Auditing and EthicsQuestion 5663 of 212
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12. Whether correct classification and provisioning norms have been applied in the account of Precision Engineering?

Options

AThe account is correctly classified but provision should be made for hundred percent of the unsecured portion besides making specified provision on secured portion.
BThe account should have been classified as Doubtful asset and besides making required provision on secured portion, provision should have been made for hundred percent of the unsecured portion.
CThe account should have been classified as loss asset and full provision should have been made in the books of accounts.
DThe account should have been classified as Doubtful asset and full provision should have been made in the books of accounts. (2 Marks)
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Correct Answer

✅ Option C — The account should have been classified as loss asset and full provision should have been made in the books of accounts.

All Options:

  • AThe account is correctly classified but provision should be made for hundred percent of the unsecured portion besides making specified provision on secured portion.
  • BThe account should have been classified as Doubtful asset and besides making required provision on secured portion, provision should have been made for hundred percent of the unsecured portion.
  • CThe account should have been classified as loss asset and full provision should have been made in the books of accounts. ✓
  • DThe account should have been classified as Doubtful asset and full provision should have been made in the books of accounts. (2 Marks)

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Detailed Solution & Explanation

Correct Answer: Option **C**

Explanation:
Under RBI guidelines on asset classification, if there are potential threats to recovery, such as significant erosion in the value of the security, the asset should be straightaway classified as a Doubtful or Loss Asset as appropriate, irrespective of the period for which it has remained substandard.

Specifically, the RBI master circular states that if the realizable value of the security is less than 10% of the outstanding balance in the borrowing account, the value of security should be ignored, and the asset must straightaway be classified as a **Loss Asset** with a 100% provision made in the books of accounts.

Let's evaluate the details of Precision Engineering:
- Sanctioned credit limit = ` 300.00` Lacs
- Outstanding balance as of 31 March, 2024 = ` 308.00` Lacs
- Realizable value of security (the building is damaged and no machinery/stocks are available; only land is available) = ` 25` Lacs

The ratio of the realizable value of the security to the outstanding balance is calculated as follows:
textRatio=fractextRealizableValueofSecuritytextOutstandingBalancetimes100\\text{Ratio} = \\frac{\\text{Realizable Value of Security}}{\\text{Outstanding Balance}} \\times 100
textRatio=frac25308times100approx8.12\\text{Ratio} = \\frac{25}{308} \\times 100 \\approx 8.12\\%

Since the realizable value of the security (` 25` Lacs) is less than 10% of the outstanding balance (` 308` Lacs) — i.e., `8.12\\% < 10\\%` — the security should be ignored and the account must straightaway be classified as a **Loss Asset**. Consequently, a full provision (100% of the outstanding amount) should have been made in the books of accounts. Therefore, the bank's classification of the account as a Substandard Asset is incorrect.

Hence, **Option C** is the correct answer.

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