Enhancing audit quality of Loans and advance to customers in small and medium commercial joint stock banks at Ernst $ Young Vietnam

auditing next year only need to collect new contracts that take effect after the previous audit) and make a summary, include all information as follows: Creditor[r]

VIETNAM NATIONAL UNIVERSITY, HANOI

INTERNATIONAL SCHOOL

GRADUATION PROJECT

ENHANCING AUDIT QUALITY OF LOANS AND ADVANCE TO CUSTOMERS IN

SMALL AND MEDIUM COMMERCIAL JOINT STOCK BANKS

AT ERNST & YOUNG VIETNAM

Tran Dieu Hong Anh

Hanoi - 2020

VIETNAM NATIONAL UNIVERSITY, HANOI

INTERNATIONAL SCHOOL

GRADUATION PROJECT

ENHANCING AUDIT QUALITY OF LOANS AND ADVANCE TO CUSTOMERS IN

SMALL AND MEDIUM COMMERCIAL JOINT STOCK BANKS

AT ERNST & YOUNG VIETNAM

SUPERVISOR: MA Ngo Tri Trung STUDENT: Tran Dieu Hong Anh STUDENT ID: 16071146 COHORT: AC2016B

MAJOR: Accounting, Analyzing and Auditing

Hanoi - Year 2020

LETTER OF DECLARATION

I hereby declare that the Graduation Project “Enhancing audit quality of loans and advance to customers in small and medium commercial joint stock banks at Ernst

& Young Vietnam” is the results of my own research and has never been published

in any work of others During the implementation process of this project, I have seriously taken research ethics; all findings of this projects are results of my own research and surveys; all references in this project are clearly cited according to regulations

I take full responsibility for the fidelity of the number and data and other contents of my graduation project

Hanoi, 25th May 2020

Student

Tran Dieu Hong Anh

ACKNOWLEDGEMENT

First and foremost, I would like to express my sincere gratitude to my supervisor, MA Ngo Tri Trung, for providing invaluable guidance throughout this thesis His vision, sincerity and motivation have deeply inspired me He has taught

me the methodology to complete my research and to present the works as clearly as possible It was a great privilege and honor to work and study under his guidance I have been extremely lucky to have a supervisor who cared so much about my work, and who responded to my questions and queries so promptly I would also like to thank him for his time and dedication during the discussion I had with him on research work and thesis preparation

Completing this work would have been more difficult were it not for the support provided by all my lecturers at International School - Vietnam National University I have had chance to apply my knowledge in university into practice Through my internship, I realized that I have taken many useful classes in accounting and audit to help my audit work

I am extremely grateful to Ernst & Young Vietnam Limited Company for giving me the opportunity to take the internship at the company During the internship, I have acquired many practical skills and experiences, which help me to take further step in my career path I also thank to my seniors and staff at EY in Hanoi office for always supporting and giving me precious advices

Due to the limited time and lack of practical expertises, it is difficult to avoid limitations and some inevitable mistakes in the thesis I look forward to receiving the comments and the instructions from the lecturers to improve and complete the shortcomings

Hanoi, 25th May 2020

ABSTRACT

This research investigates about the audit procedures of loans and advance to customers section in financial audit at Ernst & Young Vietnam for commercial banks Loans and advance is the survival unit of the bank, if this section does not properly work the bank itself may become bankrupt Based on audit procedures, exploring about the strengths and limitations of the process The research was conducted using qualitative approach It began with observational and descriptive method to obtain procedures performed by EY Vietnam, according to EY GAM In order to acquire in-depth knowledge about the points that auditors should focus on when auditing loans and advance for commercial banks, the research used questionnaire designed for respondents, who are staff and seniors working at EY Audit procedures were conducted at EY consist of 3 phases: Scope and Strategy phase, Execution phase and Conclusion phase Finally, even there are some limitations, the process of auditing loans and advance to customers is standard and effective This research also gives advices for further research and can be considered as the reference for the study and

research purpose

Keywords: loans and advance to customers, audit, financial statements, commercial banks, Ernst & Young Vietnam

Table of Contents

CHAPTER 1: INTRODUCTION 10

1.1 The necessity of thesis 10

1.2 Research objectives 11

1.3 Research method 11

1.4 Research framework and structure 12

CHAPTER 2: LITERATURE REVIEW 13

2.1 Overview about audit financial statements 13

2.2 Overview about loans and advance to customers in small and medium commercial banks conducted by audit firms 15

2.2.1 Feature of loans and advance to customers on financial statements 15

2.2.2 Accounting for loans and advance to customers 17

2.2.3 Common misstatements related to loans and advance to customers 23

2.3 Audit assertions of conducting an audit on loans and advance to customers 25

2.3.1 Audit assertions for conducting an audit on loans and advance to customers in small and medium commercial banks 25

2.3.2 Audit assertions for presentation and disclosure for loans and advance to customers in small and medium commercial banks 26

2.4 Audit of loans and advance to customers within an audit process at E&Y 26

2.4.1 Scope and Strategy phase 27

2.4.2 Execution phase 33

2.4.3 Conclusion phase 39

CHAPTER 3: METHODOLOGY 42

3.1 Methodology 42

3.2 Source of data 42

3.3 Data and data collection: 43

3.3.1 Observational and descriptive method 43

3.3.2 Questionnaire 44

CHAPTER 4: FINDINGS AND DISCUSSION 46

4.1 Findings for the Scope and Strategy phase of the audit 47

4.2 Findings regarding the execution phase of the audit 60

4.2.1 Test of controls 60

4.2.2 Analytical procedures 68

4.2.3 Confirmation letter for loans and advance to customers 70

4.2.4 Test of details 71

4.2.5 Loan review - Provision 74

4.3 Findings related to the conclusion phase of the audit 78

CHAPTER 5: CONCLUSIONS AND RECOMMENDATIONS 84

5.1 Assessment the audit of loans and advance to customers conducted by EY Vietnam 84

5.1.1 Strength of an audit of loans and advance to customers at EY Vietnam 84

5.1.2 Limitations of auditing loans and advance to customers at EY Vietnam 85

5.2 Recommendations to improve the audit quality of loans and advance to customers of commercial banks at EY Vietnam 88

5.2.1 Enhancing the accuracy of analytical procedures 88

5.2.2 Providing short-term training course to improve professional competence 88

5.2.3 Improving the collection of audit evidence 89

5.2.4 Establishing audit team specializing in specific type of businesses 91

5.3 Limitation 92

5.4 Conclusion 92

REFERENCES 94

APPENDICES 97

ABBREVIATIONS

LIST OF TABLE

Table 2 1 Audit assertions of loans and advance to customers 25

Table 2 2 Audit assertions of interest income 26

Table 2 3 Presentation and disclosure related to audit assertions of 26

Table 4 1 Determine PM, TE, SAD at ABC Bank 55

Table 4 2 Audit program for loans and advance to customers of commercial banks 56

