Bank Audit Manual

February 28, 2000 REVENUE AUDIT MEMORANDUM ORDER NO. 2-00 SUBJECT : Bank Audit Manual TO : All Internal Revenue Officers and Others Concerned I. OBJECTIVES 1. To provide Revenue Officers with an Audit Manual which contains uniform procedures and techniques in the investigation of taxpayers belonging to the banking industry for the purpose of ensuring the conduct of quality audit in view of the industry's peculiarities, nature of transactions and specialized accounting system. 2. To prescribe mandatory reporting requirements for all cases involving taxpayers under the banking industry. II. RATIONALE The banking industry has a significant impact of the country's economy. As such, it is governed by special laws and is being regulated by the Bangko Sentral ng Pilipinas. Due to the nature of business and existence of voluminous transactions, the banking industry has distinct accounting terminologies, procedures and practices, as well as financial reports. Aside from this, almost all banks have highly sophisticated computerized accounting systems. With these peculiarities of the industry and the advanced information technology being adopted by banks, it is imperative that the Bureau should have sufficient knowhow on the industry's operations and method of recording financial transactions. Thus, this manual was conceived to guide our Revenue Officers in the determination of the correct tax liabilities of banks. While the manual provides suggested audit procedures and techniques, the Revenue Officers are not precluded from applying other examination techniques which they may find relevant and necessary under the circumstances. III. REPORTING REQUIREMENTS Revenue Officers conducting the audit/investigation of banks are required to accomplish and comply with all the reporting requirements specifically provided in this Bank Audit Manual. IV. REPEALING CLAUSE This Order supersedes all revenue issuances or portions thereof inconsistent herewith. V. EFFECTIVITY This Order shall take effect immediately upon approval. (SGD.) DAKILA B. FONACIER Commissioner of Internal Revenue AUDITS TECHNIQUES MANUAL CHAPTER I Banks I. NATURE OF BUSINESS Banks basically earn income through the spread between the cost of its funds (interest paid and the expenses of acquiring and investing funds) and the yield it can obtain by investing funds in securities or loans and income from fees charged for other services is becoming an increasingly important part of a bank's income. Banks are governed by special rules and regulations issued mostly by the Bangko Sentral ng Pilipinas (BSP) in consonance with the General Banking Act (R.A. 337 ), Central Banking Act (R.A. 265 ), Foreign Currency Deposit Act (R.A. 6426 ), and other banking laws. A large portion of the assets held by banks consists of cash and negotiable items which may be kept both for their own account and in trust for others. aTcIAS Loans constitute a major group of banks' assets. Their fair presentation involves an evaluation of the adequacy of the reserve or allowance for losses. Banks have three ways in serving the public, the community and the government. First, they accept deposits generally in the form of: 1. savings deposits 2. demand deposits 3. fixed deposits (deposits with predetermined maturity dates e.g. time deposits) Second, they extend loans. The various types of loans are: 1. As to borrower/purpose: 1.1 commercial loans 1.2 consumer (personal) loans 1.3 directors, officers, stockholders and related interests (DOSRI) loans 2. As to security: 2.1. clean loans 2.2 secured loans 2.2.1. real estate mortgage (REM) loans 2.2.2 chattel mortgage (CHM) loans 2.2.3 back-to-back loans (loans vs. deposits) 3. Others 3.1 housing 3.2 retail loans Third, they act as the financial center of the public and provide other financial services such as: 1. trust accounts 2. safekeeping 3. safekeeping 4. savings bond and travelers' checks 5. credit cards 6. payment of utility bills 7. acceptance of tax payments 8. trading of securities [initial public offerings, local and foreign bonds, government securities such as treasury bills (T-bills), and private securities such as commercial papers] II. CLASSIFICATION AND FUNCTIONS OF BANKS There are four (4) classifications of banks in the country: A. Commercial Banks A.1 Regular Commercial Banks A.2 Universal Banks or Expanded Commercial Banks B. Offshore Banks C. Specialized Government Banks D. Thrift banks D.1 Savings and Mortgage Banks D.2 Savings and Loan Associations D.3 Rural Banks D.4 Private Development Banks A. Commercial Banks Commercial banks (KBs) are institutions which are authorized to perform all types of banking operations, especially the acceptance of demand deposits and foreign exchange notes. Credits are extended to their clients or debtors in the form of loans and bills discounted, trust receipts, acceptances and bills of purchase arrangements. Furthermore, KBs can grant or extend all kinds of loans, whether short-term or long-term, secured or unsecured. Other functions of KBs include investing in government securities and in readily marketable bonds and other debt instruments issued by private entities; buying and selling of foreign exchange notes; financing import and export business activities through letters of credit; and maintaining foreign currency deposits and loans. The universal banks or expanded commercial banks (EKBs) under the expanded banking system are allowed to underwrite or invest in non-allied undertakings such as leasing, insurance, securities brokering, investment or merchant banking, and foreign exchange trading. Non-commercial banks, on the other hand, are only limited in the performance of allied undertakings like investing in holding companies and performing commercial and thrift banking activities. A foreign bank may apply for either a commercial or an expanded commercial banking license. Foreign banks without branches in the Philippines may have equity participation in local companies engaged in allied undertakings. The functions of Commercial Banks are : 1. Accept deposits and trust accounts from residents and non-residents: 2. Grant loans or credits to clients/borrowers: 3. Deposit with foreign banks abroad, offshore banking units (OBUs) and other foreign currency deposit units (FCDUs); 4. Invest in foreign-currency-denominated debt instruments: 5. Grant foreign currency loans as may be allowed by the Bangko Sentral ng Pilipinas: 6. Borrow from other FCDUs, OBUs, and from non-residents subject to existing rules on foreign borrowings: 7. Engage in foreign currency-swap with the BSP, as well as with other FCDUs and OBUs: 8. Engage in foreign exchange trading; and with prior BSP approval, engage in financial futures and option trading: and 9. On request/instructions of its foreign correspondent bank, it may: 9.1 Issue letters of credit for a non-resident importer in favor of a non-resident exporter. 9.2 Pay, accept, or negotiate drafts/bills of exchange drawn under the letter of credit; and 9.3 Make payment to the order of the non-resident exporter. B. Offshore Banks Offshore banking units (OBUs) operate under the regulatory guidelines prescribed by the Monetary Board of the Bangko Sentral ng Pilipinas (BSP). The Monetary Board requires that only banks which are organized under any law other than those of the Republic of the Philippines and their branches, subsidiaries or affiliates are qualified to operate offshore banking units in the Philippines. The local branches of foreign banks are authorized to accept foreign currency deposits only upon receipt of a corresponding certificate of authority to operate as an offshore banking unit which is issued by the Monetary Board. In issuing the certificates of authority to operate as offshore banking units, the Monetary Board takes into consideration the applicant's liquidity and solvency position, net worth and resources, management, international banking expertise, contribution to the Philippine economy, and other relevant factors such as participation in equity of local commercial banks and appropriate geographic representation. The BSP neither considers nor accepts the application to operate an offshore banking unit unless the applicant submits a sworn undertaking from its head office, parent or holding company that it will provide and maintain in its offshore banking unit net office funds the minimum amount of US$1,000,000.00. Foreign Currency Deposit Unit (FCDU) Foreign currency deposit unit refers to that unit of a local bank or a local branch of a foreign bank authorized by the BSP to engage in foreign currency-denominated transactions. Commercial banks may be authorized to function under the expanded foreign currency deposit system if they meet the following minimum qualifications: 1. Its networth or combined capital accounts (the total of unimpaired paid-in capital, surplus, and undivided profits, net of such valuation reserves and other capital adjustments) is at least equal to the minimum capital requirement for a commercial bank as prescribed by the Monetary Board; 2. It has shown profitable operations for a period of two (2) consecutive business years immediately preceding the date of application; 3. It has substantially complied with the applicable laws and existing rules and regulations of the Bangko Sentral ng Pilipinas; and 4. Bank officers shall have at least two (2) years of actual experience in foreign exchange operations or related activities or have undergone training in foreign exchange operations acceptable to the BSP. C. Specialized Government Banks There are three (3) banks classified as specialized government banks under the present system. These banks are the Development Bank of the Philippines (DBP), the Land Bank of the Philippines (LBP) and the Philippine Amanah Bank These banks are under the control of the Philippine Government. DBP is licensed as a universal bank (EKB). It is mandated to help spur the growth of the agriculture industry and to promote the establishment of the private development banks (PDBs). DBP, however, is the only EKB that does not perform foreign exchange operations, although it serves as one of the channels of the government's foreign borrowings from multilateral and bilateral funding sources. Loans extended by DBP are primarily channelled to the following activities: 1. The establishment or development of agricultural and industrial enterprises including public utilities, mining, livestock, and fisheries; 2. Home building and home-financing projects; 3. Purchase of preferred shares of agricultural or industrial enterprises to finance