With a view to control the rapidly rising defaults and frauds in the financial system in India, RBI being the central banking regulator adopted a concurrent audit procedure to oversee the same. As a result, specified financial institutions have to carry out different types of periodic audits throughout the year to ensure fairness and compliance. These include financial, secretarial, internal as also statutory audit. One such type of audit is a legal audit which mandates verification of title documents[1]. Presently, banks are mandated to conduct independent legal audits for all INR 5 crore or upward credit risk exposure until the credit is repaid. As our team has been fortunate to conduct multiple legal audits, here we consolidate the importance and good practices which enhance the value of any legal audit.
What is legal audit?
An audit refers to reverification and detailed inspection of documents according to the scope of an audit engagement. So, a legal audit is an audit niche which focuses on completeness, existence and validity of legal documents. It affords authenticity to the completeness of documents accepted by any institution on basis of which transactions may have been carried out. For instance: If a bank lends money on the basis of a mortgage, then in a legal audit the documents accepted during the transaction will be verified by professional Auditors. So, depending on the scope of work, the audit may be limited to verification of title documents or comprehensiveness of loan documents involved in the transaction. This ensures that no bogus lending has taken place. It guards the company from potential financial risk.
Steps involved in legal audit
Any process of legal audit can be broken down into the following steps to better understand and manage the process –
- Audit Engagement
- This includes pre-audit discussion and documentation. In this stage, the client approaches the Auditor for conducting legal audit and conveys the scope of work involved therein to the Auditor, after which an engagement letter is sent and consent is confirmed by the prospective Auditor.
- The engagement letter outlines the purpose and scope of audit, venue of audit, timelines, professional charges, format of Audit Report and other related aspects which helps the Auditor in planning the audit programme.
- Audit Plan and Programme
- Then, on the basis of the engagement, the Auditor decides the extent to which the documents need to be verified. Here, a primary timeline for the process is estimated.
- Further, the legal audit team is composed by the Auditor on basis of actual constraints such as time or place as well as experience requirements of the client. Accordingly, before beginning the verification process, the team is briefed about the standard procedure.
- Document Verification
- Then from a specified day, the team commences physical verification of the associated documents. Alternatively, in some audits e-verification is carried out through a virtual data room set up by the client access to which is provided to the auditors.
- This is done at the branches of the company being audited. Parallelly, the client may set up a virtual data room to permit the conducting of the audit remotely.
- Evidence and Results
- During audit, the team verifies the documents as per standard set and briefed in the plan.
- The team carefully records deviations from the standards with all relevant and complete information.
- Draft Audit Report
- Then, the results are consolidated in an Audit Report. The report includes a summary of the engagement, the audit scope & plan, evidence collected (if any) and results along with the observations & opinion of the Auditor.
- The primary report includes queries and observations which may be clarified or responded to by the internal client team. After these clarifications, the Auditor finalizes and issues the Audit report.
- Audit Closure
- Once the final report is issued, the client management may conduct a meeting with the Auditor to understand and improve the existing internal controls.
Tips and tricks of a successful audit
Certain practices become fundamental to managing a well-executed Audit which can be described as follows:
- Defining clear scope of the audit
- The initial clarity of what the Audit engagement entails is crucial between the client and the Auditor. For instance: Whether the audit is to ensure the record of a document or includes a verification of the contents of such document should be understood. This helps to create a good audit plan tailored to the needs of the client.
- The Audit Team
- One of the most important components of any audit is the communication and co-ordination of the audit team. The team should be professional and maintain confidentiality of the documents. It should also be on the same page about the standard procedures while handling documents or even recording deviations.
- Uniformity
- Maintaining a consistency in recording similar deviations helps with crisp and concise presentation. Further, presentation in simple client friendly format increases value added by the task. It makes a report more readable to the management and also permits further statistical analysis by the management.
- End of day stock and reconciliation
- As Audit is a tedious task, heavy in documents and detail, an end of day reconciliation becomes prudent. It helps to maintain a control over the quality of the process.
- Timely updates throughout the process
- Lastly, as a result of these co-ordinated practices, the client can be kept in loop through the process to address any anxiety that they may have regarding audit. This permits audit to become a transparent and fruitful task which optimally benefits the Auditor and the client.
Therefore, as growing good governance has vastly impacted the compliance protocols in the industry, legal audit forms a part of the post disbursement inspection. It ensures compliance to internal controls, authenticity of business transactions to the management and enhanced trust and goodwill to the company. However, as selecting a sound audit team forms a big part of a successful and smooth audit, engaging the right counsel may be prudent.
[1] RBI Notification, Legal Audit of title documents in respect of large value loan accounts, RBI /2012-13/524 dated June 7, 2013, DBS (rbi.org.in).