## Audit of Income in Banks

### (i) RBI Direction on Materiality and Basis of Recognition

Income recognition basis depends on whether the income is material:

Test	If Met → Basis
Any income item > 1% of Total Income of the bank	Accrual basis (Gross Basis)
Any income item > 1% of Profit Before Tax of the bank	Accrual basis (Net Basis)
Income is not material (below both thresholds)	Bank may recognise on Cash Basis

> Material income must always be recognised on an accrual basis. Immaterial income can optionally be on cash basis.

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### (ii) Reversal of Income (Very Important)

#### General Rule

When any advance (including bills purchased and discounted) becomes NPA:

Interest accrued but not received must be reversed.
This reversal also applies to Government Guarantee Advances (not just regular advances).

#### Commission and Similar Income

In respect of NPA accounts:

Commission and similar income that has accrued should cease to accrue in the current period.
Past accrued but uncollected amounts must also be reversed.

#### Interest Income Wrongly Booked in Current Year

If interest income was incorrectly booked in the current year:

1. Reverse the interest income; AND

2. Make a provision for an equal amount of the income recognised in the current year.

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### (iii) Auditor's Specific Inquiry

Inquire about large debits in the Interest Income account that are unexplained.
Inquire whether communication was made to the borrower about any difference in interest charged (i.e., reconciliation with borrower's records).

Worked example

### Example 1

Materiality Test for Income Recognition Basis:

Bank's Total Income = ₹500 crore.

Profit Before Tax = ₹80 crore.

1% of Total Income = ₹5 crore.

1% of PBT = ₹80 lakh.

Income item A = ₹6 crore → Exceeds 1% of Total Income → Must be recognised on Accrual (Gross) Basis.

Income item B = ₹1 crore → Exceeds 1% of PBT but < 1% of Total Income → Recognised on Accrual (Net) Basis.

Income item C = ₹50 lakh → Below both thresholds (< ₹80 lakh) → Bank may use Cash Basis.

### Example 2

Reversal of Income on NPA:

A term loan account becomes NPA on 01-Oct-2024.

Interest accrued from 01-Jul-2024 to 30-Sep-2024 = ₹1,20,000 → Already credited to Interest Income.

Interest from 01-Oct-2024 to 31-Mar-2025 = ₹2,40,000 → Should NOT be accrued.

Audit finding: Bank has continued to book ₹2,40,000 as income after NPA date.

→ Auditor requires: (1) Reverse ₹2,40,000 from Interest Income, AND (2) Make a provision of ₹2,40,000.

Also: The ₹1,20,000 already booked for the pre-NPA quarter should be reversed if not collected.

⚠️ Common exam mistakes

Thinking the reversal of income on NPA applies only to new NPAs — it applies to all NPAs, including accounts that became NPA in prior periods if income was erroneously booked.
Forgetting that the reversal rule applies to government guarantee advances — the guarantee doesn't make the advance immune from the income reversal requirement.
Assuming immaterial income must be on cash basis — the RBI rule says bank 'may' use cash basis for immaterial income; it is permitted but not mandatory.
Reversing income without also making an equal provision when the income was wrongly booked in the current year — both steps (reversal + provision) are required together.
Applying the 1% materiality test only to the Total Income threshold — there are two independent tests (1% of Total Income OR 1% of PBT); income exceeding either threshold must be on accrual basis.

Reference: Para on Income Recognition — RBI Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning

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Audit of Income – RBI Materiality Directions and Reversal of Income

Worked example