their fixed and operating capital requirements; and 4. Various local government unit-sponsored activities such as construction of public markets, toll bridges, waterworks and other relevant generating services. The LBP is principally mandated to finance agrarian reform programs. Licensed as a commercial bank, LBP's banking operations subsidizes the government's agrarian reform activities. The Philippine Amanah Bank is intended to serve the financing and banking needs of the Muslim community. D. Thrift Banks Thrift banks are organized in the form of stock corporations. The Monetary Board of the BSP sets the minimum paid-up capital of thrift banks in an amount the Board considers necessary for the safe and sound operations of thrift banks and for the protection of the general public. Thrift banks are not allowed to organize without prior issuance of a certificate of authority from the Monetary Board. Thrift banks are primarily intended to encourage further savings and meet the credit needs of households and small and medium enterprises. Thrift banks are categorized into savings and mortgage banks (SMBs), stock savings and loan associations (SSLAs), rural banks, and private development banks (PDBs). SMBs accept savings deposit and invest them in medium and long-term loans to assist in business and housing requirements. On the other hand, SSLAs accumulate the savings of their members and shareholders and utilize these funds for loans or as investments. Meanwhile, PDBs serve the needs for capital and adequate investment credit in the form of long-term and medium-term loans to businesses. Under RA No. 7906 or the Thrift Banks Act which was enacted in 1995, thrift banks are also authorized to invest in the equities of allied undertakings subject to certain conditions. Allied undertakings include banking and finance, leasing, farming and agriculture-related activities and other activities as may be determined by the Monetary Board. The Monetary Board of the BSP supervises the operations of thrift banks which may consist of placing limits to the maximum credit allowed to any individual borrower, indicating the manner in which technical assistance shall be extended to thrift banks; imposing a uniform accounting system and the manner of keeping the accounts and records; instituting periodic surveys of loans and lending procedures, audits, test-check of cash and other transactions; conducting training courses for personnel; and supervising their business operations. The functions of thrift banks are : 1. Accept deposits and trust accounts from residents and non-residents; 2. Grant loans or credits to clients/borrowers; 3. Deposit, on short-term maturity, with foreign banks abroad, OBUs and other FCDUs; 4. Invest in foreign currency-denominated debt instruments which are of short-term maturity, and are readily marketable; 5. Grant short-term foreign currency loans as may be allowed under existing BSP rules and regulations; 6. Borrow, on short-term maturity, from other FCDUs and from foreign banks abroad, and OBUs, subject to existing rules on foreign borrowings; and 7. Engage in foreign currency-swap with the BSP, as well as with other FCDUs and OBUs. D.1 Savings and Mortgage Banks Savings and mortgage banks are corporations organized primarily for the purpose of accumulating the small savings of depositors and investing them, together with its capital, in bonds or in loans secured by bonds, real estate mortgages, and other forms of security. The loans and investments of saving and mortgage banks are generally limited to the following, subject to the rules and regulations of the Monetary Board of the Bangko Sentral ng Pilipinas (BSP): 1. Loans with the security of their own savings deposit obligations or of mortgage and chattel mortgage bonds which they have issued, or with the security of savings deposit obligations of other banks doing business in the Philippines. 2. Medium-term loans of the following types: a. Loans for the encouragement of cattle, carabao and other livestock breeding which shall be repaid in regular installments and shall have as principal security a lien on the animals, real estate and other securities, to the bank's satisfaction. b. Equipment loans for the acquisition of instruments, machinery, and other movable equipment including fertilizers used in the production, processing, transformation, handling or transportation of agricultural and industrial products. Such loans shall constitute a first lien on the assets acquired with the proceeds of the loan, together with the lien on other properties of the debtor. 3. Mortgage loans for the conservation, enlargement or improvement of the productive properties, or the acquisition of machinery or other property with fixed installation. Such loans shall be secured by a first mortgage on the property. 4. Real estate mortgage loans for the following purposes: 4.1 For the construction, acquisition, expansion or improvement of rural and urban properties. (a) For the refinancing of similar loans and mortgages; and (b) For such other purposes as may be authorized by the Monetary Board of the BSP. 5. High-grade bonds and other evidences of indebtedness, and loans against such obligations. 6. Drafts, bills of exchange, acceptances, or notes arising out of current commercial transactions which are endorsed or accepted by any solvent bank operating in the Philippines. 7. Collateral trust bonds or notes, or obligations secured by such bonds or notes, secured by a first mortgage or by a participating interest in a first mortgage on improved urban or rural real estate in cities and municipalities of the Philippines. 8. Loans secured by the pledge to the corporation/borrower of gold or silver bullion. 9. Loans with first mortgages transferred to the corporation/borrower as collateral security on improved and otherwise unencumbered real estate. D.2. Savings and Loan Association Savings and loan associations are corporations whose capital stock is required or is permitted to be paid in by the stockholders in regular, equal, periodical payments and whose purpose is to accumulate the savings of its stockholders, to repay said stockholders thru accumulated savings and profits upon surrender of their shares, to encourage industry, frugality, and home building among its stockholders on the security of their investments and with the pledge of shares of the capital stock owned by such stockholders as collateral security. The capital stock of such associations shall be paid in by the stockholders in regular, equal, periodical payments known as dues, at such times in such amounts as shall be provided in the by-laws of the association. The dues of each share of stock subscribed for a stockholder shall continue to be paid by the stockholder to the association until the share has been duly withdrawn, cancelled or forfeited or until the share has reached its matured value (i.e., when the dues paid on each share and the net earnings thereof in accordance with the by-laws shall amount to the matured value of the share). However, such association may issue and sell paid-up stock for each and also investment stock to be paid in installments, and may pay to the holders of such paid-up stock out of the net profits such rates dividends as may be fixed from time to time by the board of directors of the association, which shall be expressed in the stock certificates and shall not participate further in the profits or accretions of the association. D.3 Rural Banks Rural banking was introduced in 1952 to serve the credit needs of small borrowers in the rural areas that are considered as poor risks by commercial banks (KBs) due to their lack of bankable properties. Rural banks are like thrift banks, except that their clientele include, among others, farmers and cooperatives in rural communities. Loans or advances extended by rural banks are primarily for the purpose of meeting the normal credit needs of farmers, fishermen or farm families owning or cultivating land dedicated to agricultural production, as well as the normal credit needs of cooperatives and merchants. In the granting of loans, the rural banks give preference to applicants whose cash requirements are small. D.4 Private Development Banks Development banks are organized in the form of stock corporations to provide banking services principally to service the needs of agricultural and industrial enterprises, particularly in the countryside and preferably for small and medium enterprises. These banks are also authorized to perform all other functions of a thrift bank. In general, development banks are established to undertake the following activities: 1. To accept such deposits as are allowed thrift banks under existing laws and BSP regulations including, but not limited to demand, savings, and time deposits; 2. To grant loans for the establishment, development or expansion of any agricultural or industrial enterprise; 3. To accept and manage trust funds and properties and carry on the business of a trust corporation; 4. To acquire, assign, or otherwise dispose of marketable securities and other debt instruments which are essential to the effective conduct of their general banking activities; and 5. To enter into such contracts of guaranty on suretyship as are generally allowed domestic banking institutions under the General Banking Act. The Monetary Board of the BSP supervises the operations of development banks. With the approval of the Monetary Board, development banks, just like any other banks may establish branches, agencies, or extension offices on a nationwide basis. DAaHET III. TERMINOLOGIES COMMON TO THE INDUSTRY The terminologies commonly used in the banking circles are as follows: 1. Bank means a duly authorized entity engaged in the lending of funds obtained from the public through the receipt of deposits or the sale of bonds, securities, or obligations of any kind and all entities regularly conducting such operations. 2. Batch is a group of deposits, checks, papers or instruments with common characteristics assembled for a common purpose. 3. Branch refers to a separately managed department of a bank or a unit of a foreign corporation. 4. Cash Items include Philippine or acceptable foreign currencies in various denominations either in paper bills or in coins. 5. Certificate of Deposit refers to a receipt payable to the depositor for funds deposited with a bank. 6. Checks and Other Cash Items include all cash items, checks and other negotiable instruments in the banks' custody. 