Table 4 3 Debt covenant compliance 58

Table 4 4 List of questions to understand control design 62

Table 4 5 Report on entity level control at ABC Bank 67

Table 4 6 Report on fraud and significant risk 68

Table 4 7 Assertions for audit work and documents 72

Table 4 8 Assertions for audit work and documents for interest receivable 74

Table 4 9 Loans classification 77

Table 4 10 Subsequent events questionnaires to 15 March 2020 79

LIST OF FIGURE

Figure 4 1 Total assets of commercial banks from 2017 to 2019 46

Figure 4 2 Total equity of commercial banks form 2017 to 2019 46

Figure 4 3 Three audit phases at EY Vietnam 47

Figure 4 4 Specific of scope and strategy phase for financial statements at EY Vietnam 47

Figure 4 5 Test of controls process 61

Figure 4 6 ITRA audit process 62

Figure 4 7 Considerations for test of controls 66

Figure 4 8 Loans leadsheet 70

Figure 4 9 EY Microstart 71

Figure 5 1 Example of audit timeline 89

CHAPTER 1: INTRODUCTION 1.1 The necessity of thesis

In the rapid economic growth, challenges in using the information arise from many reporting frameworks and initiatives in this area, the information reported and the perceived lack of high-quality, consistent and comparable information In addition, due to management mechanisms the government intervention cannot directly impact on the market economy, in which have enterprise entities With the trend of investment, increased trade and the opportunities from changes such as new technologies into Vietnam, it is the foundation for providing audit and assurance services The independent audit history dates back to the 1991 and since then, through nearly 30 years of establishment and sustainable development, it has reflected remarkable success Assurance services plays an critical role in the modern economy with high quality audits key to build trust in business and reduce information risks through increasing transparency of financial information and preventing and detecting fraudulent Based on the audit results, the financial statements users have accurate and objective information to properly evaluate the financial situation and make decisions Besides, through the audit process, auditors can also make recommendations to help clients complete the internal controls system, improve the effectiveness of business activities in general and financial management in particular

Loans are one of the most important sources of equity to satisfy the needs for investment, production and construction Temporary borrowings from individuals or organizations for a certain period incurs frequently in business operation A commercial bank is a financial institution that grant loans, accept deposits and offer basic financial products to make money by providing different type loans to customers and earning interest income from those loans A commercial bank may specialize in just one or a few types of loans such as mortgages, auto loans, business loans and personal loans For most banks, loans are the primary use of their funds and the principal way in which they earn income The purpose of the loan is also a factor

in the loan underwriting decision; loans taken out to purchase real property such as homes, inventory, etc… are generally considered less risky, as there is an underlying

asset of some value that the bank can reclaim in the event of nonpayment Therefore, management and the loans purposes have a significant impact on the auditor’s opinion and audit report

Being one of the four prestigious auditing firms in the world, Ernst & Young has provided assurance services for a large number of enterprises and entities Clients

at EY Vietnam are large corporations, financial institutions, large-scale enterprises with diverse and complicated demands for loans Therefore, in the auditing process, Ernst & Young identifies loans which considered as material items and contained many risks that require significant consideration while conducting an audit

As a student in Accounting – Auditing major, the researcher believes that each student should prepare for themselves both theoretical and practical technical knowledge in order to meet the professional requirements Through the internship at Ernst & Young Vietnam, the researcher has gained empirical experience in performing an audit, especially, auditing of loans and advance to customers

Therefore the researcher chooses the topic named: “Enhancing audit quality of loans and advance to customers in small and medium commercial joint stock banks at EY Vietnam” with the desire to further describe auditing process of the

firm in this bachelor thesis

1.2 Research objectives

The thesis provides analysis and theoretical framework about auditing loans and advance to customers in commercial banks conducted by the methodology applied in Ernst & Young Vietnam Ltd Based on the research, the thesis points out the strengths, limitations, as well as give reasonable solutions, recommendations for process improvement of auditing loans and advance to customers section, performed

by Ernst & Young Vietnam Ltd

1.3 Research method

Observational and descriptive method: Method based on the primary and secondary information, data is collected through the research period at Ernst & Young

- Theoretical research method: worldview method, analysis and synthesis

theory, logic and generalized problem

- Empirical method: search, analyze, process information, and describe the

statistical methods, practical experience through real work

Survey method: To obtain deeper understanding about the process of auditing loans and advance to customers account performed in Ernst & Young Vietnam, the author designs the questionnaire for independent auditors who currently working in Ernst & Young Vietnam This survey gathers information on a large scale in a short period of time It helps the researcher can get the responses to gain insight knowledge and identify different viewpoints to understand more about audit procedures of loans

at commercial banks from many auditors with the same question, then will be able to draw the trend and identify the most accurate answers

Data sources: In this thesis, the researcher use two sources of data, which are primary data and secondary data

- Primary data: Those data collected by interview method from the research

period at Ernst &Young Vietnam, in order to identify the different viewpoints

in auditing loans and advance to customers, as well as the advantages and limitations of the process of auditing loans and advance to customers at EY Vietnam

- Secondary data: Those information and knowledge collected from EY Global

Audit Methodology, normative documents from State Bank of Vietnam, Government Agencies and Line Ministries

1.4 Research framework and structure

The thesis structure consists five main chapters, which are Introduction, Literature review, Methodology, Findings & Discussions, and Conclusion & Recommendations, respectively

CHAPTER 2: LITERATURE REVIEW

An effective and well-conducted review as a research is based upon past knowledge It is important for the researcher to review the available literature for advancing knowledge and facilitating theory development This helps in understanding the nature and design of the research investigation and provides evidence that the researcher is familiar with what is already existed

