Secured Loans

Different forms of Secured Loans and AUDIT
Funds of an entity could be either own funds or owed funds. Borrowings are categorized as loans.
Loan is a one-time receipt from the lender (which may be released in installments as in the case of factory buildings, civil works, plant and machinery, etc.). Loans are to be within the borrowing powers of the company as per the Companies Act.
Loans of a company can be:

From institutional lenders such as banks, IDBI, IFCI, etc., which are secured.
From small investors, such as fixed deposits from public which are unsecured.
Debentures, which may be either secured or unsecured
Inter-corporate deposits, which are from other companies, which may or may not be under the same management

What is a security?
A security is a tangible asset, current or fixed, which is given to the custody of the lender with a stipulation that the lender could dispose of the security and appropriate the proceeds in case of default in repayment. A loan could be fully or partly secured.

Security of a current asset

In the case of a pledge, the lender has possession of the asset charged, which would be released only on payment of the dues. In the case of hypothecation, the possession is with the borrower, with a stipulation that the lender can seize the asset upon failure to repay the loan. The lender exercises a lien over the asset.
Loan against gold, NSCs, fixed deposits of bank, shares of companies, etc., are loans on pledge. All these are given to the custody of the lender, who will release the asset only on repayment in full of the amount borrowed.
Loans against vehicles, personal loans for purchase of durables, such as televisions, air-conditioners, etc., are loans on hypothecation. The borrower has possession of these goods.
Security of immovable property
An immovable property is secured by way of a mortgage, which could be an equitable mortgage (simple deposit of title deeds with the lender) or a registered mortgage, where the mortgage deed is to be registered with the registrar of assurances.
A guarantee is an assurance given by a third party to the contract that he would pay the amount if the principal borrower fails to pay.
There is nothing tangible given to the custody of the lender. Therefore, the loan against a guarantee does not constitute a secured loan. Loans against guarantees be it even by the Government, have to be shown under the head unsecured loans and not secured loans.
When an asset is given to the custody of the lender, the asset is said to be charged to the lender. The lender gets the right on the asset upon failure of the borrower to repay the loan. The charge can be a first/second charge or a pari passu charge.

Charge on an asset
In the case of first charge, the lender gets absolute right on the security. Any surplus from the sale of the asset should be turned over to the borrower.
In the case of the second charge the lender gets the right on the asset after satisfying the first lender. Any surplus after satisfying his claim should be turned over to the borrower.
Pari passu charge gives a parallel proportionate right to the lenders. Realization of the asset should be shared in proportion to the balances outstanding to the respective lenders.
Company law requirements

Registration of charge: Law requires any such charges on assets to be registered. Creation of charge is to be registered with the Registrar of Companies (RoC) within 30 days from the date of such creation or such extended time as permitted by the RoC. Such a registration secures the position of the lender. It is in the interest of the lender to ensure that the charge is registered. If the charges are not registered, the lender cannot enforce his charge on the asset.
Disclosure: Where a loan is disclosed as a secured loan, the details and nature of security should also be disclosed. If the loan is further secured by the personal guarantee of any of the directors, the fact should also be stated.
AS 10 provides an option to disclose the amount due to the hire vendor either as a deduction from the cash price of the asset or alternately as a secured loan.

Audit requirements: Section 227(1A) casts a responsibility on the auditors regarding such secured loans as well. Where a loan is disclosed as a secured loan, the auditor should ensure that the loan is properly secured.
To ensure that the loan is properly secured, the auditor has to carry out the following procedures:
Examine the document of loan for the nature and extent of security.
Obtain a letter from the lender that to the effect that the asset is held by them as a security.
Check the certificate of registration of charge (Forms 8 and 13).
Insist upon a management representation to this effect.
Verify the register of charges that this security is registered with the RoC and entered in this register.
Check the disclosure under secured loans.
Interest on secured loans
Disclosure of interest on secured loans is tricky. When interest is due and payable, it is a current liability and shown as such. But if it becomes overdue, the lenders can extend their charge on the interest also and consequently the amount gets merged with the secured loans. Since interest is not compounded, it cannot be shown as an addition to the loan but as a separate item.
Consider a company having secured debentures on which interest is payable on the first day of July and January every year. In the balance sheet as on March 31, 2XX6, interest payable for the broken period from January 1 to March 31, 2XX6 should be disclosed under current liabilities. In case interest due on January 1, 2XX6 also remains unpaid, that amount due from July 1, 2XX5 to January 1, 2XX6 should be disclosed along side secured debentures under the head secured loans but not as an addition to secured debentures.
Audit of secured loans
The auditor should verify the minutes of the board meeting for raising a loan.
Ensure that the loan is within the borrowing powers or a specific resolution passed by the general body for raising such loans.
Vet the loan documents of secured loan to understand the terms of loan such as installment payable, rate of interest, details of security.
Vouch the disbursement of loan with reference to the entries in the books of account and account copy from the lender.
If the repayment is by way of an EMI or such other fixed amount, calculate the split out of the amount between principal and interest and account for the same accordingly.
Calculate interest on loan as per the terms of the loan both with reference to the rate and the period. If the sanction says the interest is at quarterly or half-yearly rests, calculations should be made accordingly.
Examine whether interest is disclosed as per the requirements of law.
Ensure that the loan is disclosed only at the principal outstanding and that the nature of security is also mentioned.
To comply with CARO requirement, trace the usage of loan and ensure that it is used only for the purpose for which it was intended. Verify receipts issued by the payee for all the payments out of this loan. Obtain a management representation to this effect.
Source:
Business Line, Monday, May 21, 2007

compiled by ABASH

MEMBER OF JAB WE MET CA

REDEFINING PROFESSIONALISM..............