7. Clearing is the process of sending, receiving and/or exchanging of checks and other items deposited for exchange or settlement among member banks through the facilities of the BSP. 8. Commercial Paper refers to an evidence of indebtedness regardless of maturity period and is issued on a "with or without recourse" basis. 9. Correspondent Bank is usually a foreign bank where a local bank has made a special arrangement to facilitate transactions in behalf of its clients. 10. Customers' Liability Under Acceptance (Domestic) comprises of customers' liability arising from acceptance created in connection with the financing of negotiations of letters of credit involving shipments, movements or storage of merchandise. Warehouse receipts or shipping documents or other similar documents conveying or securing title to the goods covered are likewise usually released to customers under trust receipt agreements. 11. Customers' Liability Under Acceptance (Foreign) means liability arising from time drafts drawn against usance letter of credit (suppliers' credit) issued by the bank. Warehouse receipts or shipping documents or other similar documents conveying or securing title to the goods are usually released to customers under trust receipt agreements. The bills under this account are booked in subsidiary records in both foreign and local currency. Peso equivalents are calculated at a prescribed control rate and are revalued at the bank's selling rate at maturity. 12. Demand Deposit is also called current account or checking account which does not usually earn interest and which is withdrawable by check. 13. Deposits refer to money placed in a bank to the account of any depositor for safekeeping. This is withdrawable on demand or after a specified period of time and earns interest As regards offshore banking, deposits are funds in foreign currencies which are accepted and held by an OBU in the regular course of business with the obligation to return an equivalent amount to the owner thereof, with or without interest. TCAScE Deposit Substitutes mean alternative forms of obtaining funds from the public, other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower's own account, for the purpose of relending or purchasing of receivables and other obligations or financing their own needs or the needs of their agent or dealer. For this purpose, the term "public" means borrowing from twenty (20) or more individual or corporate lenders at any one time. Debt instruments may include, but are not limited to, promissory notes, repurchase agreements, certificates of assignment or participation, and similar instruments with or without recourse as may be authorized by the BSP. However, debt instruments issued for inter-bank call loans with maturity of more than five (5) days to cover deficiency in reserves against deposit liabilities, including those between or among banks and quasi-banks, are not considered as deposit substitutes debt instruments. The following borrowings are considered as deposit substitutes: a. All interbank borrowings by or among banks and non-bank financial institutions authorized to engage in quasi-banking functions evidenced by deposit substitutes instruments, except interbank call loans to cover the deficiency in reserves against deposit liabilities as evidenced by interbank loan advice or repayment transfer tickets. b. All borrowings of the national and local government and its instrumentalities including the BSP, evidenced by debt instrument denoted as treasury bonds, bills, notes, certificates of indebtedness and similar instruments. c. All borrowings of banks, non-bank financial intermediaries, finance companies, investment companies, including the trust department of banks and investment houses, evidenced by deposit substitute instruments. d. All borrowings of corporations evidenced by commercial papers whether or not registered with Securities and Exchange Commission, from the Philippine National Bank, Development Bank of the Philippines, Government Service Insurance System and the Social Security System, and from all private institutional lenders. e. All borrowings of thrift banks and rural banks through the credit facilities of the BSP, Philippine National Bank, Development Bank of the Philippines, Government Service Insurance System, and the Social Security System, evidenced by deposit substitute instruments. 15. Domestic Bills Purchased (Clean) compose of clean bills purchased consisting principally of: a. Local drafts and/or negotiable instruments which have been discounted with or purchased by the bank; and b. Checks purchased by banks covered by unexpired domestic bills purchased lines allowed under existing rules and regulations which are either encashed or credited to customer's deposit accounts upon purchase. 16. Export Bills Purchased (Foreign Regular) represent drafts or bills of exchange purchased by the bank, originating from export transactions involving commodities or services drawn on foreign banks/buyers. 17. Export Bills Purchased (FCDU/EFCDU) refer to drafts or bills of exchange drawn against usance and sight letters of credit, purchased by the bank directly from resident exporters under the FCDU system, originating from export transactions involving commodities or services. 18. Financial Future Sold/Bought (Trading/Hedging) represent the amount of future contracts sold/bought for trading or hedging purposes which shall be recorded at its foreign currency amount and at its local currency equivalent at the applicable rate of exchange on transaction date. 19. Float refers to any unidentified item or unresponded transaction with another unit with banking operation. 20. Foreign Bills Purchased (Clean) represent clean bills purchased by the bank from its customers consisting of principally of checks, drafts, coupons, treasury warrants and other negotiable instruments denominated in foreign currency payable or collectible abroad. Such purchases from depositors/last endorsers may be by way of immediate credit to their deposit accounts or outright over-the-counter payments. 21. Foreign Currency Deposit Unit is a unit or department in a local branch or in an existing local branch of a foreign bank, which is authorized by the BSP to operate under the expanded foreign currency deposit system. TAcSCH 22. Forward (Future) Exchange Sold/Bought refers to the amount of formal commitments entered into by the bank under a forward (future) exchange contract to sell/purchase foreign exchange at the rate agreed upon in the contract, payment and delivery of which are to be made on a stipulated future date exceeding two (2) days from transaction date. 23. Gross Offshore Income represents all income derived by OBUs authorized by the BSP from foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the BSP to transact business with OBUs, including any interest income derived from foreign currency loans granted to residents. 24. Gross Onshore Income means gross income derived by a depository bank under the expanded foreign currency transactions with local commercial banks including branches of foreign banks that may be authorized by the BSP to transact business with foreign currency deposit system units and other depository banks under the expanded foreign currency deposit system, including interest income from foreign currency loans granted by such depository banks under the expanded foreign currency deposit system to residents. 25. Interest is the amount which a depository bank may pay on deposits and deposit substitutes in accordance with rates authorized by the BSP. 26. Inward Bills for Collection represent the amount of domestic or foreign bills, drafts or checks received for collection locally or from foreign correspondents for collection from drawees. 27. Kiting is a term used in the banking and finance circle to describe the malpractice of individuals who cover up malversation of cash and check collections by taking advantage of the time element. 28. Lending Investor includes all persons who are engaged in the business of lending money to others with interest. 29. Letter of Credit means a written instrument issued by the buyer's bank authorizing the seller to draw in accordance with certain terms, and stipulating in legal form that all such bills will be honored. It sets forth the terms and conditions when the person in whose favor the letter has been opened may draw drafts against such credit, at the same time guaranteeing the payment or acceptance of such drafts if they comply with the letter's terms. 30. Loan Ledger is a record for every borrower of all the outstanding commercial loans extended by the bank. 31. Long-Term Deposit or Investment Certificate refers to certificate of time deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts, and other investments with a maturity period of not less than five (5) years, the form of which shall be prescribed by the BSP and issued by banks only (not by non-bank financial intermediaries and finance companies) to individuals in denominations to Ten Thousand Pesos (P10,000) and other denominations as may be prescribed by the BSP. 32. Manager's/Cashier's Check is a check of a drawee bank signed by the bank's manager or cashier. 33. Marginal Deposit means non-interest bearing deposit given by an importer or borrower to a bank for the purpose of opening a letter of credit with the bank. 34. Non-Resident is an individual, corporation or other juridical person not included in the definition of a "resident." 35. Offshore Banking refers to the conduct of banking transactions in foreign currencies involving the receipt of funds principally from external sources and the utilization of such funds. 36. Offshore Banking Unit is a branch, subsidiary or affiliate of a foreign banking corporation which is duly authorized by the BSP as a separate unit to transact offshore banking business in the Philippines. 37. Overdraft is a situation wherein depositor's drawings exceed the available balance of deposit thereby resulting to a negative balance in the deposit account being maintained in the bank. SDEHIa 38. Override refers to a mechanism installed to check the operation of an automatic device with respect to transactions requiring on-line approval by the bank's authorized officer. 39. Proof Sheet or Block Sheet is a summary of transactions in journal entry form showing the debits and the credits of accounts. 