The researcher has undertaken an extensive literature survey regarding to the study The objective of the literature review is to get an insight in the areas of auditing loans and advance to customers Accordingly, to achieve the objectives, the researcher has classified the review of literature into four parts as follows: The first part introduces general information about audit financial statements, the second part points out the definition and characteristics of loans and advance to customers In the next part, audit objectives while conducting an audit will be described and the last part presents a general process of auditing

2.1 Overview about audit financial statements

The purpose of auditing financial statements is to increase the credibility of users with respect to the financial statements, through the auditor's opinion on whether the financial statements are true and fairly stated, in all material aspects, and consistent with the framework of the disclosure and presentation of the financial statements, according to Linda, E (1981), In particular, auditing is the accumulation and evaluation of evidence about financial information obtained through audit period

to determine and report on the degree of correspondence between the financial information prepared by client and a wide set of criteria (Arens, A A et al, 2010) Similarly, the purpose of auditing which indicates in the Auditing Standard issued by Public Company Accounting Oversight Board evidently stated the objective of auditing the financial statements by independent auditor is the impartial opinion on the financial statements of the company In all material aspects, auditor’s opinion about financial health, operations results, and client’s cash flows in conformity with generally accepted accounting principles The auditor's report is the medium that

expresses audit opinion, if in special circumstances, disclaims an opinion (Simunic, D., 1980)

Frank, D H (2001) pointed out that the audited financial statements play an critical role in the investor for making investment decisions Precisely, he proved that investors who viewed media reports tended to focus on negative news and misclassified more unaudited information as audited and assessed the credibility of the unaudited report much higher than investors who viewed hardcopy materials Those investors who did not look company’s risk management program, just assessed only unaudited report was more credible also judged the firm's potential earnings to

be higher, resulted in wrong decision Notifying users with an “audited/ unaudited” label will attenuate these effects Contrary to this view, Brant, E et al (2014) performed an experiment to prove information presented in financial statement has strongly effect to the investors’ decision The research survey was conducted using

an online questionnaire sent out to nonprofessional investors such as business school graduates who invest in individual stocks and analyze company financial data The result indicated that investors who receive a critical audit matter paragraph are more likely to change their investment decision than investors who receive a standard audit report or investors who receive the same critical audit matter paragraph information

in management's footnotes Therefore, quality of the audit is drastically increased for both investors as well as their companies (Joseph, V C., 1992)

When the initial market for audit services is perfectly competitive, arguments about the relationship between audit firm size and audit quality are still controversial The four prestigious audit firms in the world are Ernst & Young, Deloitte Touche Tohmatsu, Pricewaterhouse Coopers and KPMG, resulted in the excessive market share of these firms compare to non – big audit companies (Kimberly, D et al, 2011) However, whether the audit quality in these Big 4 audit firms is higher than remaining firms Marshall, A G et al (2006) conducted an analysis and pointed out that the error rates for Big 4 audit firms are significantly lower compared to non‐Big 4 firms Similarly, conclusion of Francis, J and Yu, M (2009) in their research, which was undoubtedly stated audit quality is higher than average in Big 4 firms They also

declared this conclusion made no claims that audit quality is unacceptably low in smaller companies Nevertheless, Alastair, L et al (2011) had different opinion by using the matching model, they indicated that the audit quality from Big 4 firms is insignificantly different from those of non – Big 4 firms Their result also suggested that the differences between Big 4 and non – Big 4 firm mainly reflected client characteristics and, more specifically, client size

2.2 Overview about loans and advance to customers in small and medium commercial banks conducted by audit firms

2.2.1 Feature of loans and advance to customers on financial statements

Loans normally have the following distinguishing characteristics:

1 Time to maturity Time to maturity describes the length of the loan contract Loans are classified according to their maturity into short-term debt, intermediate-term debt, and long-term debt Revolving credit and perpetual debt have no fixed date for retirement Banks provide revolving credit through extension of a line of credit Brokerage firms supply margin credit for qualified customers on certain securities In these cases, the borrower constantly turns over the line of credit by paying it down and reborrowing the funds when needed A perpetual loan requires only regular interest payments The borrower, who usually issued such debt through a registered offering, determines the timing of the debt retirement

2 Repayment Schedule Payments may be required at the end of the contract or

at set intervals, usually on a monthly or semi-annual basis The payment is generally comprised of two parts: a portion of the outstanding principal and the interest costs With the passage of time, the principal amount of the loan is amortized, or repaid little by little until it is completely retired As the principal balance diminishes, the interest on the remaining balance also declines Interest-only loans do not pay down the principal The borrower pays interest

on the principal loan amount and is expected to retire the principal at the end

of the contract through a balloon payment or through refinancing

3 Interest Interest is the cost of borrowing money The interest rate charged by lending institutions must be sufficient to cover operating costs, administrative costs, and an acceptable rate of return Interest rates may be fixed for the term

of the loan, or adjusted to reflect changing market conditions A credit contract may adjust rates daily, annually, or at intervals of 3, 5, and 10 years Floating rates are tied to some market index and are adjusted regularly

4 Security Assets pledged as security against loan loss are known as collateral Credit backed by collateral is secured In many cases, the asset purchased by the loan often serves as the only collateral In other cases the borrower puts other assets, including cash, aside as collateral Real estate or land collateralize mortgages Unsecured debt relies on the earning power of the borrower

There are different types of loans that a business might take out according to Decision 1627, Circular 39/2016/TT-NHNN as follows:

A commercial loan (long-term loan) is a debt-based funding

arrangement that a business can set up with a financial institution such as insurance companies, banks, brokerage companies A commercial loan has mature from more than five years Commercial loans are generally used to purchase a long-term assets or help fund day-to-day operational costs Long-term bank loans are always supported by a company's collateral, usually in the form of the company's assets The loan contracts usually contain restrictive covenants detailing what the company can and cannot do financially during the term of the loan Commercial loans usually charge flexible interest rates that are tied to the bank prime rate or else to the London Interbank Offered Rate (LIBOR) Many borrowers must file regular financial statements, usually

at least annually Lenders also usually require proper maintenance of the loan collateral property

