame that enable people to carry out their responsibilities. 5. Monitoring is a process that assesses the quality of internal control performance over time. AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 14 Desiree D. Cemefrania, CPA G. Audit Procedures Information Technology Considerations. Financial institutions operations are characterized by large volumes of transactions and, therefore, generally rely heavily on computers. In evaluating an institution's internal control and assessing control risk, control issues involving information technology are significant and should receive considerable attention. The independent accountant should consider matters such as:  The extent to which information technology is used for significant accounting applications.  The complexity of the institution's information technology, including whether outside service centers are used.  The organizational structure for information technology, including the extent to which on-line terminals and networks are used.  The physical security controls over computer equipment.  Controls over information technology (for example, program changes and access to data files), operations, and systems.  The availability of data.  The use of information technology assisted audit techniques to increase the efficiency of performing procedures. (Using information technology assisted audit techniques may also provide the independent accountant with an opportunity to apply certain procedures to an entire population of accounts or transactions. In addition, in some accounting systems, it may be difficult or impossible for the independent accountant to analyze certain data or test specific control procedures without information technology assistance.) The AICPA Auditing Procedure Study Auditing in Common Computer Environments, provides guidance to independent accountants when institutions use microcomputers, local area networks, end-user computing, data base management systems, or telecommunications in conjunction with their accounting systems. The Auditing Procedure Study identifies a number of electronic data processing technologies and software applications that may affect the financial AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 15 Desiree D. Cemefrania, CPA statement audit, describes how these technologies and applications work, and discusses possible ramifications for the financial statement audit. V. References  IMPLEMENTING RULES AND REGULATIONS OF LENDING COMPANY REGULATION ACT OF 2007 (REPUBLIC ACT NO. 9474)  AICPA Audit and Accounting Guide Depository and Lending Institutions: Banks and Savings Institutions, Credit Unions, Finance Companies and Mortgage Companies AUDITING AND ASSURANCE: SPECIALIZED INDUSTRIES 16 Desiree D. Cemefrania, CPA