40. Quasi-Banking Functions means the borrowing of funds from twenty (20) or more personal corporate lenders at any time, through the issuance, endorsement or acceptance of debt instruments of any kind other than deposits, for the borrowers own account, or through the issuance of certificates of assignment or similar instruments with recourse, or of repurchase agreements, for purposes of relending or purchasing receivables and other similar obligations. However, commercial, industrial, and other non-financial companies which borrow funds through any of these means for the limited purpose of financing their own needs or the needs of their agents or dealers, is not considered as performing quasi-banking functions. 41. Resident refers to: a. An individual citizen of the Philippines residing therein; or b. An individual who is not a citizen of the Philippines but is permanently residing therein; or c. Corporation or other juridical person organized under the laws of the Philippines. CcaASE 42. Savings Deposit is a deposit which may be withdrawn by the depositor at any time, subject only to the right of the depository bank to require reasonable prior notice in writing before withdrawal may be made. 43. Spot Exchange Sold/Bought represents the amount of formal commitments entered into by the bank under a spot exchange contract to sell/purchase foreign exchange at the rate agreed upon in the contract, payment and delivery of which are to be effected by the seller within two (2) days from transaction date. 44. Suspense Account is a balance sheet account used as dumping ground for irreconcilable/unlocated differences (e.g. sundry debits/credits). 45. Ticket refers to any form used as basis in the recording of transactions in the books of accounts. 46. Time Deposit means a deposit which has a definite time of maturity and cannot be withdrawn by the depositor until maturity except in case of authorized pre-termination. 47. Transit Letter is a form on which are listed checks and other cash items that are drawn upon drawee banks located outside the city/municipality where the possessor bank is situated. 48. Trust Assets are assets held and managed by a bank as trustee under a trust agreement for the use, benefit or advantage of the designated beneficiaries. 49. Trust Receipt refers to a receipt given by an importer to the bank which has guaranteed the release of the goods, vesting title in the lender although the goods are in the possession of the buyer/importer. Under the terms of the trust receipt, the importer is permitted to take physical possession of the merchandise although legal title of ownership remains with the bank. 50. Uncollected Funds is a term used to describe a portion of a deposit or account which has not been collected or paid because the items deposited are en route (in transit) to the drawee bank for payment. Yield is the difference between the amount which the lender/investor loaned/placed as investment and the amount to be received by him upon maturity of the debt investments/deposit substitutes which shall in no case be lower than the interest rate prevailing at the time of the issuance or renewal of the said debt instruments/deposit substitutes. IV. PECULIARITIES OF THE INDUSTRY Bank accounting is quite different from the conventional double entry bookkeeping. The significant differences in the system are as follows: 1. Daily posting of transactions and trial balancing of the general ledger. A statement of condition is prepared daily. Income and expense account balances are carried in the statement of condition under the profit and loss accounts to eliminate closing these accounts to undivided profits daily. 2. Use of entry ticket instead of conventional columnar journals. The entry ticket is one device used to help speed up the flow of accounting information. This is used for all transactions and is not limited as to the contra to cash transactions. 3. Use of blocksheet or proofsheet to summarize daily transactions per unit, department or division, which are then posted to the general and subsidiary ledgers. 4. Use of reciprocal accounts such as "Due To/From Head Office," "Due To/From Branches," "Inter-Office Account" is a usual practice needed to facilitate transactions, transfers and/or charging, crediting of accounts between/among departments, branches and/for Head Office. 5. Accounting journal entries are sometimes supplemented by contingent accounting entries and such contingent accounts form an integral part in the presentation of the financial statements. 6. The use of non-ledger or memorandum accounts. cAaDCE These accounts are used to record the bank's commitment and contingent liabilities; such as letters of credits issued, unissued savings bonds, travelers checks held on consignment, etc. 7. The need for speed in classifying and summarizing accounting transactions often results in the use of abbreviated accounting information. 8. The maintenance by commercial banks of two sets of books Regular (Peso) books and FCDU (Foreign Currency Denominated Transaction) books. These books are consolidated/combined daily with the FCDU books converted at Philippine Dealing System (PDS) rate for the day. 9. Existence of voluminous transactions, the majority of which offset balance sheet accounts. 10. Use of office electronic devices and paraphernalia to aid, check and validate highly voluminous bank transactions is a common practice in the industry. V. TAX TREATMENT Banks are directly liable to the following taxes under the Tax Reform Act of 1997: 1. Income Tax 1.1 Regular Banking Unit (RBU) Subject to regular income tax rate under Sec. 27(a) of the Tax Code. 1.2 Offshore Banking Units SacTAC 1.2.1 Onshore Income Subject to 10% final income tax on income from foreign currency transactions and interest income from foreign currency loans. 1.2.2 Offshore Income Exempt from income tax. 1.2.3. On all Other Income Subject to regular income tax rate under Sec. 27 (a) of the Tax Code. 1.3 Minimum Corporate Income Tax A minimum tax of 2% of gross income is imposed when the minimum corporate income tax is greater than the regular corporate income tax. 2. Gross Receipts Tax (Sec. 121) 2.1 On interest, commissions and discounts from lending activities and on income from financial lending on the basis of remaining maturities of instruments from which such receipts are derived, as follows: a. Short-term maturity (not more than 2 years) 5% b. Medium-term maturity (over 2 years but not exceeding 4 years 3% c. Long-term maturity (over 4 years but not exceeding 7 years) 1% d. Long-term maturity (over 7 years) exempt 2.2 On dividends exempt 2.3 On royalties, rentals of property (real or personal), profits from exchange, and other items treated as gross income 5% 3. Withholding tax 3.1 Withholding tax on compensation [Sec. 24 A(1)(c))] (RR 2-98) 3.2 Creditable or Expanded Withholding Tax (RR 2-98) 3.3 Final Withholding Tax (RR 2-98) 3.4 Fringe Benefits Tax [Tax 33(A)] (RR 3-98) 4. Documentary Stamp Tax (Title VII of NIRC) VI. AUDIT PROCEDURES As a general rule, the Revenue Officer (RO) must observe the audit procedures set forth in Volume I of the Handbook on Audit Procedures and Techniques to be supplemented by the practical approaches suggested herein. In the audit of banks, the RO should always bear in mind that all his audit efforts are directed towards determining the correct tax liabilities of the taxpayer. He is encouraged to, at all times, reflect on the tax consequence of each significant detail uncovered in the course of the audit. Planning is necessary in the audit of banks. The RO has to conduct a preliminary review of the financial data and review internal audit reports, the reports of examination by supervisory agencies, and other pertinent correspondence. The RO must perform the following analytical procedures during the planning stage: Footnotes 1. Review internal and external auditors' reports, financial statements (including the footnotes) and the tax returns of the taxpayer. 2. Review the reports of examination issued by concerned regulatory authorities. Note any significant areas of concern like internal control weakness or non-compliance with reporting requirements that may have an impact on the scope of audit for the year under investigation. 3. Review local and national industry group information made available by regulatory agencies. ADcSHC 4. Review the analytical information contained in management's financial reports to the board of directors. A. INCOME A.1 General Audit Procedures 1. Reconcile net income reflected in the financial statements and the net income appearing in the income tax return. Determine nature of significant variances based on the analysis of financial statement accounts, if any. 2. Reconcile balances of financial statement accounts with the general ledger accounts. Ascertain the grouping of accounts as they conform with the audited financial statements balances. 3. Verify the correctness of inclusion/exclusion of items treated as reconciling items in the computation of the income tax due. 4. Perform analytical review of all major income accounts by comparing current balance with prior year's balance. Investigate significant changes. 5. Scan all ledgers for unusual entries and other items. Investigate any unusual items noted. Take note if these are properly recorded, and if not, analyze if there is any tax implication. A.2 Specific Audit Procedures 1. Interest Income on Regular Loans 1.1 Determine the amount of interest income and accrued interest receivable on loans as reflected in the books of accounts. Compare the figures with the reported amounts per audited financial statements (F/S) and income tax return (ITR). Verify details of discrepancies noted. 1.2 Test-check entries to the interest income account from the general ledger to the subsidiary ledger to ascertain accuracy and propriety of recorded transactions. 1.3 Determine the bank's method of calculating and recording interest income and accruals. 1.4 Test the computation and recording of interest income and accrued interest receivable to determine if the method of interest calculation is consistently applied and recorded in the books of accounts. 1.5 Determine whether interest accruals are only made on interest-accruing loans. In accordance with BSP rules and regulations, no accrual of income shall be made on loans that are past due for more than 6 months. 1.6 Ascertain whether all receipts and accruals of interests are properly reflected in the return. 2. Discounts on Notes and Loans 2.1 Test-check the debits to unearned interest discount from the general ledger to the subsidiary ledger to determine if they are properly credited as income. 2.2 Test-check the accuracy of the computation of the earned portion of discounts and verify if they are properly credited to income account. 