A intermediate loan (medium term loan) is a loan from a bank for a

specific amount that has a specified repayment schedule and a floating interest rate Term loans have mature ranging from one to five years They are used to fund assets that aren't long-term in nature such as production equipment that

may have an economic life of only around 3 years or other businesses use these loans for monthly operations

A short-term loan is usually cash-advance type loan, designed to cover

short-term expenses or provide additional capital during seasonal revenue Commercial banks are main suppliers, who provide loans with term up to one year for corporations Customers choose short-term loan because it is less risky

in terms of solvency and interest rate in comparison with other loans

An unsecured loan will be issued and supported only by the borrower's

creditworthiness, rather than by some sort of collaterals This loan is not tied

to any assets and the lender can’t automatically size the property as payment for the loan Generally, a borrower must have a high credit rating to receive an unsecured loan Commercial paper is an example of an unsecured loan A secured loan is backed by collateral; if it is not repaid, the lender can seize the collateral and sell it to use the proceeds of loan to recover the funds

Interest receivable is the amount of interest that has been earned, but which has not yet been received in cash The usual journal entry used to record this transaction is a debit to the interest receivable account and a credit to the interest income account When the actual interest payment is received, the entry is a debit to the cash account and a credit to the interest receivable account, thereby eliminating the balance in the interest receivable account The interest receivable account is usually classified as a current asset on the balance sheet, unless there is no expectation to receive payment from the borrower within one year

Loans and interest receivables make a great impact to financial indicators such as: profit margin, debt to equity ratio, short-term and long-term solvency ratios, times interest earned ratio, etc

2.2.2 Accounting for loans and advance to customers

a Accounting for loans and advance to customers

Account no 21xx to Account 29xx according to SBV account “Lendings” reflects all loans and its principal repayment taken by the entity The account isn’t used to recorded loans arose due to issuance of bond Although all loan balance is followed by account no.21xx to no 29xx, it is compulsory to classify closing balance of such loans to short-term, medium, long-term loans The allocation is based on remaining lending term rather than total original term as classification of short-term and long-term investment

Classification of loans

There are several ways to classify and monitor loans such as: by sources, by lenders, by currency, etc However, remaining lending term is the most popular benchmark due to the requirement of loan disclosure in financial statements The method saves time for accountants in preparing FSs

According to the regulations clearly stated in Circular 200/2013/TT-BTC, all loans must be allocated to short-term and long-term debt due to their remaining loan term Short-term debts include both such loans whose due date is within the next 12 months or one operating cycle and current-portion of long-term debts which must be paid in the next 12 months Long-term loans are loans whose their remaining loan term are longer than the next 12 months Interest and principal of those loans are paid in monthly, quarterly or annually basis basing on specific loan conditions that are clearly stated in loan contracts Interest rate are determined by various method such as: single, compound, floating, or proportion of LBOR, NIBOR, etc

Accounting for loans and advance to customers

1 Accounting for disbursement

a Based on documents of disbursement, conduct disbursement transaction and accounting as follows:

Debit 21x1: Amount disbursed to customers

Credit 1011 or 4211,…: Amount disbursed to customers

b Accounting for interest receivable

On a regular basis, based on the loan contract, loan balance, interest rate the person in charge calculates the receivable amount of customers and records:

For loans have debt classification as group 1:

Debit 394x: Amount interest receivable

Credit 702x: Amount interest receivable For the accrued interest amount but customer have not paid on time or the loan has been transferred from debt group 1 to loan from group 2 to group 5, the bank shall transfer the debt group and set up risk provision according to regulations For loans from group 2 to group 5:

Increase 941: receivable interest, overdue interest

c Accounting for debt collection (principal and interest)

Based on debt collection documents, conducting accounting transactions:

o Principal debt collected

Debit 1011, 4211,…: Principal amount collected

Credit 21x1: The principal amount collected

o Interest debt collected

For loans in group 1:

Debit 1011, 4211, : Interest amount collected

Credit 394x: Interest amount collected For loans from group 2 to group 5:

+ Debit 1011, 4211, …: Interest amount collected (includes penalty interest, if any)

Credit 702x: Interest amount collected (includes penalty interest, if any)

+ Decrease 941: Interest earned (includes penalty interest, if any)

2 Debt classification and provision of credit risks

a Accounting for debt classification

- Based on the list of debt classification approved and authorized by

competent authorities:

For principal:

Debit to new group lending: value of loans transferred to group

Credit in old loan group: value of loans transferred to group For loan interests: If the loan is transferred from debt group 1 to group 5

For interest already accrued in the current year:

Debit 702x: Interest amount already accounted into the accrual plan of the year for the loans transferred to other groups

Credit 394x: Interest amount For interest already accrued in the previous year:

Debit 809x Interest amount already accounted in the previous years’ accruals of loans transferred to other groups

Credit 394x: Interest amount

At the same time, accounting for off-balance sheet for this interest:

Increase 941x: The recorded interest amount of the transferred loan group

For loans from group 2 to group 5 are transferred to group 1:

Debit 394x:The interest receivable of the loans are transferred to group 1

Credit 702x: The interest receivable of the loans are transferred

to group 1

b Accounting for provision and returning credit risk provision

Based on the Proposal for setting up credit risk provision and the detail lists of credit risk provision for each loan approved and accounted by competent authorities:

If the amount of risk provision is already set up larger than than the balance of risk provision fund in accounting book, addition risk provision shall be made:

Debit 8822: Total risk provision that must be set up in the period

Credit 2191: Specific amounts must be additionally set up in the period

Credit 2192: The general provision amount must be additionally set up in the period

If the amount of risk provision deduction is smaller than the balance of risk provision fund in accounting book, returning risk provision shall be made as follows:

Debit 2191: Specific provision amounts reversed in the period

Debit 2192: General provision reversed in the period

Credit 8822 Risk provision reversed amount

All accounts for loans and advance to customers as well as interest receivable and provision are enclosed in Appendix 01

Accounting documents for loans:

For loans from individuals: Because individuals are not legal entities

so they have the right to handle and use their assets, individuals can lend in cash Therefore, when businesses borrow from individuals, the set of documents include: (1) Decision of the Board of Directors/Minutes of the Board meeting on borrowing; (2) Contract of borrowing (borrowing) money; (3) Bank statement (if transfer), (4) Receipt of loan; (5) Payment slip (in case

of payments in cash), (6) Minutes of liquidation of loan agreement upon repayment of principal and interest; (7) Loan interest calculation sheet; (8) Certificate on personal income tax withholding (if interest is paid)