3. Interest Income on Demand Loans, Time or Term Loans and Other Types of Loans 3.1 Test/verify whether all interests due on loans upon payment on maturity are properly accounted for and recorded as income. 3.2 Test-check interests collected for a selected period and trace the entries made to the general ledger account. 4. Income from Investments 4.1 Determine the average total investment for a specific period and test-check the accuracy of computation of interest/dividend/investment income. CDTHSI 4.2 Ascertain that only income pertaining to the period under investigation was taken up as income where the accrual method of reporting income has been adopted. 4.3 Test check whether interest/dividends due are actually earned and recorded. 5. Interest Income on Bills 5.1 Obtain a schedule of retired import bills and customer's liability acceptances under trust receipts for the period covered by the audit. 5.2 Test-check the interest collected on retired import bills and customers' liability acceptances under trust receipts against the corresponding liquidation statement for a selected period. 5.3 Verify if interests collected on treasury bills were completely reported as income. 6. Other Income 6.1 Sale of Promissory Notes or Participation 6.1.1 Determine at the balance-sheet date whether any portion of promissory notes or participations are being held for sale and have been valued at the lower of cost or market (either in the aggregate or individual loan basis). Consider prior-sale activities, types of promissory notes sold, transactions subsequent to year end, pending contracts, and management intentions. 6.1.2 Ascertain whether changes in the valuation allowance for promissory notes held for sale are included in the determination of net income for the period. 6.2 Income from Bonds 6.2.1 Check whether there are redemptions of old bonds or recoveries of old obligations written-off in prior years. 6.2.2 Determine the proper factual and legal basis in subjecting such items to income tax. 6.3 Sale on Disposition of Capital Assets 6.3.1 Analyze changes in capital asset accounts to verify any disposition or exchange of fixed or capital assets during the year under audit. ICcDaA 6.3.2 Check if all income derived from sale, exchange, or disposition of capital assets have been reported as ordinary gains/capital gains. 6.4 Rental Income 6.4.1 Verify rental income on office spaces and safety deposit boxes. 6.4.2 Verify rental income received on acquired assets and other bank properties. 6.4.3 Verify the sources of the declared rental income and cross-check the same from the list of the bank's tenants/lessees. 6.4.4 Review the covering contracts to determine the amount of rental and the other terms and conditions. Verify if the income received and declared for tax purposes is in accordance with the terms and conditions embodied in the said contract. 6.4.5 Test-check whether there are advance rentals which are credited to income. 6.5 Sale of Investments 6.5.1 Analyze changes to investment accounts to determine whether the taxpayer has made dispositions of its domestic or foreign investments. Check if these transactions are properly recorded for tax purposes. 6.5.2 Test-check the accuracy of exchange profits/losses that were earned/incurred by the bank as a result of the sale of its foreign exchange holdings. A.3 Other Procedures 1. Verify accuracy of the income figures reflected in the audited financial statements and income tax returns. 1.1 Secure a copy of Statement of Income and Expenses and compare the figures reflected thereat with the balances appearing in the audited financial statements and income tax returns. Verify discrepancies noted. 1.2 Test-check the accuracy of the income reflected in the Daily Statement of Income and Expenses by reviewing entries therein and examine supporting documents for larger items. 1.3 Test-check entries in the debit and credit tickets and trace postings to ledger accounts. 1.4 Review the entries in the unearned interests, premiums and discount and other accrued income. Consider examining supporting journals or reports. DIEAHc 2. Determine other sources of revenue realized by banks like gain on sale of acquired assets. For acquired assets sold on installments, verify the initial amount of collections on such sales on the year of sale to determine if the sales qualify as installment sales. Check accuracy of tax computation. 3. Analyze changes in retained earnings. Investigate large or unusual entries particularly credits to the account not arising from income from operations. 4. Scrutinize all documents/records that may be evidences of transactions giving rise to income such as: a. Loan ledgers with information as to the borrower, type of loan, date granted, due date, security, original principal, interest payments, terms and rate, principal balances at the beginning of the year, additions/payments/renewals during the year and balances at the end of the year, accrued interest balance at the beginning of the year, interest earned or collected during the year and accrued interest balance at the end of the year. However, in accordance with existing BSP rules and regulations, no interest shall be computed on past-due loans for more than 6 months. b. Loan documents such as loan approval memo, promissory notes, mortgage agreements, deeds of trust, land contracts, pledges, of deeds of assignments, etc. c. Various types of collection items such as drafts, acceptances, bonds, coupons and notes, etc. 5. Review reconciliation of income (loss) per books with the income (loss) reflected in the income tax return. B. EXPENSES B.1 General Audit Procedures 1. Analyze direct operating costs and other expenses. Determine expenses that are unusually substantial, and put emphasis in the audit of such expenses. 2. Concentrate on expenses directly connected with the earnings of substantial income. 3. Match expenses against related revenues. Determine whether there are expenses incurred attributable to liabilities or loans obtained, the proceeds of which were invested in tax exempt/tax paid investment. Consider the possibility of treating such transactions as interest arbitrage and disallowing the portion of claimed interest expense relating to the generation of such tax-exempt income. 4. Verify certain payments made for expenses with material balances and examine supporting documents such as purchase agreements, purchase invoices, check vouchers, checks issued, accounting tickets and other documents. 4.1 Prepare an analysis of charges and credits to expense accounts related to the findings per investigation. 5. Investigate material amounts of negative entries found in the expense ledgers. 6. Verify expenses claimed arising from related-party transactions and/or transactions attributable to DOSRI loans. Perform the following audit procedures to determine if related-party transactions exist: 6.1 Review copies of the following: a List of equity investments in allied undertakings; b. List of stockholders; and c. List of company officers and members of the board of directors. Obtain copies of these records/documents in case they have material effect on the assessment. 6.2 Inquire from management relevant information about related parties. Obtain related party confirmation, if applicable, and inquire about any recorded or unrecorded transaction that has been discovered during the year. 6.3 Analyze footnotes or notes to the audited financial statements to determine disclosed information that may have tax implications. 6.4 Verify related-party transactions while examining confirmations of loans/advances as well as those involving substantially large and unusual transactions. 6.5 Test-check supporting documents of significant related-party transactions to determine the following: a. Business purpose; b. Board of Directors' approval; c. Reasonableness of the transaction and consistency with the bank's existing guidelines and policies; and d. Financial capacity of related parties. 7. Review bank policy with respect to transactions with bank officers who are also members of the client's board of directors. Be alert on the possibility that the transactions may neither be at arms-length or above-board. 8. Ascertain whether the expenses claimed as deductions have fully satisfied all the legal requirements for deductibility. B.2 Specific Audit Procedures 1. Payroll and Fringe Benefits 1.1 Secure copies of the annual alphabetical (alpha) list of employees from whom taxes were withheld during the year (BIR Form No. 1743IR) and the annual information return on income payments not subjected to withholding tax (BIR Form No. 1701B). 1.2 Reconcile the total of gross wage/fringe benefits reflected in the alpha list of income recipients with the total compensation/fringe benefits appearing in the general ledger and audited financial statements. Account for any discrepancy noted and determine if such discrepancy shall be subject to the appropriate withholding taxes. 2. Depreciation And Amortization 2.1 On Property And Equipment 2.1.1 Verify fixed assets' records to determine the accuracy of cost of fixed assets, accumulated depreciation and amortization by examining their beginning balances, additions, retirements/deductions, and ending balances during the year under investigation. Reconcile the same with the amounts shown in the general ledger. 2.1.2 Compare current year's balances of fixed assets capitalized leased assets, accumulated depreciation, accumulated amortization, and depreciation expense with the balances in the preceding years. Investigate significant changes. 2.1.3 Analyze additions to and retirements of fixed asset accounts including adjustments, if any. 2.1.4 Analyze gain or loss on sale of property and equipment. Trace amounts to deeds of sale or other supporting documents and records. Determine the reasonableness of the consideration or payment received from the sale. 2.1.5 Vouch major additions to property and equipment account. Determine the bank's capitalization and depreciation policies. 2.1.6 Verify the method of depreciation and amortization used by the taxpayer and determine if such is consistently applied. In case of any change in the method, this should be supported by prior written approval from the BIR; otherwise, make the necessary recomputation of the allowable expense based on the old method. 2.1.7 Review repairs and maintenance, acquisition of supplies, small tools and other accounts that have been directly charged to expenses. Determine existence of expenses that have prolonged the lives of the assets for over one (1) year which should have been capitalized. 2.2 On Other Assets 2.2.1 Compare current balances in pre-operating expenses, deferred charges, intangibles, and accumulated amortization accounts with the balances of accounts in the preceding year. Investigate significant changes. 2.2.2 Check the accuracy of the computation of amortization of deferred charges and intangible assets. Verify consistency in the application of amortization policy and the amortizable period in relation to prior periods. 2.2.3 Check charges to amortization accounts with credits in the asset accounts. Analyze tax implications of discrepancies. 3. Charitable and Other Contributions 3.1 Verify nature of contributions to determine eligibility for full or partial deduction. 3.2 Vouch and test-check claims for contribution with supporting official receipts evidencing payment thereof. 4. Rental Income and Expense 4.1 Review rental income and expense accounts from leased and subleased assets. 4.2 Review lease agreements to determine if leases are not capital leases. Otherwise, the transaction shall be considered as acquisition or sale of capital assets, as the case may be. 4.3 Verify supporting documents for any repair expenses on leased assets. Review lease contract or agreement to determine whether the expense shall be chargeable to the bank or to the lessee. 5. Insurance 5.1 Review the insurance policies secured during the year. Determine the business purpose for such insurance and check their coverage and effectivity dates as reflected in the policy to determine qualification for deductibility as prescribed under existing laws, rules and regulations. 5.2 Vouch premium payments by tracing the same to the corresponding official receipts issued by the insurance company. 6. Interest Expense 6.1 Determine the amount of interest expense charged to operations giving due consideration to the limitations set forth under Republic Act No. 1605 with respect to secrecy of bank deposits: 6.1.1 Determine the total amount of interest expense as reflected in the audited financial statements, particularly the statement of income and expenses. 6.1.2 Classify and analyze interest expense account in accordance with the types of liabilities incurred (i.e., deposits and deposits substitutes, trust funds and similar investments and long-term deposits, and availments of regular loans from domestic and foreign sources). 6.1.3 Test-check documents in support of interest-bearing obligations and payments/accruals of interests to prove legitimacy of the transactions and established basis of interest computation. 6.1.4 Verify whether accruals or prepayments of interests on borrowed funds were properly taken up in the books. 6.1.5 Test-check accuracy of interest computations and trace the corresponding cost slips and/or debit and credit tickets for interests charged to operations to the entries in the expense ledger. Account for any discrepancy. 6.2 Verify the propriety of allowing the deductibility of interest expenses that are considered as reconciling items in the income tax return. 6.3 Account for charges to interest expense that are subject to applicable final or creditable withholding taxes. Compare the same with the amounts of interests actually subjected to withholding taxes. Reconcile any noted discrepancy. 6.4 Test-check recorded interest expense against the loan documents and entries in the bank's ledgers. 6.5 Verify whether some interest expenses were treated as direct offsets against interest income. If such is the case, include the amount offset to the basis of the computation of gross receipts tax and withholding taxes on interest expenses, if such amount was not part of the taxable base. 6.6 Test reasonableness of interest expense by multiplying the average balance of major categories of debt outstanding by average or stated interest rates. Normally, interest expense on deposits is computed by averaging the daily balance (ADB) of the accounts on a quarterly basis. 7. Travel and Entertainment Expenses 7.1 Scan the general ledger for charges to travel and entertainment expenses which are significant in amount. 7.2 Vouch the supporting documents evidencing payment of these expenses. 7.3 Obtain copies of the minutes of meetings or any document which outlines the company policy for travel and entertainment. Watch out for expenses classified as traveling and entertainment which are actually part of the gross compensation of bank executives or granted as fringe benefits under Section 33 of the Tax Code. 7.4 Test-check existence of individual authorizations of employees who incurred substantial travel and entertainment expenses. 7.5 Ascertain that the proper withholding tax is withheld on income payments to travel agencies and other payees. 8. Losses and Bad Debts 8.1 Ascertain that the following requisites for deductibility of bad debts as set forth under Revenue Regulations No. 5-99 are met: 8.1.1 There must be an existing indebtedness due to the taxpayer which must be valid and legally demandable; 8.1.2 The same must be connected with the taxpayer's trade, business or practice of profession; 8.1.3 The same must not be sustained in a transaction entered into between related parties enumerated under Sec. 36(B) of the Tax Code. 8.1.4 The same must be actually charged off in the books of accounts of the taxpayer as of the end of the taxable year and not merely set up as a provision for uncollectible accounts; and 8.1.5 The Bangko Sentral Pilipinas (BSP), thru is Monetary Board, should have ascertained the worthlessness and uncollectibility of the bad debts and it should have approved the writing off of the said indebtedness from the bank's books of accounts at the end of the taxable year. 8.2 Check whether losses are treated as direct offsets against income. Consider the possibility that the taxpayer may have adopted this practice in order to reduce or minimize income or receipts subject to gross receipts tax. 8.3 Analyze losses sustained from foreign currency transactions. Verify whether claims for translation losses were actually realized/sustained during the taxable year. Otherwise, these should be added back to taxable income. C. GROSS RECEIPTS TAX 1. Verify gross income subject to Gross Receipts Tax (GRT) such as interests, commissions/discounts from lending activities and income from financial leasing based on the remaining maturities of the instruments. 2. Check whether the appropriate tax rates were used by performing the following procedures: 2.1 Segregate beginning and ending balances of loans/other income receivables and unearned discounts. Classify those receivables/discounts into accounts from taxable and exempt income accounts. 2.2 Ascertain that all income subjected to final tax are properly taken up at gross amounts. 2.3 In computing the correct gross receipts subject to tax, the following basic formula may be used: Gross Revenue (Sec. 121) Interest Income Pxx Add: Other Income xx Total Gross Revenue Pxx Add/Deduct: Beginning Balances of: Accrued Income Receivable Pxx Accrued Interest Receivable xx Ending Balance of Unearned Income xx xx Less: Beginning Balances of: Unearned Interest and Discounts xx Advance Rentals on Bank Premises/Safety Deposit Box/Equipment xx Ending Balances of: Accrued Interest Receivable-Local xx Accrued Interest Receivable-Foreign xx xx Gross Receipts Pxx Less: Tax Exempt Income: Equity in Net Income of Subsidiaries Pxx Unrealized Income xx Gross Income outside the Philippines xx Dividends from Domestic Corporations xx xx Taxable Gross Receipts Pxx Less: Gross Receipts Subjected to GRT xx Gross Receipts Still Subject to GRT Pxx ==== 2.4 Test-check whether gross receipt tax rates applied on the interest payments received were adjusted when remaining maturities change, as in the case of pre-terminated loans. 2.5 Request for copies of the quarterly percentage tax returns and the working papers prepared by the taxpayer showing the items of gross receipts and the computation of the gross receipts tax paid. Compare gross receipts tax due per audit with the gross receipts tax payments during the year. 2.6 Compute the corresponding GRT due on items of additional taxable gross receipts discovered during the audit which cannot be justified or refuted by the taxpayer. D. DOCUMENTARY STAMPS TAX 1. Ascertain whether all issued documents on transactions covered under Title VII of the Tax Code have been subjected to the payment of the documentary stamp taxes (DST) at prescribed rates. 1.1 Analyze the transactions that are subject to DST. The account used by banks to record transactions subject to DST must be determined with emphasis on the nature of transactions and not on the accounts used. (e.g. trust certificate, deposit substitute, special savings in lieu of time deposit, reverse repurchase agreements [RRPs], etc.). After eliminating adjustments and correcting entries, these accounts can be used in computing the banks' DST liabilities. Refer to BSP-prescribed chart of accounts in identifying these taxable transactions. 1.1.1 Test-check accuracy of amounts of loans extended. 1.1.2 Check whether the DST on inter-bank call loans were paid. 1.1.2.1 Ascertain the maturity periods of Inter-bank Call Loans to determine whether the DST shall be imposed, as follows: if maturity is < 5days exempt from DST if maturity is > 5days subject to DST 1.1.3 Verify the accuracy of DST payments on acceptances and/or payments of bills of exchange (domestic or foreign) by performing the following steps: 1.1.3.1 Test check copies of acceptances or bills of exchange on file; 1.1.3.2 Trace the information on the drafts or documents received with the entries in the ledger account. 1.1.3.3 Sum up total amount arising from these transactions and compute for the prescribed DST. 1.1.4 On letters of credit issued, determine the total amount of letters of credit issued during the year from the general ledger. Determine whether the correct DSTs were paid thereon. 1.1.5 Check whether the correct DSTs were paid for certificates of deposits, including savings deposits with specific maturity dates. 1.1.5.1 Sum up all general ledger credit postings to these deposit accounts. 1.1.5.2 Test-check existence of adjustments to these accounts to determine propriety of the transactions. 1.1.5.3 Compute the appropriate amount of DST due on these issued certificates. 1.1.6 Verify completeness and accuracy of amounts of all loans extend, if monthly reports for loan releases, renewals, restructuring, and extensions are available. 1.1.6.1 Test-check loan ledgers and match the loan details reflected thereat with the data or information appearing in the loan documents. 