For loans from enterprises (other than credit institutions):

According to the provisions of Article 4 of Circular 09/2015/TT-BTC, enterprises (not credit institutions) when implementing Loans, loans, and loan repayments must be paid by check, or payment by payment order - money transfers, and other forms of non-cash payment Therefore, the set of documents when enterprises borrow from enterprises containing: (1) Decision

of the Board of Directors/Minutes of the Board meeting on borrowing; (2) Contract of borrowing; (3) bank statements, (4) receipts when receiving loans; (5) payment slip, (7) check, (8) payment order, (9) minutes of loan contract

liquidation and loan interest payment; (10) Loan interest calculation sheet; (11) Loan interest receipts (If interest is paid)

For loans from credit institutions: Because credit institutions have a

strict process in monitoring and checking before lending and in the process of using the loan, so the documents for lending from credit institutions often include: (1) Decision of the Board of Directors/Minutes of the Board meeting

on borrowing; (2) Credit contract; (3) Request for disbursement; (4) List of loan withdrawal; (5) Property mortgage contract (if any); (6) The minutes of mortgage payment (if any); (7) Value-added invoices, (8) Economic contracts, (9) Minutes of acceptance and handover, etc proving the purpose of borrowing by enterprises; (10) Transaction documents of the bank: bank's accounting voucher, bank transfer fee receipt, loan and principal list, bank statement, etc Credit contracts and loan withdrawal statements are important

to determine the liabilities of debtors owe debt to the bank and must repay within the debt term

b Accounting for interest receivable:

According to Circular 05/VBHN/NHNN/2018, interest receivable must be recorded in account no 3941 and account no.3942 This account reflects the interest from lending of financial activities including receivables or losses regarding financial investment activities, lending costs, capital contribution costs

in joint ventures or associates, losses of transferring short-term securities, securities transaction costs, provision for devaluation of trading securities, provision for loss of investment in other entities, losses incurred when selling foreign currencies, exchange rate losses

Regardless of loans source, lendings accountants accounts based on bank statements or specific notice of banks, credit institutions or lenders These documents must be stored in soft copy and hard copy and refer to relevant journal entries

2.2.3 Common misstatements related to loans and advance to customers

For lendings (an item in BS), they are intentionally understated or omitted

and popular frauds and errors will be listed as follows:

• Valuation/ Accuracy:

o Closing balance of these loans are not evaluated at reporting date currency (any foreign balances are not converted to VND using relevant exchange rate, normally at the end of fiscal year);

• Completeness:

o All lendings should have been recorded but have not been recorded in accounting book yet The omission will make equity higher due to the accounting equation (Assets are equal to liabilities plus equity)

• Classification

o Portion of lendings whose date of repayment is longer than 1 year are not classified as long-term lendings The portion that must be repay within 1 year are not classified as current portion of long-term debts

For interest income (an item in PL), it is likely intended to be understated

and popular frauds and errors are:

• Completeness: All interest income for the period that should be recorded have not been recorded

• Accuracy: Interest income for the period is not recorded correctly in term

of mathematics and value

• Cutoff: Interest income are not recorded in correct period based on accrual

basis rather than when cash is received for those income as cash basis stated 2.2.4 Internal controls for loans and advance to customers

As mentioned above, loans and interest receivables are likely understated to make the financial statement looks healthier than it actually is To mitigate the deficiencies, a high quality internal control system is imperative for accurate estimation of loan loss exposure, as a loan assessments require an in-depth understanding of loan payback history, collaterals and other relevant information, there are some applied control activities in accordance with COSO framework:

• Adequate separation of duties

o The accountant is responsible for recording new loans must separate with the person who records cash receipt from the lendings

o Segregation of duties between initiation and final approval of financing activities, and loan account and general ledger maintenance; between valuation monitoring and acquisition functions

• Proper authorization of transactions and activities

o All lendings should be authorized by proper personnel before loan contracts are signed, new loans and cash receipt must be recorded in accounting system

o Any significant debt commitments should be approved by BOD and the specific controls for lending and repayment may be delegated to an executive

• Documents and records

o All loan contracts must be stored until the lendings are fully repaid

o All loans must be fully recorded in accounting systems and repayment schedule for each loan contract must be followed and updated in timely manner

o Adequate detailed records of long-term debt transactions should be maintained to ensure that all lendings and repayments of principal and interest are accurately recorded

o The debt amount recorded in the subsidiary ledger should be reconciled

to the general ledger control accounts regularly

o Control procedures, such as internal verification, to ensure that term debt is properly valued; for example, premium or discount for bonds should be amortized using effective interest method to calculate interest receivable

long-o Clong-ontrlong-ol plong-oints shlong-ould ensure that llong-oans are prlong-operly classified intlong-o short-term and long-term loans according to their due dates

• Physical control over assets and records

o All loan contracts and documents related to these loans should be stored

in safety box and only authorized personnel can assess

• Independent checks on performance

o All recording procedures of loans and interest receivables should be cross-checked in timely manner by authorized personnel

2.3 Audit assertions of conducting an audit on loans and advance to customers 2.3.1 Audit assertions for conducting an audit on loans and advance to

customers in small and medium commercial banks

Loans and advance to customers appear on BS as an account, when conducting

an audit, procedures to be performed must satisfy the following assertions, according

to Arens, A A et al (2010):

Table 2 1 Audit assertions of loans and advance to customers

Completeness - All loans should have been recorded have been recorded in

accounting book

Existence - All recorded loans exist at balance sheet date

Valuation/ Accuracy - Closing balance of these loans are evaluated at reporting date

currency (any foreign balances should be converted to VND using relevant exchange rate, normally at the end of fiscal year);

- Foreign outstanding balances (all collaterals with value greater than VND billion 200 (VND billion 50 for related parties) must be valuated by independent valuer) are re-evaluated yearly to determine unrealized revaluation gain/loss

Classification - Portion of loans whose date of repayment is longer than 1 year

should be classified as long-term borrowings

- The portion that must be repay within 1 year should be classified as current portion of long-term debts

Detail tie-in - Details in the sub-ledger accounts is agreed with general ledger Rights & Obligations - The entity has title to all loans item listed