1.1.6.2 Examine on a test-basis the documents in support of loans such as loan agreements, promissory notes, hold-out agreements, sureties, deeds of real estate mortgage, deeds of chattel mortgage, etc. 1.1.6.3 Sum up all the debts in the general ledgers of the loan accounts and deduct therefrom all valid adjustments. These loan accounts may include, among others, loans and discounts, bills purchased, customers' liability on bill, etc. Account for any discrepancy noted and determine the implication of discovered discrepancy on its DST liability. 1.1.6.4 Compute the correct DST due on the loan documents issued for these loan accounts. 1.1.7 Determine whether there are additional subscriptions of capital stocks and/or declarations of stock dividends during the taxable year. Check whether the appropriate DSTs were paid on issued stock certificates or subscribed capital stock in accordance with existing rules and regulations. 2. Summarize all payments of DST made by the head office and all the branches based on BIR Form Nos. 2000/2002 filed during the year. Compare the total amount of DST due as ascertained per audit with the total amount of DST paid during the year. Account for any discrepancy noted and compute for the corresponding deficiency DST assessment. 3. Check whether all payments of DSTs were made on time in accordance with existing laws and regulations. E. WITHHOLDING TAX E.1 General Audit Procedures In order to ascertain whether taxes on all income payments subject to withholding tax have been properly withheld and remitted, the following audit procedures may be performed: 1. Reconcile the information from records of the head office and branches as reflected in the withholding tax returns and alpha list of recipients of income payments duly filed with the BIR against the expenses subject to withholding tax shown in the audited financial statements and income tax returns. 2. Prepare an analysis of all withholding taxes (compensation, creditable at source, and final) withheld and remitted. E.2 Specific Audit Procedures 1. Withholding Tax on Compensation 1.1 Test-check the accuracy of computation of withholding taxes on employees with annual salaries of over P200,000.00 on the basis of monthly payroll registers. Ascertain that corresponding taxes withheld have been remitted. 1.2 Determine whether the prescribed taxes have been withheld from employees' fringe benefits, allowances, and other emoluments. 1.3 Reconcile summary of payments of salaries, wages, etc. to employees with the amounts appearing in the alphabetical list of employees from whom taxes were withheld during the year. 1.4 Determine deficiency withholding tax due for differences noted which the taxpayer cannot satisfactorily explain or justify . 2. Expanded Withholding Tax 2.1 Account for all expenses subject to expanded withholding taxes. Take note of expenses which were directly offset against income accounts. Include such amount to determine the correct basis in the computation of taxes withheld. 2.2 Compute for the expanded withholding taxes due on these income payments and reconcile the same with the amount actually withheld and remitted to the BIR. 3. Final Withholding Tax 3.1 Ascertain the existence of income payments to residents and non-residents that are subject to final withholding taxes. In general, the following income payments are subject to final withholding taxes: a. Interest on any currency bank deposit and yield or any other monetary benefit from deposit substitute and from trust fund and similar arrangements; b. Interest paid under the expanded foreign currency deposit system; c. Interest on foreign currency loans granted by FCDUs; d. Income payments to depository banks arising from foreign currency transactions under the expanded foreign currency deposit system; e. Capital gains realized from sale, exchange, or other disposition of real properties located in the Philippines classified as capital assets; f. Income payments from foreign currency transactions, whenever applicable, depending upon the agreement between the bank and the borrower; g. Branch profit remittances, if any; and h. Dividends, rents, royalties, etc., whenever applicable. 3.2 Review pertinent contracts relative to these income payments to ascertain the correct tax base and their respective due dates for payments/remittances. 3.3 Check the provisions of existing laws and regulations to establish the taxability of the transactions and determine the applicable tax rates (e.g., codal provision on taxable items and tax rates, tax treaty provisions, special law granting tax exemption, etc.). 3.4 Reconcile all income payments subject to final withholding taxes with the amount of actual payments as reflected in the pertinent accounts in the audited financial statements such as interest expense, royalties, dividend declarations, etc. Segregate taxable and exempt transactions for purposes of determining the correct taxable base. 3.5 Determine if there are any income payments to residents and non-residents not subjected to final withholding taxes (e.g. branch profit remittances, interests, dividends, royalties, etc.), taking into account the existence of special laws affecting the tax treatment of these income payments, the applicable tax treaty provisions, if any, and such other circumstances that may affect the taxability of the transactions. 3.6 Check the accuracy of computation of withholding taxes due on interest payments subject to 20%, 10%, and 7.5% final taxes as well as all other payments subject to final withholding tax at source. Determine whether there are cases of under-withholding of final tax. 3.7 Ascertain whether the final taxes withheld at source were remitted on time. F. MANDATORY REPORTING REQUIREMENTS For consistency and uniformity, the following records and documents comprise the check-list of mandatory reporting requirements to be attached to dockets on the audit of taxpayers in the banking industry. 1. General Requirements 1.1 Letter of Authority/Audit Notice: 1.2 Audited financial statements; 1.3 Narrative Memorandum Report; 1.4 Revenue Officers Audit Reports (BIR Form 1717/0500 Series); 1.5 Revenue Officers Activity Report/Log Sheet; 1.6 Agreement Form (on tax assessments not objected to by the taxpayer); 1.7 Notice for an Informal Conference/Post Reporting Notice with Summary of Findings (for assessments objected to or protested by the taxpayer at the RDO level); 1.8 Proof of payment of deficiency tax, if any/applicable; 1) current year/period 2) previous year/period 1.9 Comparative Report of Deficiency Tax Paid/Assessed, if applicable; 1) current year/period 2) previous year/period 1.10 Delinquency Verification Report (for Claims for Tax Credit/Refund); 1.11 Table of Contents 1.12 Docket Locator Number (DLN) 2. Specific Requirements per Tax Type 2.1 Income Tax 2.1.1 Duly validated Income Tax Returns of RBU and FCDU, (BIR Form No. 1702) whenever applicable, together with all the required attachments [Official Receipt, Account Information Form (BIR Form No. 1720AIF-1), Schedule of Taxes and Licenses, Schedule of Income-Producing Properties, Schedule of Depreciation]; 2.1.2 Audited financial statements including comparative Profit and Loss Statement duly filed with the BIR; 2.1.3 Quarterly Income Tax Returns (BIR Form No. 1702Q); 2.1.4 Photo copy of Tax Debit Memo (TDM) issued by the BIR in payment of taxes, if applicable, including photo copy of utilized Tax Credit Certificate (TCC) with annotation of issued TDM at the back thereof; 2.1.5 BSP approval of Bad Debts written off; 2.1.6 Schedule of Bad Debts, if applicable; 2.1.7 Schedule of Miscellaneous Income, if applicable; 2.1.8 Reconciliation of "Book Income" and "Taxable Income"; 2.1.9 Copies of reports submitted to applicable regulatory agencies that reflect the financial condition and results of operation of the taxpayer such as the Statement of Condition and Statement of Income and Expenses required to be filed with the Bangko Sentral ng Pilipinas; 2.1.10 Working papers on selected accounts related to the findings on investigation duly signed by the investigating Revenue Officer(s); 2.1.11 Working Papers showing computation of income taxes due duly signed by the Investigating Officer(s); 2.1.12 Certificate of Creditable Taxes Withheld at Source (BIR Form 2307) issued by Payors of Income, if applicable. 2.2 Withholding Taxes 2.2.1 Duly validated Monthly Remittance Return of Income Taxes Withheld (BIR Form No. 1601); 2.2.2 Duly validated Quarterly Remittance Return of Final taxes Withheld (for Interest Paid on Depository and Yield on Deposit Substitutes/Trusts/Etc.) (BIR Form No. 1602) and Quarterly Remittance Return of Income Taxes Withheld (on Fringe Benefits Paid to Employees Other Than Rank and File) (BIR Form No. 1603); 2.2.3 Annual Information Return of Income Tax Withheld on Compensation, Expanded and Final Withholding Taxes (BIR Form No. 1604) together with the required Alpha List of Income Recipients from whom taxes were withheld duly filed with the BIR; 2.2.4 Reconciliation of the Financial Statements' figures with the Withholding Tax Returns' and Information Returns' figures; 2.2.5 Photo copy of Official Receipts issued by AABs, Collection Agents or deputized municipal treasurer in payment of withholding tax, if applicable; and 2.2.6 Working papers showing computation of withholding taxes due duly signed by the investigating Revenue Officer(s). 2.3 Other Percentage Tax (Gross Receipts Tax) 2.3.1 Duly Validated Quarterly Percentage Tax Return (BIR Form No. 2551) and Quarterly Percentage Tax Return (BIR Form No. 2552) with Official Receipts for transactions involving shares of stocks listed and traded through the Local Stock Exchange or through Initial and/or Secondary Public Offering), including all the attachments thereto; 2.3.2 Proof of claimed tax credits, if applicable. 2.3.3 Photo copy of Tax Debit Memo (TDM) issued by the BIR in payment of taxes, if applicable, including photo copy of utilized Tax Credit Certificate (TCC) with annotation of issued TDM at the back thereof; 2.3.4 Working papers showing the computation of the taxable receipts/sales (tax base) and percentage taxes due duly signed by the investigating Revenue Officers; and 2.3.5 Reconciliation of Financial Statements' figures and Percentage Tax Returns' figures. 