Interest income is a balance that accumulates all interest receivable for the whole financial year and all audit procedures should meet the following audit assertions:

Table 2 2 Audit assertions of interest income

Completeness - All interest income in the period should have been recorded have

been recorded

Existence/ Occurrence - All interest income that have been stated in the FS should occurred

in the period (starts from effective borrowings in the period)

Valuation/ Accuracy - Interest income for the period should be recorded correctly in term

of mathematics and value

Cutoff - Interest income should have been accurately recorded in correct

period based on accrual basis rather than when cash is received for these receivable as cash basis stated

2.3.2 Audit assertions for presentation and disclosure for loans and advance

to customers in small and medium commercial banks

After conducting several audit procedures to ensure the balance of loans and advance to customers as well as interest income are truly and fairly stated according

to all audit objectives have mentioned above, it is required to ensure related information of these balance in notes to FS also meet relevant audit assertions below

Table 2 3 Presentation and disclosure related to audit assertions of

loans and advance to customers

Completeness - All required disclosures related to loans are included in

Valuation/ Accuracy - All information in loans-related notes to FS must be

2.4 Audit of loans and advance to customers within an audit process at E&Y

Arens, A A et al (2010) stated that auditing process comprise of four main phases, which are (1) plan and design an audit approach, (2) perform test of control and substantive tests of transactions, perform substantive analytical procedures and test of detail of balances, and (3) complete the audit and issue an audit report

According to the Vietnamese Standards on Auditing (VSA), which is clearly presented in the Decision 366 – 2016/QD – VACPA and the VSA 220 issued by Ministry of Finance, the procedures for auditing financial statements are divided into three main sections: Planning, Implementation, and Completion Although there is difference in name of each phase and quantity, the procedures have to be performed

in an audit is similar The audit process for any item in the FSs will also follow this sequence

The general audit procedures for loans and advance to customers accounts at

EY Vietnam consist of three phases: Scope and Strategy, Execution, and Conclusion phase Details of each phase for conducting an audit of loans and advance to customers will be described as follows:

2.4.1 Scope and Strategy phase

The VSA 300 clearly stated that, planning is not an isolated phase of an audit;

it is the process that is repeated and begins immediately after or at the same time with the end of the previous audit and continues until the audit of current period Audit planning includes a schedule review of some activities and the audit procedures that need to be completed before the next audit phase are carried out

Scope and strategy phase of the audit is the most important part of any audit engagement The first generally accepted auditing standard of field work requires adequate planning to obtain sufficient appropriate evidences for the circumstances as well as allow the audit firm keep audit costs reasonable and avoid misunderstanding with the client, minimize legal liability and maintain good reputation in the business community

The Scope and Strategy phase consists of 8 steps according to Audit and assurance services, 16th edition by Alvin Aren

First, accept client and perform initial audit planning

The engagement partner must be satisfied that appropriate procedures regarding the acceptance and continuance of client relationships and audit engagements have been followed, and should decide whether or not accept the clients

no matter what they are new or continuing engagement by: (1) Identifying client’s

reasons for audit and (2) Obtaining an understanding with the client (Arens, A A et

al, 2010) After the client is accepted, the audit contract and audit team members for the engagement will be carefully prepared

For (1), there are two major factors affecting acceptable audit risk They are the likelihood and intention of financial statement users The auditor is likely to accumulate more evidence, for specific case of public companies with extensive indebtedness and companies will be solved in the near future The most uses of the statements can be determined from prior experience with the client and discussions with management Throughout the engagement, the auditor gets additional information about why the client has an audit and the likely uses of financial statements This information may affect the auditor’s acceptable audit risk (AAR) For example, if the company has a great amount of loans, the AAR will be low due

to the risk of violating loan covenant that may lead to going concern problem and the strict requirements of banks or financial institutions in reimbursing these borrowings

For (2), auditing standards require that auditors document their understanding with the client in an engagement letter, which includes the engagement’s objectives, the responsibilities of the auditor and management, and the engagement’s limitations

It also states any restrictions to be imposed on the auditor’s work, deadlines for completing the audit, any assistance provided by the client’s personnel in obtaining records and documents, and schedules prepared for the auditor It always includes an agreement on fees The engagement letter’s purpose is to inform the client that the auditor cannot guarantee for all acts of fraud will be discovered

Furthermore, as clearly stated in terms of acceptable audit risk, an auditor is unlikely to accept a new client or continue serving an existing client if acceptable audit risk is below the risk threshold that the firm is willing to accept

In the end of this step, the auditor should develop a preliminary audit strategy, considering the nature of the client’s business and industry and identifying where there is greater risk of significant misstatements The auditor also considers other factors such as the number of client locations and the past effectiveness of client controls in developing a preliminary approach to the audit The planned strategy helps

the auditor determine the resources required for the engagement, including engagement staffing

Second, understand the client’s business and industry to obtain related information

According to Arens, A A et al (2010), in this step, “the auditor must obtain a sufficient understanding of the entity and its environment, including its internal controls, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures”

Loans and advance to customers may be accounted in different accounting policies due to some authorized special regulations for financial institutions The treatment requires higher attention from audit team during the engagement

Other internal factors represent how effective internal controls system will be the considered as guidelines for auditors to identify and remain questioning mindset for detecting frauds and errors The entity with high level of construction may overstate historical cost of asset by over-capitalizing interest receivable Or weak management with high financial objectives may lead to the understatement of such loans in the FS The internal controls system is effective so the risk control is lower, materiality is set at higher level Thus the volume of procedures, the audit works are reduced and vice versa, the weaker internal control system, the higher control risk, the lower materiality level is set and require more audit procedures to detect the frauds and risks influence the information presented in the FS

Third, perform preliminary analytical procedures

After accepting client and performing initial audit planning Each item in the

FS is seriously considered by performing preliminary analytical procedures The comparison of financial ratios to industry average and main competitors of the client

is used to assist auditors in identifying areas with increased ROMMs, For loans and advance to customers and interest receivable, it is necessary to seriously use some important ratio such as current ratio, quick ratio, debt to asset ratio, debt to equity ratio and interest coverage ratio

Fourth, set preliminary judgement of material and planning materiality

According to the Vietnamese Standards on Auditing No.320, misstatements are considered to be material if they could influence the decisions of users of the financial statements It is applied by auditors at the planning stage, execution stage and evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements

The materiality normally is set by a percentage of net revenue, total assets or profit before tax If the client experiences high level of loans with strict covenant, materiality level may lower due to the higher inherent risk Any violence to those covenants may lead to requirement of immediate payment for all outstanding debts and going concern will appear This procedure compares client ratios to benchmarks

of industry or competitor to obtain an indication of the company’s performance Such preliminary tests can reveal unusual changes in ratios compared to prior years, or to industry averages, and help the auditor identify areas with increased risk of material misstatements that require further attention during the audit (Arens, A A et al, 2010)

To design proper audit procedures to audit loans and interest receivable, it is necessary to identify significant risks due to fraud or errors as well as assess inherent risk and understand internal control over all lending and interest receivable At this step, auditors use a questionnaire to obtain relevant and adequate information

Fifth, identification of significant risks dues to frauds and errors

To determine significant risks due to fraud or errors, auditor uses the following technique:

• Nature of the client’s business: if the entity experiences high level of loans

due to construction, it is essential to consider classification of interest receivable (capitalize or non-capitalize) and risk of loans and interest receivable account will

be higher

• Results of previous audits: if there are qualified audit onion or key audit

matters due to loans being stated in previous audit, risk of such accounts should

be greater in current year’s engagement

• Related parties: if there are a tremendous amount of loans have arisen

between related parties (parent – subsidiary or subsidiary – subsidiary company), inherent risk for loans will be higher due to the risk of inadequate disclosure

• Complex or nonroutine transactions: If the entity takes complex and

non-routine loan-related transaction such as using swap or issuing convertible bond, risk of misstatement will be greater

The work done helps auditor to understand the meaning of loans and interest receivable to operating activities and how the entity controls those account balances Result of these procedures will seriously affect to final decision on materiality level as well as audit procedures for loans and interest receivable in audit program The higher risk such accounts carry, the more procedures should

be performed, and also the more experienced staff should be assigned to engagement

Seventh, understand internal control and assess control risk

To understand internal control over loans and advance to customers and interest receivable, the auditor normally uses COSO framework as a general guidance beyond specific instruction of the audit firm Five components include (1) control environment, (2) risk assessment, (3) control activities, (4) information and communications as well as (5) monitoring are simultaneously considered by completing a series of related questions

For (1), (2), (4), and (5), they are the same for all items in FS

“The control environment consists of the actions, policies, and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about internal control and its importance to the entity.” (Alvin A Aren, 2010)

“Risk assessment involves a process for identifying and analyzing risks that may prevent the organization from achieving its objectives The four underlying principles related to risk assessment are that the organization should have clear objectives in order to be able to identify and assess the risks relating to those objectives; should determine how the risks should be managed; should consider the

potential for fraudulent behavior; and should monitor changes that could impact internal controls.” (Alvin A Aren, 2010)

“The underlying principles related to information and communication stress the importance of using relevant, quality information that is communicated both internally and externally as necessary to support the proper functioning of internal controls.” (Alvin A Aren, 2010)

“Monitoring activities deal with ongoing or periodic assessment of the quality

of internal control by management to determine that controls are operating as intended and that they are modified as appropriate for changes in conditions The underlying principles related to monitoring include performing periodic evaluations and communicating any identified deficiencies to the appropriate parties responsible for taking actions to remediate the deficiencies.” (Alvin A Aren, 2010)

For (3), different balances in FS contain different characteristics that require various control activities to ensure no frauds and errors exist According to Arens, A

A et al (2010): “Control activities are the policies and procedures in addition to those included in the other four control components that help ensure necessary actions are taken to address risk to the achievements of the entity’s objectives” Some particular control point to ensure each process performed as designed and effective for auditing loans are:

• Adequate documentation must verify that a note or bond was properly authorized

• Any significant debt commitments should be approved by the board of directors and the specific controls for lending and repayment may be delegated to an executive

• Segregation of duties between initiation and final approval of financing activities, and loan account and general ledger maintenance

• Adequate detailed records of long-term debt transactions should be maintained to ensure that all lendings and repayments of principal and interest are correctly recorded

• The debt amount recorded in the subsidiary ledger should be reconciled accurately to the general ledger control accounts regularly

• Etc…

Last but not least, finalization of an overall audit program

The audit strategy is the mix of five tests: risk assessment procedures, TOC, STOT, SAP and TOD The lead auditor decides the most cost-effective types of all tests, then design a detailed audit program which contains a list of audit procedures should be performed in the audit engagement: specific audit techniques, scope of audit work, documents regarding loans account should be gathered

2.4.2 Execution phase

In this phase, auditors should understand the lending process at commercial banks for performing audit procedures better Steps in the lending process at commercial banks are briefly described as follows:

- Finding prospective loan customers:

• Loans to individual arise from a direct request from a customer who approaches a member of the lender’s staff and asks to fill out a loan application

• Business loan request, often arise from contacts the loan officers and sales representatives make as they solicit new accounts form firms operating in the lender’s market area

- Evaluating a prospective customer’s character and sincerity of purpose

usually follows, allowing the customer to explain his/her credit needs

• That interview is particularly important because it provides an opportunity for the loan officer to assess the customer’s character and sincerity of purpose

• If the customer appears to lack sincerity in acknowledging the need to adhere to the terms of a loan, this must be recorded as a strong factor weighing against approval to the loan request

- Making site visits and evaluating a prospective customer’s credit record

• IT a business or mortgage loan is applied for, a loan officer often makes a site visit to assess the customer’s location and the condition of the property and to ask clarifying questions

money to this customer to see what their experience has been

• Did the customer fully adhere to previous loan agreements and, where required, keep satisfactory deposit balances?