2.4 Documentary Stamp Tax 2.4.1 Duly filed Monthly Documentary Stamp Tax Declaration/Return (BIR Form No. 2000) and corresponding Official Receipts; 2.4.2 Duly filed Corporate Stock Documentary Stamp Tax (DST) Declaration for Existing Corporation as of February 28, 1998 (BIR Form No. 2000-A) with corresponding Official Receipts; 2.4.3 Duly filed Corporate Stock Documentary Stamp tax (DST) Declaration for New Corporation (BIR Form No. 2000B) with corresponding Official Receipts; 2.4.4 Duly filed Information Return for Documentary Stamp taxes Paid (BIR Form No. 2002); 2.4.5 Duly filed Corporate Stock Documentary Stamp Tax (DST) Declaration for Existing Corporations on Additional Stock Authorization and New Subscription (BIR Form No. 2000-C); 2.4.6 Photo copy of Tax Debit Memo (TDM) issued by the BIR payment of taxes, if applicable, including photo copy of utilized Tax Credit Certificate (TCC) with annotation of issued TDM at the back thereof; 2.4.7 Working papers showing details and computation of correct tax base duly signed by the investigating Revenue Officer(s); and 2.4.8 Working papers showing computation of documentary stamp taxes due duly signed by the investigating Revenue Officer(s). PRO-FORMA FINANCIAL STATEMENTS OF A COMMERCIAL BANK 1] ABC BANKING CORPORATION BALANCE SHEET AS OF _____________________ A S S E T S Cash on Hand Pxxx Checks and Other Cash Items xxx Due from Bangko Sentral ng Pilipinas xxx 2] Due from Local Banks xxx 2] Interbank Loans Receivable xxx Loans and Discounts: Demand Loans - Clean Pxxx - Secured xxx Bills Discounted xxx Time Loans - Clean xxx - Secured xxx - Home Insurance Guaranty Corporation xxx Past Due xxx Items in Litigation xxx Total Pxxx Less: Allowance for Probable Losses xxx xxx Agrarian Reform and Other Agricultural Credit Loans: Other Agricultural Credit Loans Pxxx Past Due xxx Items in Litigation xxx Total Pxxx Less: allowance for Probable Losses xxx xxx Bills Purchased: Export Bills Purchased Pxxx Domestic Bills Purchased-Clean xxx Foreign Bills Purchased-Clean xxx Past Due xxx Items in Litigation xxx Total Pxxx Less: Allowance for Probable Losses xxx xxx Customers' Liability on Bills/Drafts under Letters of Credit Trust Receipts: Customer's Liabilities - Inward Bills Foreign Currency Pxxx - Inward Bills-Trust Receipts xxx - Domestic Bills Trust Receipts xxx Past Due - Import Bills and Acceptances xxx Items in Litigation xxx Total Pxxx Less: Allowance for Probable Losses xxx xxx Customers' Liability for Bank's Acceptances Outstanding Restructured Loans: Restructured Loans Pxxx Past Due xxx Items in Litigation xxx Total Pxxx Less: Allowance for Probable Losses xxx xxx Development Incentive Loan xxx Underwriting Accounts xxx 3] Trading Accounts - Loans xxx - Investments xxx Investment in Bonds and Other Debt Instruments xxx Equity Investments xxx 2] Due from Head Office/Branches/Agencies xxx 2] Bank Premises, Furnitures and Fixtures Bank Premises - Building Pxxx Less: Accumulated Depreciation xxx Pxxx Leasehold Rights and Improvements xxx Furniture, Fixtures and Equipment Pxxx Less: Accumulated Depreciation xxx xxx xxx Real and Other Properties Owned and Acquired xxx 3] Bond Sinking Fund xxx 3] Other Assets: Petty Cash Fund Pxxx Foreign Currency Notes and Coins on Hand xxx Returned Checks and Other Cash Items xxx Miscellaneous Checks and Other Check Items xxx Accounts Receivable Pxxx Less: Allowance for Probable Losses - Accounts Receivable xxx xxx Accounts Receivable - Loans and Discounts Pxxx Less: Allowance for Probable Losses - Accounts Receivable- Loans and Discounts xxx xxx Accrued Interest Receivable xxx Documentary Stamps xxx Postage Stamp xxx Stationery and Supplies-Unissued Accountable Forms xxx Prepaid Expenses xxx Deferred Charges xxx Shortages xxx 2] Other Investments xxx Miscellaneous Assets xxx Sundry Debits xxx xxx TOTAL ASSETS Pxxx === LIABILITIES AND CAPITAL Deposit Liabilities: Demand Pxxx Savings xxx Time Certificates of Deposit xxx Pxxx Time Certificate of Deposit-Special Financing xxx Due to Foreign Currency Deposit Unit xxx Treasurer's/Cashier's/Manager's and Gift Checks: Manager's Check Pxxx Gift Checks xxx xxx Bills Payable: Bangko Sentral ng Pilipinas Pxxx Others xxx xxx Bonds Payable xxx Payables for Securities Purchased xxx 3] Marginal Deposits: Import Liabilities and Capital Pxxx Import Liabilities Capital-Exempted Items xxx Domestic Liabilities and Capital xxx Customers' Liability-Draft on Inward Bills/Trust Receipts xxx Due to the Treasurer of the Philippines xxx Due to Foreign Banks (Local Currency) xxx Due to Philippine Crop Insurance Corporation xxx Accrued Interest, taxes and Other Expenses: Other taxes and Licenses Payable Pxxx Interest Payable xxx Other Expenses Payable xxx xxx Outstanding Acceptances Executed By Or For Account of this Bank xxx Unearned Income and Other Deferred Credits xxx Other Liabilities: Advance Rentals on Safety Deposit Boxes Pxxx Other Deferred Credits xxx Accounts Payable xxx Accounts Payable-Loans and Discounts xxx Overages xxx 2] Withholding Taxes Payable xxx Deposits for Keys on Safety Deposit Boxes xxx Miscellaneous Liabilities xxx Other Credits-Dormant xxx Other Credits-Unclaimed Balances xxx Sundry Credits xxx xxx TOTAL LIABILITIES Pxxx Capital Stock Preferred Capital Stock-Subscribed Pxxx Preferred Capital Stock-Subscriptions Receivable xxx Preferred Capital Stock-Paid-in xxx Common Capital Stock-Subscribed xxx Common Capital Stock-Subscriptions Receivable xxx Common Capital Stock-Paid in xxx Stocks Dividends Distributable xxx Pxxx 4] Surplus Balance at beginning of year Pxxx Transfer from undivided profits xxx Less: Transfer to surplus reserve Pxxx Cash dividends: Preferred Pxxx Common xxx xxx xxx Balance at end of year xxx Surplus Reserves Reserve for Trust Business Pxxx Reserve for Self-Insurance xxx Reserve for Contingencies xxx Other Surplus Reserves xxx xxx Undivided Profits-Regular banking Unit Balance at beginning of year Pxxx Add/(Deduct): Net Income/Loss During the Year xxx Total Pxxx Less: Transfer to Surplus xxx Balance at end of year xxx Undivided profits-Foreign Currency Deposit Unit/Expanded Foreign Currency Deposit Unit Balance at beginning of year Pxxx Add/(Deduct): Net Income/Loss During the Year xxx Total Pxxx Less: Transfer to Surplus xxx Balance at end of year xxx Appraisal Increment Reserve xxx TOTAL CAPITAL Pxxx TOTAL LIABILITIES AND CAPITAL Pxxx === CONTINGENT ACCOUNTS Unused Commercial Letters of Credit: Domestic Letters of Credit Outstanding (Sight and Usance) Pxxx Sight Import Letters of Credit Outstanding xxx Sight Import Letters of Credit Outstanding-Cash xxx Usance Import Letters of Credit Outstanding xxx Stand-by Letters of Credit Domestic xxx Pxxx Outward Bills for Collections: Foreign Pxxx Domestic xxx xxx Committed Credit Line for Commercial Paper Issues xxx Items Held for Safekeeping/Custodianship xxx Other Contingent Accounts: Inward Bills for Collection Pxxx Spot Exchange Bought xxx Spot Exchange Sold xxx Forward (Future) Exchange Bought xxx Forward (Future) Exchange Sold xxx Forward Rate Agreement Bought xxx Forward Rate Agreement Sold xxx Financial Options Bought xxx Financial Options Sold xxx Financial Futures Bought xxx Financial Futures Sold xxx Interest Rate Swap Receivable xxx Interest Rate Swap Payable xxx Trust Department Accounts xxx Underwriting Accounts Unsold xxx Deficiency Claims Receivable xxx Outstanding Guarantees Issued xxx Securities Held as Collateral xxx Travellers Checks Unsold xxx Late Deposits/Payments Received xxx Miscellaneous Contingent Account xxx Miscellaneous Contingent Account-Foreign Currency xxx xxx TOTAL CONTINGENT ACCOUNTS Pxxx === OTHER INFORMATION: Trust Generated Funds Pxxx === NOTES: 1] This is only a pro-forma financial statement of a commercial bank and this statement varies from one bank to another depending on the type of the bank's operations. 2] Classification as asset or liability account depends on balance as of the end of the year. 3] Applicable to EKBs. 4] Branches of foreign banks use Assigned Capital account in lieu of Capital Stock account. EXHIBIT 1 ABC BANKING CORPORATION STATEMENT OF INCOME AND EXPENSES FOR THE PERIOD ENDED _____________ OPERATING INCOME: Interest Income: Loans and Discounts Discounts Earned Pxxx Demand Loans xxx Time Loans xxx Time Loans-Home Insurance Guaranty Corporation xxx Pxxx Temporary Overdrawings xxx Restructured Loans xxx Agrarian Reform/Agricultural Credit Loans xxx Bills Purchased xxx Import and Domestic Bills under Letter of Credits/Trust Receipts Pxxx Past Due/items in Litigation xxx Deposit in Local banks xxx xxx Pxxx Bank Commissions: On Collection Pxxx On Letter of Credits xxx Miscellaneous xxx xxx Service Charges/Fees: Loans and Discounts Pxxx Others xxx xxx Trading Gain/Loss - Government Securities Pxxx - Gold xxx xxx Profit/(Loss) on Sale or Redemption of Investments xxx Foreign Exchange Profit/(Loss) xxx Income/(Loss) - Trust Department xxx Other Income: Rental on Safety Deposit Boxes Pxxx Recovery on Charged-Off Assets xxx Miscellaneous Income/(Loss) xxx Miscellaneous Income-Dividend Received xxx xxx TOTAL OPERATING INCOME Pxxx OPERATING EXPENSES: Interest on Deposits: Savings Pxxx Time Certificates xxx Bonus Savings xxx Pxxx Interest on Bills Payable: Bangko Sentral ng Pilipinas Pxxx Others xxx xxx Interest - Others xxx Finance Charges xxx Compensation/Fringe Benefits: Salaries and Wages-Regular Pxxx Overtime xxx Premium and Holiday Pay xxx Fringe Benefits-Education and Training xxx - Others (Taxable) xxx - Others (Non-Taxable) xxx SSS, Medicare and Employees' Compensation Premium-Bank's Share xxx Medical, Dental and Hospitalization xxx Bank's Contribution - Retirement/Provident Fund xxx - Back Service Liability xxx xxx Management and Other Professional Fees xxx Supervision and Examination Fees xxx Fines, Penalties and Other Charges xxx Taxes and Licenses xxx Insurance: Philippine Deposit Insurance Company Pxxx Others xxx xxx Depreciation/Amortization: Depreciation-Bank Premises xxx Furnitures, Fixtures and Equipment xxx Amortization-Leasehold Rights and Improvements xxx xxx Litigation/Assets Acquired Expenses xxx Bad Debts Written Off xxx Provisions for Probable Losses Pxxx Provisions for Year-End Expenses xxx xxx Other Expenses: Rent Pxxx Power, Light and Water xxx Fuel and Lubricants xxx Travelling Expenses xxx Repairs and Maintenance xxx Security, Messengerial and Janitorial Services xxx Postage, Telephone, Cables and Telegrams xxx Freight Expenses xxx Documentary Stamps Used xxx Stationery and Supplies Used xxx Periodicals and Magazines xxx Advertising and Publicity xxx Representation and Entertainment xxx Membership Fees and Dues xxx Donations and Contributions - Charitable xxx - Others xxx Miscellaneous-Athletic and Cultural Expenses xxx Clearing and Processing Fees xxx Miscellaneous Expense xxx xxx TOTAL OPERATING EXPENSES xxx NET OPERATING INCOME/LOSS Pxxx ADD/(DEDUCT) EXTRA ORDINARY CREDITS/CHARGES xxx NET INCOME DURING THE YEAR Pxxx ====