• A previous payment record often reveals much about the customer’s character, the sincerity of purpose, and a sense of responsibility in making use of credit extended by a lending institution

- Evaluating a prospective customer’s financial condition

• If all is favorable to this point, the customer is asked to submit several crucial documents the lender needs to fully evaluate the loan request, including complete financial statements and, in the case of corporation, Board of Directors’ resolutions authorizing the negotiation of a loan with the lender

• Once all documents are on file, the lender’s credit analysis division conducts a thorough financial analysis of the applicant, aimed at determining whether the customer has sufficient cash flow and backup assets to repay the loan

• The credit analysis division then prepares a summary and recommendation, which goes to the appropriate loan committee for approval

• On large loans, members of the credit analysis division may give an oral presentation and discussion will ensue between staff analysts and the loan committee over the strong and weak points of a loan request

- Assessing possible loan collateral and signing the loan agreement

• If the loan committee approves the customer’s request, the loan officer or the credit committee will usually check on the property or other assets to

be pledged as collateral to ensure that the lending institution has immediate

access to the collateral or can acquire title to the property involved if the loan agreement has defaulted

• Once the loan officer and the loan committee are satisfied that both the loan and the proposed collateral are sound, the note and other documents that make up a loan agreement are prepared and signed by all parties to the agreement

- Monitoring compliance with the loan agreement and other customer services needs

• The new agreement must be monitored continuously to ensure that the terms of the loan are being followed and that all required payments of principal and interest being made as promised, for larger commercial credits, the loan officer will visit the customer’s business periodically to check on the firm’s progress and see what other services the customer may need

• Usually, a loan officer or other staff members enter information about a new loan customer in a computer file known as a customer profile

This file shows what services the customer is currently using and contains other information required by management to monitor a customer’s progress and financial service needs

After understanding lending process, auditors perform audit procedures, details of each procedure are described as follows:

a Performing test of controls

According to Arens, A A et al (2010), the auditor should obtain and document a sufficient understanding of an entity’s internal control to evaluate the risk of material misstatement, whether due to error or fraud Designing tests of controls to obtain relevant audit evidence includes identifying conditions (characteristics or attributes) that indicate performance of a control, and deviation conditions which indicate departures from adequate performance The presence or absence of those conditions can then be tested

by auditors Client’s control system is manual or automatic requires the following evidence:

• Make inquires of appropriate client personnel

• Examine to test existence, completeness, accuracy of documents, records and reports

• Observe and perform a walkthrough for any control activities

• Reperform client procedures

b Performing substantive tests of transactions

Substantive tests consist of STOT, SAP and TOD STOT are used to determine whether audit objectives have been satisfied for each class of transaction

- Analytical procedures play an important role in the audit process It is implemented throughout the audit, from scope and strategy, execution and conclusion phase (Hirst, D., et al, 1996) SAP involves comparison

of recorded amounts and expectations developed by the auditors to indicate possible misstatements in the financial statements and provide substantive evidence

- TOD focuses on the ending general ledger balances for both balance sheet and income statement accounts

- Some examples of audit procedure should be performed in auditing of loans and interest receivable are:

TOC and STOT procedures:

• Is the account who is responsible for recording new loans also the person who records cash receipt from the loans?

• Are all loans properly authorized by personnel before signing loan contract? Are new loans and cash receipt fully recorded in accounting system?

• Are all loan contracts stored until the loans are fully repaid?

• Are payback schedule for each loan contract recorded in accounting system? Who is the person that follow and update contract in timely manner?

• Are all loan contracts and documents regarding those loans stored in safety box and only authorized personnel can assess

• Are all recording procedures of loans and interest receivables cross-checked in timely manner by authorized personnel?

• Recalculate interest receivable based on regulated bank interest rates and monthly payments

TOD procedure

• Reconciliation of opening balances and year-end balances between financial statements, ledgers and detailed books and prior year's audit reports

• Affirm loans balance by:

o Reconcile a detailed list of borrowers with a detailed book, debt reconciliations

o Prepare and send confirmation letters to borrowers have large balances

o Reconciliation prenumbered consecutively confirmation with balance in the details book Further check is needed if there are differences In case of not receiving confirmation letter, check the payment of loans after the financial statement date

o Gather confirmation letters from borrowers in the prior year that currently have no balance, but according to the information collected, this loan cannot be fully paid

o Review the arising transactions to determine whether any transactions have been recorded or unreasonably classified

o Collect loan contracts effective during the audit period (if auditing next year only need to collect new contracts that take effect after the previous audit) and make a summary, include all information as follows: Creditors, CIF number (Customer ID), Number of contract days, Debt commitment, The approval of the loan contract, The approval of the loan contract, Loan date, due date, Interest rate and term (%) and fixed interest rate (if any), Loan amount (original currency, VND conversion), Amount receivable in the next accounting year, Guarantees for loans

o Check on new loans and debts to ensure that new loans are accurately recorded; check the calculation and accounting of interest receivable by checking loan contracts and certifying letters or other related documents; consider the appropriateness of interest rates against current regulations; check the refund amount corresponding to the debt repayment plan; Consider whether using a loan for the right purpose or not

o Check receivables related to loans:

Reconciliation of loan interests recorded by the lender's interest calculation sheet (bank statement, credit fund, ) Estimate interest receivables based on the information on the loan contract and compare with the interest receivable which has been recorded to ensure that interest receivable have been fully and properly recorded

Check whether the distribution of interest in the period and allocate to the users is appropriate or not

Check the capitalization of loan interests (if borrowing loans for capital construction investment)

o Check the classification of long-term debt to current portion

of term debt; recalculate the current portion of term debts by referring to loan contracts, debt repayment plans and payment situation during the year

long-o Flong-or llong-oans and debts in flong-oreign currencies: Check the application of exchange rates, calculation methods and accounting of exchange rate differences, re-evaluate the balance at the end of the period according to regulations

o Check the classification and presentation of loans on financial statements

2.4.3 Conclusion phase

In the last phase, auditors must (1) accumulate additional evidence related to presentation and disclosure-related audit objectives, (2) review for contingent liabilities and subsequent events, (3) accumulate final evidences regarding loans and interest receivable, (4) evaluate results, (5) issue audit report and (6) communicate with audit committee and management

For (1), audit evidences in this stage are obtained through manually agreeing all information in loans-related notes to FS to hard copy or soft copy of all loan contracts The note of loans should contain the information: loan term, interest rate, collaterals and specific loan conditions (if any) Closing balance of long-term loan disclosed in note to FS should be correctly classified to current portion of long-term debts and non-current portion ones by agreeing those number to working papers of loan Furthermore, to enhance readability and understandability of the note, it is essential to clearly state loan balances that due within the next 12 month because this benchmark’s purpose is to help FS’s users can exactly assess financial health of the entity